Why aren't annuities more popular 401(k) distribution options?

Jul. 12, 2011 2:44 PM ET
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We are the employees of Smart401k. Contributions to Seeking Alpha come from our investment advisers, our president and CEO, our vice president and our financial communications specialists. Smart401k is a web-based investment adviser providing unbiased investment recommendations for employees participating in employer-sponsored retirement plans. We provide personalized investment advice based on the funds in an individual's plan and that person's unique financial situation. We're online at www.smart401k.com.

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Richard Thaler’s recent article The Annuity Puzzle hypothesizes about the reasons for low utilization of annuity products as 401(k) distribution vehicles.

In working through the sample participants in The New York Times piece, many people would agree that the certainty and simplicity of pension payout – on the surface – seems to be a superior option compared with the uncertainty and complexity of the typical distribution options available in a typical 401(k) plan.

So why don’t participants annuitize their 401(k) balances more often at retirement?

According to Thaler, three of the main reasons are:
 

(1) People perceive buying an annuity is bad for their heirs,

 

(2) People view buying an annuity as a gamble, in which they have to live a certain number of years to ‘break even,’

 

(3) There is a complicated “shopping” process, with your life savings at stake.

While I don’t disagree with any of the items on the list, I would add another one:  bad reputation. The word annuity carries negative connotations. Two that come to mind are high expenses and restrictive contracts.  People seem to be more willing to accept the fees and risks associated with investing in the market than the risk that, were they hit with a hardship, they could not access their retirement assets.

What do you think? What other reasons do you believe help explain why participants aren’t more eager to purchase annuity products to provide their paycheck in retirement?

Scott Swezy
Vice President, Smart401k

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