Annuity Puzzle: how products are designed matters
By Eduardo Rodríguez Montemayor
PPI’s Editorial Board
editorial@pensionpolicy.net
Getting an annuity with our savings pot at the time of retirement is the only contract that
guarantees periodic pension payments for life. Yet, few people do it when offered to option to do
so. What explains this puzzle?
An annuity is a financial contract that pays out a periodic amount for as long as the annuitant is alive, in
exchange for an initial premium.
Defined-contribution (DC) pension schemes usually make it voluntary to choose whether to buy an annuity
or not at the time of retirement with the assets accumulated in our individual pension funds. The expansion
of DC schemes worldwide makes this decision increasingly important for more people. What we observe is
that many people choose not to annuitize and rather withdraw the whole retirement pot at once (or in
few installments).
This is often referred to as the ‘annuity puzzle’ because economic theory suggests that annuitizing a portion
of wealth is convenient for people. Annuities overcome longevity risk, i.e. the risk of outliving one’s assets.
In addition, they can make life easier to retirees by avoiding complex decisions.
