Private Pensions, Mortality Risk, and the Decision to Annuitize

This paper examines household decisions about whether or not to annuitize retirement resources. A lifecycle model of consumption, implemented with the use of dynamic programming techniques, is used to construct a utility-based measure of annuity value for individuals and couples in the Health and Retirement Survey. Variation in the calculated “annuity equivalent wealth” arises from differences in mortality risk, marital status, risk aversion, and the presence of pre-existing annuities such as Social Security. I find that a one-percentage point increase in the annuity equivalent wealth leads to nearly a one-percentage point increase in the ex ante probability of annuitizing balances in defined contribution pension plans. However, because much of the variation in the expected annuity decision is left unexplained by the life-cycle model, other factors are also analyzed. Health status and an individual’s time horizon for financial decision making are significant determinants of the decision. There is no evidence that bequest motives are an important factor in making marginal annuity decisions. _____________________________________________________________________________________________ I thank Courtney Coile, Peter Diamond, Bill Even, Jon Gruber, Jerry Hausman, Olivia Mitchell, Sendhil Mullainathan, Mark Warshawsky, Scott Weisbenner, and especially James Poterba for helpful discussions. Helpful comments were also received from seminar participants at the 1999 ARIA meetings, Georgia State University, Harvard University, the Kennedy School, Miami University, University of Maryland, University of Michigan, MIT, TIAA-CREF, and Williams College. Financial support from the National Science Foundation and the Aging Program of the National Bureau of Economic Research / National Institute on Aging is gratefully acknowledged. Address: Harvard University, 79 JFK Street, Cambridge, MA 02138. Ph: 617-495-1648. Fax 617-496-7301 Email: [email protected] JEL Classification: H55, J14, G22, G23