Simulation Analysis of the Decision to Annuitize Pension Balances∗

Prior studies of life annuities that use classical dynamic programming methods to solve for annuity decisions find large gains from annuitization. The fact that few people actually buy annuities leads to an “annuity puzzle.” An alternative method of analysis, which uses concepts from approximate dynamic programming and samples of life histories from a pension simulation model, is shown to produce findings similar to those of prior studies. The alternative method is used to estimate the extent to which being married and having other retirement income reduces the gains from annuitization. The gain-reducing effects of annuity loading factors, loss aversion, and changing consumption needs are also estimated. Preliminary Draft Not For Quotation ∗The research reported in this paper was funded by the Employee Benefits Security Administration under Department of Labor contract J-9-P-2-0031, which supports the development and use of PENSIM for simulation analysis of employer-sponsored pensions. The views expressed in the paper are solely those of the author and do not necessarily represent the views of the Employee Benefits Security Administration. †Economist, Policy Simulation Group ([email protected]). The author thanks Asa Janney for extensive assistance in developing PENSIM and in conducting this analysis.