Don’t Run Out of Money: Why Annuities Matter

Running out of money in retirement is a major concern for many American workers.

The phenomenon is dubbed longevity risk because of the potential danger of exhausting one’s assets before death. A core objective of any retirement plan should be to provide lifetime income insurance in the form of an annuity, which provides pension benefit installments over the remainder of an individual’s life, rather than allowing benefits to be distributed as a lump sum.

While annuities better ensure that individuals will not exhaust their retirement assets, retirees tend to be wary of them.

Here are three reasons why:

  1. People care about fairness. According to a new paper, survey respondents were less likely to see annuities positively when asked whether it is fair for the insurance company to keep any remaining funds once a person dies.
  2. People are confused by them, as each comes with its own complicated tax rules and implications.
  3. People hate fees.

Fortunately, city leaders can help quell these fears by educating employees about their options.

According to the Bureau of Labor Statistics’ National Compensation Survey, approximately 57 percent of local government employees have access to a money purchase plan with an annuity option. In a money purchase pension plan, employers make fixed contributions, typically calculated as a percent of employee earnings, and allocate them to individual employee accounts each year. This type of plan is a defined contribution (DC) plan, which places the investment risk/reward completely on the employee. And over 90 percent of local government employees have access to a traditional defined benefit (DB) plan, with some type of annuity option once employees meet retirement eligibility.

Here’s a crash course on options:

  1. Straight-life annuity– For single employees, this provides a monthly payment based on a given plan formula.
  2. Fifty percent joint-and-survivor annuity– For married employees, this provides a “joint” benefit to the retiree and spouse while they are both alive, and half that amount to the spouse upon the death of the retiree. About 94 percent of local government employees have access to this option through their traditional DB plan.
  3. Lump sum– This provides retirees with a single lump-sump payment rather than a periodic annuity. The lump sum equals the amount that must be invested today to produce a lifetime of payments at retirement. In this case, the retiree is in control of the pace at which funds are used.
  4. Pop-up provision– While the typical joint-and-survivor annuity assumes the spouse will outlive the retiree, this option assumes the retiree will outlive the spouse and provides the retiree with an increased annuity payment upon the death of the spouse.
  5. Level income – This allows for retirement income other than pensions and specifically provides a retiree with a greater benefit prior to receipt of Social Security and a lesser benefit once those payments begin.
  6. Period certain annuity – This provides a benefit for a certain number of years only, such as for 10, 15 or 20 years.

While it’s sometimes difficult to let go of sentiments around fairness and potential perceived violations thereof, one thing local government employees can do, with the help of our elected officials, is to become educated on how annuities work.

Here are five questions all elected officials should be asking their plan providers and human resources staff:

  1. What percent of my workforce is currently eligible to retire? How do you define eligibility versus how your employees define it?
  2. What percent of my workforce will be eligible to retire in the next 5-10 years?
  3. Do my employees know what distribution options are available to them through their pension plan?
  4. If not, how can I work with my plan provider to understand those choices and communicate them to my employees?
  5. How can my human resources staff help me periodically monitor the distribution choices of my retirees?


Anita-Yadavalli-small-2About the Author: Anita Yadavalli is the Program Director of City Fiscal Policy at NLC. Anita leads NLC’s Public Sector Retirement initiative, with a focus on research and education for city leaders on retiree healthcare benefits, as well as research and programming on other city fiscal policy issues.