Is Retiree Demand for Life Annuities Rational? Evidence from Public Employees

Oregon Public Employees Retirement System (PERS) retirees must choose between receiving all of their retirement benefits as life annuity payments and receiving lower life annuity payments coupled with a partial lump sum payout. For the median retiree, the expected present value of the incremental life annuity payments is 1.50 times the lump sum payout, and demand for lump sums is low. This pattern is consistent with value-maximizing decisions by retirees. However, when we exploit variation in the value of the incremental life annuity payments arising from how PERS calculates retirement benefits, we find robust evidence that demand for lump sum payouts is higher when the forgone life annuity payments are more valuable. We also find that demand for lump sum payouts is higher when the lump sum payout is “large, ” and when equity market returns over the prior 12 months are higher. Collectively, these findings suggest that retirees value incremental life annuity payments at less than their expected present value, either because they do not know how to accurately value life annuities or because they have strong demand for large lump sum payouts. In contrast, when we measure variation in the value of the incremental life annuity payments along a dimension that is easier for retirees to observe and interpret—poor health at retirement—we find evidence consistent with value-maximizing decision-making.