Small accounts, big decisions: How multiple savings impact retirement payout choices

The Hebrew University of Jerusalem

New study shows that retirees are more likely to cash out smaller retirement accounts instead of turning them into steady income streams, even though they might do the opposite with larger accounts. This choice can hurt their long-term financial security, leaving them with less stable income in retirement. For financial companies, this behavior has implications in their ability to manage assets liabilities risks (ALM).

A new study by Dr. Abigail Hurwitz and Prof. Orly Sade from Hebrew University, forthcoming in Management Science, sheds light on how retirees manage their savings across multiple accounts and its impact on their payout decisions at retirement. Titled Is One Plus One Always Two? Insuring Longevity Risk While Having Multiple Savings Accounts, the research explores how individuals with more than one retirement savings account choose between annuitization—insuring themselves against longevity risk—and cashing out their savings in a lump sum.

Drawing on proprietary data from a leading Israeli insurance company, accompanied by a laboratory experiment and an online experimental survey, the study highlights a critical trend: smaller accounts are much more likely to be cashed out than larger ones. The researchers use occupation as a proxy for wealth and find that individuals with higher expected wages are more likely to annuitize their savings but less likely to annuitize smaller accounts. This behavior, according to Hurwitz and Sade, is not merely about income but also the diversification of savings across multiple accounts.

“We discovered that the composition of multiple accounts influences annuitization decisions, especially for smaller versus larger accounts,” said Dr. Abigail Hurwitz. “This can have significant implications for retirees, particularly regarding their long-term financial security.”

The study uses both administrative data and a series of experiments to analyze this phenomenon. An online survey and a laboratory experiment revealed that retirees are less likely to annuitize small accounts due to mental accounting, a concept that leads individuals to treat money differently depending on how it is categorized or allocated. A supplementary survey conducted with financial experts indicated that these professionals were less influenced by the distribution of funds across accounts and were more inclined to consider the entire portfolio.

The study's findings are far-reaching, particularly for financial institutions managing pension funds. “Our results suggest that financial institutions should consider the size distribution of accounts when forecasting annuitization behavior and longevity risk,” said co-author Prof. Orly Sade. “It is vital for asset and liability management strategies, especially as these decisions directly impact the future reserves required for annuity providers.”

This research provides crucial insights into how retirees manage their savings and make annuitization decisions, highlighting significant implications for both financial institutions and policymakers.

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Journal

Management Science

DOI

10.1287/mnsc.2022.02489 

Method of Research

Data/statistical analysis

Subject of Research

People

Article Title

Is One Plus One Always Two? Insuring Longevity Risk While Having Multiple Savings Accounts