The Annuitization of Your Retirement Savings

The annuitization of your retirement savings should be a simple matter! In practice, however, very few people buy annuities at retirement.

In 1965 a guy by the name of Yaari wrote a paper in which he argued that you should put all of your retirement savings into an annuity at retirement. Seeing that you don't know how long you're going to live, your options are limited to investing in a form of a retirement fund or in some type of annuity. In his paper he argued that by buying an annuity you lock in a higher retirement income compared to an alternative investment. In short: those people who pass away early effectively subsidize those that live longer. So, an annuity gives you an increased income while it eliminates risk.

So, why don't they? Why do most retirees cash out their retirement savings rather than buying an annuity?

A working paper by Shlomo Benartzi, Alessandro Previtero and Richard H. Thaler - published in October 2011 - puts it like this:

“One simple reason is that many people simply have not saved up enough to make buying an annuity a viable option, especially since it is sensible to have an emergency fund that is liquid. The sizable portion of households with little or no wealth at retirement are in essence completely annuitized since their only source of income is social security.”

So, what have I done? What's my experience?

Well, I cashed out as soon as it was legally possible to cash out without penalties. That was many years ago. Frankly, I can't remember why I decided to do this. I can't recall that I needed the cash. I think I thought at the time that I could do better investing the funds myself than the return I could expect from an annuity.

I think I am wiser today. Or rather, I know better today. The notion that I, or for that matter you, can do better is a fallacy!

For many years I have advised friends and colleagues to buy annuities. Especially Swiss annuities. For a separate page on Swiss annuities, please click here.

Buying an annuity with your retirement savings will almost certainly increase your spendable monthly retirement income, it will eliminate uncertainty, it will settle once and for all how much you can and should draw every month, and will clearly indicate to you when you can start retirement!

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