EBRI Issue Brief

Annuity and Lump-Sum Decisions in Defined Benefit Plans: The Role of Plan Rules

Jan 17, 2013 20  pages


• Amidst growing concerns about workers outliving their retirement savings, a key question--both as a matter of national retirement policy and understanding the potential role of plan design and education in influencing individual decision-making--is how many retiring workers actually choose to annuitize (to take a stream of lifetime income) vs. opting for a lump-sum payment.

• The key finding of this study is that differences in DB plan rules or features result in very different annuitization rates in defined benefit (DB) plans. In fact, the results show that the rate of annuitization varies directly with the degree to which plan rules restrict the ability to choose a partial or lump-sum distribution.

• This study shows that annuitization rates vary significantly across these different plan types, which makes any attempt to combine the annuitization rates across these different plan types uninformative.

• Combining all the plans across the years 2005-2010, workers who made their payout decision between ages 50 and 75 had a minimum job tenure of five years, a minimum account balance of $5,000, and had an annuitization rate of 65.8 percent. But within this group of workers, those who had no plan restrictions on a lump-sum distribution had an annuitization rate of only 27.3 percent.

• In all the years studied, plans with no lump-sum distribution (LSD) options have the highest annuitization rates, very close to 100 percent. Traditional defined benefit and cash balance plans with no restrictions on LSDs had the lowest annuitization rates.

• In 2010, the annuitization rate for all plans combined was 65.5 percent, while for plans with no LSD option it was 98.8 percent, but the annuitization rate for defined benefit plans with no restrictions on LSDs was 44.3 percent, while for cash balance plans with no restrictions on LSDs it was 22.3 percent.

• For older workers across most plan types, annuitization rates increase steadily with account balance, but this is not the case for younger workers.

• Annuitization rates also increase with tenure, but for younger workers (20-50) with low tenure (less than 10 years), annuitization rates are very low. For older workers (50-75), annuitization rates are higher even in cases of low tenure.

• Annuitization rates are very low for those below age 40, but from that point onwards, annuitization rates increase for all types of plans. Annuitization rates appear to peak between 65 and 69, but then fall sharply.