Many defined contribution plans pay benefits as a lump sum, putting retirees' lifetime income security at risk. Longevity income annuities address this concern.
Summary
Longevity income annuities (LIAs), whose payouts begin no later than age 85 and continue for life, provide an effective way to hedge longevity risk for a relatively low price. The authors of this paper build a life cycle portfolio framework for evaluating the welfare improvements of including LIAs in defined contribution retirement plans. Their model accounts for uncertain capital market returns, labor income streams, mortality, taxes, Social Security benefits, and 401(k) plan rules.
Key Insights
- Women and men both can expect to benefit from LIAs, as can the less-educated and lower-paid subpopulations.
- LIAs are most beneficial to plan participants who optimally commit 8% to 15% of their plan balances at age 65 to an LIA that starts payments at age 85.
- Plan sponsors can integrate LIAs as defaults in their plans by converting as little as 10% to 15% of retiree plan assets.
