When exploring the annuity puzzle, economists have tried to assess whether the "implementation gap" is due to "good" reasons or for "bad" reasons. (UBS)

While most investors agree that annuities would help them in different areas, only about 14% of families have actually gone through the process to purchase one. Economists call this discrepancy “the annuity puzzle.”


How can we address the annuity puzzle?


When exploring the annuity puzzle, economists have tried to assess whether the "implementation gap" is due to "good" reasons or for "bad" reasons.


For example, a good reason would be that a family is more interested in maximizing the value of inheritance for their heirs. Another good reason would be that the family's Social Security income is already enough to cover their spending needs, or they are willing and able to significantly cut their spending during periods of poor market performance.


By contrast, bad reasons would include misunderstanding how annuities work, being unrealistically pessimistic about life expectancy, or having an outdated assessment of annuities' payout terms (which have dramatically improved in the last three years).


In our view, it's easy to see why many investors are confused about annuity offerings, and don't know where to start even if they already see the potential benefits: The industry is filled with jargon, there are many products that use the name "annuity" but have distinct characteristics from one another, and annuities aren't purchased like other investment options. If you're interested in learning about annuities, we recommend that you start by asking your financial advisor to teach you about single premium immediate annuities, where you simply invest an upfront lump sum in exchange for an income stream that will last the rest of your lifetime.


After learning about these basics, your advisor can help you to understand other types of annuities, such as variable annuities that allow you to keep more control over how your funds are invested, when you begin to tap your investment's income potential, and how much you want to keep as a death benefit for your heirs.


In our view, the best way to get started is to follow these three steps:


  1. Check your longevity risk. Ask your financial advisor to help you stress-test your financial plan for longevity risk. For example, can you afford to sustain your spending until age 100? It's possible that you or your spouse will live that long. Even without a major scientific breakthrough on aging, you should remember that there's around a 50% chance that you outlive your life expectancy.
  2. Address any planning gaps. If your financial plan shows longevity risk, your financial advisor can help you to assess your options. Some longevity risks can be addressed through "self-insuring" strategies, such as changing your asset allocation or adjusting your spending and gifting plans. In other situations, such as those we review in " Three reasons to seek annuity income ," adding an allocation to annuities may help you to boost the sustainability of your family's spending plans by transferring some risk to an insurance company.
  3. Make a plan and get started. Research has shown that making a simple plan—or sharing your intention with someone else—can help you turn your goals into reality. After finishing steps #1 and #2, your financial advisor can help you to follow a step-by-step plan for addressing your questions, weighing your choices, and implementing the strategy that best suits your family's needs.

Main contributors – Justin Waring, Daniel J. Scansaroli, Ainsley Carbone, Katie Williams


Read the original report : Solving the “annuity puzzle”, 9 January 2024 , which includes additional disclosures.



Timeframes may vary. Strategies are subject to individual client goals, objectives, and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.