CHICAGO — While income annuities are the most cost-effective way to provide income at retirement, investors are reluctant to purchase them, according to a new study.
Consumers aren’t annuitizing enough of their portfolios, according to the study, which was released Aug. 14 by the Wharton Financial Institutions Center at the University of Pennsylvania in Philadelphia and New York Life Insurance Co. Inc.
In addition to paying investors a return on their investment, income annuities are designed to pay them a portion of the original principal with each payment.
As a result, buyers are guaranteed a permanent stream of income, which they wouldn’t get if they put their nest egg in a traditional portfolio of stocks and bonds.
How much is enough?
The study,
“Investing Your Lump Sum at Retirement,” concludes that individuals should annuitize 50% to 70% of their assets, and in some cases, up to 80%, said David F. Babbel, a fellow at the Wharton Financial Institutions Center and a professor emeritus of insurance, risk management and finance at the University of Pennsylvania. He is the co-author of the study.
“When you treat an annuity as another asset class, the risk and return characteristics are so attractive that you end up using a good portion of the rest of your assets devoted to annuitization,” Mr. Babbel said.
When investors put a significant chunk of their nest egg into an annuity, they can afford to be fairly aggressive with their remaining assets, he said.
Maybe so, but annuities — especially variable annuities — have experienced a torrent of bad publicity in recent years.
Much of that publicity involved fees, as well as withdrawal charges.
“The things that had been criticized in literature have been addressed by innovation,” Mr. Babbel said.
“You still have the psychology issues,” he said. “Insurance companies can’t change the psychology.”
One of those issues is the fact that people don’t like giving up control of their money, said Mike Gallo, senior vice president at New York Life, which sells annuities. “A lot of products today have flexibility and control features, so they’re not losing total control and can get access to money if they need it.”
Lingering concerns
Another issue involves concerns about not leaving an inheritance for children, Mr. Gallo said. With products available today, death benefits are available,
he added.
Another reason people don’t annuitize is because they think that over the long haul, stocks exceed the performance of annuities, according to the study. But the study showed that annuities often perform well.
The market for life annuities has become “very competitive in recent years,” according to the study. The price tag for annuities has also dropped, the study showed.
There is no question that income annuities are cost-effective, said Doug McIntosh Jr., vice president of institutional income consulting with
Prudential Financial Inc. in Newark, N.J., which also sells annuities.
But if investors still don’t embrace these products, the industry may need to consider an alternative, he said.
“If I can’t get a pre-retiree to use a certain vehicle, it won’t do them any good,” Mr. McIntosh said. “Then the question is, are we delivering the most effective vehicle?”
Of course, an annuity may not be right for everybody.
“If you are unhealthy at 65 and have low prospects to regain your health, an annuity purchase may not be the way to go,” according to the study.
