Managing Longevity Risk in U.S. Retirement Plans Through Mandatory Annuitization

Abstract

Over the past 20 years, the United States has experienced a profound shift in the way that employment-based retirement benefits are delivered to workers. The traditional life annuity from a defined benefit (DB) plan has been largely replaced by lump sums from defined contribution (DC) plans. Along with investment risk, American workers are bearing a larger share of the longevity risk inherent in all retirement systems. As Americans benefit from longer lives, they are facing a harsh reality: will their retirement assets last long enough? Workers have embraced the flexibility offered by the widely available, and very popular, 401(k) plan. Often described as a do-it-yourself retirement program, these plans have allowed workers to accumulate significant levels of retirement savings. Employers like them too because they are less costly and easier to administer than traditional DB plans. Will this enthusiasm wane as baby boomers retire and face the daunting task of managing this pool of assets over retirements that can span 30 or 40 years or longer? Retirees have been reluctant to annuitize their assets for many reasons, and the annuity market in the United States is relatively small. The shift from DB to DC plans has left a majority of workers with only one form of annuitized benefit: Social Security. Yet life annuities offer the best method of managing longevity risk, both for the individual and for society. This paper suggests a possible framework for the mandatory annuitization of U.S. retirement savings, considers the experience of other countries, and analyzes the advantages and disadvantages of mandatory annuitization. If properly structured, it is possible that the benefits of an annuity mandate would outweigh the drawbacks.