Most defined contribution (DC) pension plans in the United States pay lump sum benefits, although the US Treasury recently urged companies to protect retirees from the risk of living beyond what their assets will allow them to, converting a portion of their balances into Longevity Income Annuities (LIAS). These are deferred Life Annuities that begin payments at a maximum of 85 years of age and continue for life, providing an effective way to cover the systematic longevity risk (individual) at a relatively low price.

Using a life-cycle model, the authors of this study measured the welfare improvements derived from including the LIAS in the menu of decumulation options of DC pension plans, controlling by gender, educational level and preferences. The authors found that introducing an LIA in the menu of pension plans is attractive for the majority of participants of DC pension plans that optimally allocated between 8% to 15% of their accumulated funds, at age 65, to the purchase of an LIA starting payments at 85 years of age. The purchase of this LIA improves well-being between 5% and 20% of the average accumulation for retirement at age 66 (assuming average mortality tables), compared to the option of not buying an LIA.

The authors also found that an approach in which the participant chooses his optimal allocation, using a fixed portion of the accumulated balance to purchase an LIA (between 8% and 15%), is better than other default approaches that employers could use for the decumulation of their funds. In fact, if the sponsors of DC pension plans were to determine that 10% of the accumulated balance would be used for purchasing an LIA, by default, welfare would be reduced compared to the option of using the optimal allocation chosen by the participant. The results depend on the mortality rate: for participants with higher a mortality rate, using a default allocation of 10% for the purchase of an LIA gives rise to a greater reduction of welfare, since the life annuity prices based on average mortality are very high. A solution to this problem is to allow only those who have at least USD 65,000 accumulated in their individual accounts to purchase an LIA.

Most defined contribution (DC) pension plans in the United States pay lump sum benefits, although the US Treasury recently urged companies to protect retirees from the risk of living beyond what their assets will allow them to, converting a portion of their balances into Longevity Income Annuities (LIAS). These are deferred Life Annuities that begin payments at a maximum of 85 years of age and continue for life, providing an effective way to cover the systematic longevity risk (individual) at a relatively low price.

Using a life-cycle model, the authors of this study measured the welfare improvements derived from including the LIAS in the menu of decumulation options of DC pension plans, controlling by gender, educational level and preferences. The authors found that introducing an LIA in the menu of pension plans is attractive for the majority of participants of DC pension plans that optimally allocated between 8% to 15% of their accumulated funds, at age 65, to the purchase of an LIA starting payments at 85 years of age. The purchase of this LIA improves well-being between 5% and 20% of the average accumulation for retirement at age 66 (assuming average mortality tables), compared to the option of not buying an LIA.

The authors also found that an approach in which the participant chooses his optimal allocation, using a fixed portion of the accumulated balance to purchase an LIA (between 8% and 15%), is better than other default approaches that employers could use for the decumulation of their funds. In fact, if the sponsors of DC pension plans were to determine that 10% of the accumulated balance would be used for purchasing an LIA, by default, welfare would be reduced compared to the option of using the optimal allocation chosen by the participant. The results depend on the mortality rate: for participants with higher a mortality rate, using a default allocation of 10% for the purchase of an LIA gives rise to a greater reduction of welfare, since the life annuity prices based on average mortality are very high. A solution to this problem is to allow only those who have at least USD 65,000 accumulated in their individual accounts to purchase an LIA.