Most Investors Don’t Understand Annuities

People don’t use annuities nearly as much as economic theory predicts, something called the annuity puzzle. The root of the ‘puzzle’ is familiar enough, economics assume that we all make rational, utility-optimizing decisions about our life, but even an industry as adept at marketing as asset management hasn’t been able to bridge the gap very effectively. A new study suggests that people’s view of annuities are especially irrational simply because the financial instruments are hard to get your head around.

“It is difficult for the average person contemplating retirement to determine how to draw down his wealth,” write Jeffrey Brown, Arie Kapteyn, Erzo Luttmer, and Olivia Mitchell of the Wharton School in their paper Cognitive Constraints on Valuing Annuities....