Time Inconsistent Preferences and the Annuitization Decision

Good news can involve difficult decisions. For example winning a lottery jackpot can go along with the decision, whether to have the jackpot paid out immediately as a lump sum or as periodic annual payments. Also when entering retirement most people face the decision whether they want their defined contribution account balance paid as a lump sum or to annuitize that amount. The fact that people tend to choose the lump sum even if economic reasons suggest that they should choose the annuity is called the annuity paradox. In a large online survey we find that people behave time inconsistent: older people have a stronger tendency to choose the lump sum than younger people when they are asked to predict today what to choose when they retire. This effect is considerably stronger for participants that answer simple time preference questions inconsistently. Our findings suggest to think about precommitment devices for the annuitization decision, in the retirement case, already at the time when the defined benefit plan is started.

[1]  Dean S. Karlan,et al.  Tying Odysseus to the Mast: Evidence from a Commitment Savings Product in the Philippines , 2005 .

[2]  G. Sorger.  Time-preference and commitment , 2007 .

[3]  P. Krishnan,et al.  Stock Market Participation, Portfolio Choice and Pensions over the Life-Cycle , 2007 .

[4]  Irena Dushi,et al.  Household annuitization decisions: simulations and empirical analyses , 2004, Journal of Pension Economics and Finance.

[5]  Ayse Öncüler,et al.  An Investigation of Time Inconsistency , 2009, Manag. Sci..

[6]  Jawwad Noor,et al.  Hyperbolic discounting and the standard model: Eliciting discount functions , 2009, J. Econ. Theory.

[7]  Ulrike Malmendier,et al.  Paying Not to Go to the Gym , 2006 .

[8]  Lena Osterhagen,et al.  Multiple Imputation For Nonresponse In Surveys , 2016 .

[9]  Lisa R. Anderson,et al.  Who Chooses Annuities? An Experimental Investigation of the Role of Gender, Framing, and Defaults , 2008 .

[10]  Robert Zeithammer,et al.  Consumer Preferences for Annuities : Beyond NPV , 2013 .

[11]  David I. Laibson,et al.  Golden Eggs and Hyperbolic Discounting , 1997 .

[12]  R. Herrnstein,et al.  Preference reversal and delayed reinforcement , 1981 .

[13]  R. H. Strotz.  Myopia and Inconsistency in Dynamic Utility Maximization , 1955 .

[14]  D. Read.  Monetary incentives, what are they good for? , 2005 .

[15]  J. Mirowsky,et al.  Subjective life expectancy in the US: correspondence to actuarial estimates by age, sex and race. , 1999, Social science & medicine.

[16]  Martin Weber,et al.  How Risky Do I Invest: The Role of Risk Attitudes, Risk Perceptions, and Overconfidence , 2010, Decis. Anal..

[17]  A reconciliation of time preference elicitation methods , 2013 .

[18]  Wei-Yin Hu,et al.  Behavioral Obstacles in the Annuity Market , 2007 .

[19]  R. Thaler,et al.  An Economic Theory of Self-Control , 1977, Journal of Political Economy.

[20]  D. Hamermesh,et al.  Expectations, Life Expectancy, and Economic Behavior , 1985 .

[21]  Erzo F. P. Luttmer,et al.  Do Consumers Know How to Value Annuities? Complexity as a Barrier to Annuitization , 2011 .

[22]  Peter R. Orszag,et al.  The Value for Money of Annuities in the UK: Theory, Experience and Policy , 1999 .

[23]  O. Mitchell,et al.  Asset allocation and location over the life cycle with investment-linked survival-contingent payouts , 2009 .

[24]  K. Kirby,et al.  Modeling Myopic Decisions: Evidence for Hyperbolic Delay-Discounting within Subjects and Amounts , 1995 .

[25]  J. T. Warner,et al.  The Personal Discount Rate: Evidence from Military Downsizing Programs , 2001 .

[26]  John Ifcher,et al.  Happiness and Time Preference: The Effect of Positive Affect in a Random-Assignment Experiment , 2011 .

[27]  Susanne Pech.  Portfolio decisions on life annuities and financial assets with longevity and income uncertainty , 2004 .

[28]  R. Pollak,et al.  SECOND-BEST NATIONAL SAVING AND GAME-EQUILIBRIUM GROWTH , 1980 .

[29]  Andrew Caplin,et al.  The Joy of Giving or Assisted Living? Using Strategic Surveys to Separate Public Care Aversion from Bequest Motives , 2010 .

[30]  Alessandro Previtero.  Stock Market Returns and Annuitization , 2010 .

[31]  G. Loewenstein,et al.  Anomalies in Intertemporal Choice: Evidence and an Interpretation , 1992 .

[32]  Manel Baucells,et al.  Probability and Time Trade-Off , 2012, Manag. Sci..

[33]  M. Hurd,et al.  An Analysis of the Choice to Cash Out Pension Rights at Job Change or Retirement , 2006 .

[34]  A. Lusardi,et al.  Financial Literacy and Stock Market Participation , 2007 .

[35]  Brigitte C. Madrian,et al.  What Makes Annuitization More Appealing? , 2012, Journal of public economics.

[36]  Jeffrey R. Kling,et al.  Why Don&Apos;T People Insure Late Life Consumption: A Framing Explanation of the Under-Annuitization Puzzle , 2008 .

[37]  Thomas Epper,et al.  Risk preferences are not time preferences: balancing on a budget line: comment , 2015 .

[38]  Han Bleichrodt,et al.  Intertemporal Tradeoffs for Gains and Losses: An Experimental Measurement of Discounted Utility , 2010 .

[39]  M. Yaari,et al.  Uncertain lifetime, life insurance, and the theory of the consumer , 1965 .

[40]  J. Poterba,et al.  Joint Life Annuities and Annuity Demand by Married Couples , 1999 .

[41]  Sudipto Banerjee.  Income Composition, Income Trends, and Income Shortfalls of Older Households , 2013, EBRI issue brief.

[42]  Martin Ahlbrecht,et al.  An empirical study on intertemporal decision making under risk , 1997 .

[43]  Morten I. Lau,et al.  Estimating Individual Discount Rates in Denmark: A Field Experiment , 2002 .

[44]  G. Ainslie.  Specious reward: a behavioral theory of impulsiveness and impulse control. , 1975, Psychological bulletin.

[45]  G. Loewenstein,et al.  Time Discounting and Time Preference: A Critical Review , 2002 .

[46]  R. Thaler,et al.  An Economic Theory of Self-Control , 1977, Journal of Political Economy.

[47]  O. Mitchell,et al.  Optimal Portfolio Choice over the Life-Cycle with Flexible Work, Endogenous Retirement, and Lifetime Payouts , 2011 .

[48]  J. Piggott,et al.  Explaining Low Annuity Demand: An Optimal Portfolio Application to Japan , 2008 .

[49]  Laurence J. Kotlikoff,et al.  The Family as an Incomplete Annuities Market , 1979, Journal of Political Economy.

[50]  Stephan Meier,et al.  Discounting Financial Literacy: Time Preferences and Participation in Financial Education Programs , 2013, SSRN Electronic Journal.

[51]  A. Rapoport,et al.  Discount rates inferred from decisions: an experimental study , 1987 .

[52]  C. Ai,et al.  Computing Interaction Effects and Standard Errors in Logit and Probit Models , 2004 .

[53]  David Laibson,et al.  A Debt Puzzle , 2000, Knowledge, Information, and Expectations in Modern Macroeconomics.

[54]  J. Reuter,et al.  How Do Retirees Value Life Annuities? Evidence from Public Employees , 2009 .

[55]  Josef Perner,et al.  Framing decisions: Hypothetical and real , 2002 .

[56]  Daniel Schunk,et al.  The German SAVE study : design and results , 2008 .

[57]  Jeffrey R. Brown,et al.  Procrastination, Present-Biased Preferences, and Financial Behaviors , 2014 .

[58]  Matthias Sutter,et al.  Working Papers in Economics and Statistics Group polarization in the team dictator game reconsidered , 2007 .

[59]  James M. Poterba,et al.  Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market , 2000, Journal of Political Economy.

[60]  U. Ben-Zion,et al.  Discount rates inferred from decisions: an experimental study , 1989 .

[61]  Stephan Meier,et al.  Present-Biased Preferences and Credit Card Borrowing , 2009, SSRN Electronic Journal.

[62]  R. Maurer,et al.  Optimal Portfolio Choice with Annuities and Life Insurance for Retired Couples , 2014 .

[63]  R. Thaler.  Some empirical evidence on dynamic inconsistency , 1981 .

[64]  David Laibson,et al.  Self Control and Liquidity: How to Design a Commitment Contract , 2011 .

[65]  O. Mitchell,et al.  Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth , 2006 .

[66]  G. McClelland,et al.  Misleading Heuristics and Moderated Multiple Regression Models , 2001 .

[67]  David J. Hardisty,et al.  How to measure time preferences: An experimental comparison of three methods , 2013, Judgment and Decision Making.

[68]  M. Warshawsky,et al.  Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses , 2007 .

[69]  T. Koopmans.  Stationary Ordinal Utility and Impatience , 1960 .

[70]  T. Nijman,et al.  Optimal Annuity Risk Management , 2009 .

[71]  A. Odum,et al.  Impulsivity and cigarette smoking: delay discounting in current, never, and ex-smokers , 1999, Psychopharmacology.

[72]  Michael D. Hurd,et al.  Mortality Risk and Bequests , 1989 .

[73]  O. Mitchell,et al.  New Evidence on the Money's Worth of Individual Annuities , 1997 .

[74]  Behavioral Obstacles in the Annuity Market , 2007 .

[75]  O. Mitchell,et al.  Can Americans Afford to Retire? New Evidence on Retirement Saving Adequacy , 1998 .

[76]  Jeffrey R. Brown,et al.  Empirical Determinants of Intertemporal Choice , 2013 .

[77]  Colin Camerer,et al.  The Effects of Financial Incentives in Experiments: A Review and Capital-Labor-Production Framework , 1999 .

[78]  Annamaria Lusardi,et al.  Financial Literacy and Planning: Implications for Retirement Wellbeing , 2005 .

[79]  J. Andreoni,et al.  Risk Preferences Are Not Time Preferences , 2012 .

[80]  Charles M. Harvey,et al.  Value functions for infinite-period planning , 1986 .

[81]  A. Brugiavini.  Uncertainty resolution and the timing of annuity purchases , 1993 .

[82]  Warren K Bickel,et al.  Within-subject comparison of real and hypothetical money rewards in delay discounting. , 2002, Journal of the experimental analysis of behavior.

[83]  Monika Bütler,et al.  The choice between an annuity and a lump sum: Results from Swiss pension funds ☆ , 2007 .

[84]  M. Strawczynski.  Income uncertainty and the demand for annuities , 1999 .

[85]  John G. Lynch,et al.  Spotlights, Floodlights, and the Magic Number Zero: Simple Effects Tests in Moderated Regression , 2012 .

[86]  Charles Sprenger,et al.  Estimating Time Preferences from Convex Budgets , 2010 .

[87]  Erzo F. P. Luttmer,et al.  Complexity as a Barrier to Annuitization: Do Consumers Know How to Value Annuities? , 2013 .

[88]  Alessandro Previtero.  Stock Market Returns and Annutization at Older Ages , 2012 .

[89]  Johann K. Brunner,et al.  Adverse selection in the annuity market with sequential and simultaneous insurance demand , 2002, SSRN Electronic Journal.