Can Annuities Solve The Retirement Crisis?

October 06, 2011

Linda Koco

A government study is drawing accolades from professionals in the insurance and financial community—a rare event, given that government and financial interests are often at odds.

The 79-page document issued by the U.S. Government Accountability Office (GAO) says experts are recommending use of income annuities to generate retirement income, among other strategies.

“It’s a great document and I’m excited about it,” says Matt Taylor, president of Taylor Retirement Service, an insurance and financial firm in Harrisburg, Pa. The annuity discussion is “fair and balanced,” he explains. In addition, it names various types of annuities, including indexed annuities, that people can use for retirement income purposes.

“It is encouraging to see that government officials are educating themselves on annuities in this way,” continues Taylor.

It’s also a good report for advisors to use when discussing retirement income issues with clients. The report, “Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices,” is available for anyone to download at the GAO website (

The report does not endorse any particular retirement income solution, and it presents the pros and cons of the various solutions it shows. But that is just fine with Taylor. “I don’t want the government to tell me to do anything, and neither do my clients,” the advisor says. The value of the report is that it provides objective information, he says.

“The report gets the conversation (about annuities and income generation) on the table,” adds Craig Lemoine, assistant professor of financial planning at The American College, Bryn Mawr, Pa.

The fact that the report comes from a reputable government source gives it more credibility than if the same information were to come from, say, a large life insurance company, Lemoine continues. That is important, especially since annuity products have gotten a bad rap in the general press much of the time, he says.

Lemoine agrees that some advisors will find the report to be a useful resource in conversations with clients. However, he suggests that advisors run how to do that by their compliance departments first. After a while, he adds, “I would be surprised if some of the larger insurers don’t come up with their own summaries that agents can use for this purpose.”

The ACLI, which represents insurers, likewise has good words for the report. It “validates the vital role annuities can play in helping people secure a paycheck for life,” says ACLI President Dirk Kempthorne in a statement.

It should be read, Kempthorne says, by workers and retirees, as well as financial planners and policymakers.

“It makes clear that annuities represent an opportunity for lifetime retirement income to supplement Social Security.” It also describes proposals to encourage the availability of annuities in defined contribution plans.


The GAO prepared the report in response to a 2010 Obama administration request for information about retirement income strategies. The departments of Labor and the Treasury had asked for a study on, among other topics, the strategies that experts recommend retirees use to ensure income throughout retirement.  

The request had followed President Obama’s Task Force on the Middle Class recommendation early last year that there be promotion of “the availability of annuities and other forms of guaranteed lifetime income.” Retirement industry professionals took the task force recommendation as a sign that retirement income strategies are now on the national agenda.

Those same professionals should be further buoyed by the new GAO report. Portions of it touch on points the annuity industry has been making for a long time about income needs and products. For instance, it cites today’s increasing life expectancy as one reason why the risk of outliving assets is a “growing challenge.”

Likewise, it says the ongoing shift away from defined benefit plans and toward defined contribution plans “may mean that increased retirement savings and other options for generating retirement income from savings such as annuities might become more important for retirees in the future.” 

Perhaps not insignificantly, the report includes references to several sources often cited in insurance circles. These include National Association of Insurance Commissioners, American Academy of Actuaries, Insured Retirement Institute, Employee Benefit Research Institute, and the Securities and Exchange Commission. In one passage, the report cites an annuity offered by American General Life Companies.

These sources are in addition to the myriad of government sources, such as the Bureau of Labor Statistics and the Social Security Administration, that GAO often cites in its reports.

The Experts’ View

The report says that that the experts the GAO consulted “tended to recommend that retirees draw down their savings strategically and systematically, and that they convert a portion of their savings into an income annuity.”

Such conversion would be “to cover necessary expenses or opt for the annuity provided by an employer-sponsored defined benefit (DB) pension, rather than take a lump sum,” the report says.

But the report also covers the pros and cons of using annuities for retirement income purposes, as detailed by the experts and GAO research.

On the pro side, it says income annuities can help protect retirees against the risk of underperforming investments, the risk of outliving assets (longevity risk) and, in the case of inflation-adjusted annuities, the risk of inflation diminishing purchasing power. It also discusses how annuities provide risk pooling, can help relieve retirees from the “burden” of managing their own investments and can help deter overspending or under-spending.

Taylor, the advisor, is particularly happy that the report includes the overspending/under-spending comment. “I see a lot of people who under-spend during retirement because of the fear that they will outlive their money,” Taylor explains. 

He has found that such clients are very interested in the income features of annuities. In fact, he says when he shows a deferred annuity that has a guaranteed income rider, most are interested in the rider first and the growth potential second.

“It’s like the clouds open up when they learn that an annuity can generate an income they cannot outlive,” he says.

On the con side, the GAO report says income annuities may be inappropriate or expensive for people who have predictably shorter-than-normal life expectancies. It points out that funds used to purchase income annuities will no longer be available to cover large unplanned expenses. Also, it notes that immediate annuities that provide for bequests have higher costs, and some experts are concerned about the risk that annuity insurers might default on making annuity payments.

Five Households

As part of its research, GAO asked the experts it consulted to assess income strategies for five households that were near retirement, based on 2008 data. The households were randomly selected from the lowest, middle and highest net wealth quintiles and had varying types of pensions.

The experts saw places where annuities could work well and other places where they may not be useful.

For example, according to the report, the experts recommended that the two middle-quintile households purchase annuities with a portion of their savings. However, the experts suggested that the lowest-quintile household accumulate some precautionary cash savings before purchasing an annuity or investing in securities.

On the other hand, the experts suggested that the two households in the highest quintile had sufficient resources to go without annuities “unless the individuals were very risk-averse and felt the need for additional protection for longevity.”

One of the two middle-quintile households did not have a DB plan. What to do then? According to the GAO report, the experts suggested this household should consider using a portion, such as half, of financial assets to purchase an inflation-adjusted annuity.

The report also discusses how the sequence of investment returns can impact the success of a drawdown strategy for retirement income and how purchase of an annuity can reduce exposure to the risks of longevity, inflation and market volatility for those using the drawdown strategy. “This discussion is very powerful,” says Taylor. “It should be helpful to anyone who is concerned about running out of money before they die.”

Other parts of the report discuss proposals for facilitating employee access to lifetime retirement income products—such as annuities—in DC plans and proposals to increase financial literacy.

Having all this on the table opens up the concept of the annuity, sums up Lemoine, the professor. This is a “fantastic” way for the country to start addressing the lifetime income need, he says. 

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].

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