The Annuity Puzzle Remains a Puzzle
32 Pages Posted: 19 Feb 2009 Last revised: 9 Mar 2016
Date Written: February 7, 2011
We examine incomplete annuity menus and background risk as possible drivers of divergence from full annuitization. Contrary to what is often suggested in the literature, we find that full annuitization remains optimal if saving is possible after retirement. This holds irrespective of whether real or only nominal annuities are available. Whenever liquidity is desired, individuals save sizeable amounts out of their annuity income to smooth consumption shocks. Similarly, adding variable annuities to the menu does not increase welfare significantly, since individuals can save in order to get the desired equity exposure. We calculate bounds on a possible bequest motive and default risk of the annuity provider and find that for realistic parameters full annuitization remains optimal.
Keywords: Asset allocation, retirement, life-cycle portfolio choice, annuity, savings
JEL Classification: D14, D91, G11
Suggested Citation: Suggested Citation