The Effect of Longevity Annuity Price Changes on Retirement Income

June 22, 2011 (PLANSPONSOR.com) - As the price of a longevity annuity increases, and as longevity risk grows, more initial retirement wealth is needed and the degree of annuitization needs to be increased—especially to achieve a 90% chance of adequacy, according to a report from the Employee Benefit Research Institute (EBRI).

However, the report also concluded, the optimal degree of annuitization with a longevity annuity depends on how much an individual’s retirement portfolio is invested in equities. For example, considering an increase in the price of a longevity annuity, among the lowest-income group analyzed, the optimal annuitization is decreased from 22% − 32% to 18% − 28% across different equity allocations of 5% − 95%.  

According to the June 2011 EBRI Notes, conversely, a decrease in the price of a longevity annuity requires less initial retirement wealth because of a positive income effect (the less the cost, the more the income). In addition, the decreased annuity price appears to increase an optimal degree of annuitization, because the longevity annuity becomes relatively less expensive in the retiree’s portfolio. For example, the optimal annuitization is slightly increased from 22% − 32% to 22% − 34% across different equity allocations of 5% − 95%.  

Findings were similar for those in the highest-income category.  

Regarding how greater longevity risk affects retirement income adequacy, the analysis shows that, in order to achieve a 90% chance of income adequacy, the retiree needs more initial retirement wealth for a given degree of annuitization, and an optimal degree of annuitization is increased because of the longer expected lifetime.   

In addition, assuming greater longevity risk, results show that annuitization with immediate or longevity annuities appears to be more effective at saving more initial retirement wealth for a desired level of retirement income adequacy, compared with no annuitization. Annuitization results are very similar for both the lowest- and highest-income categories.  

This research is a followup from research in May that analyzed the effects of factoring in long-term care in the immediate or longevity annuity decision (see EBRI Analyzes Retirement Income Adequacy of Annuities).  

The June 2011 EBRI Notes can be found at http://www.ebri.org.

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