Abstract
Despite the fact that the increasing involvement of the private sector in pension provision has brought more flexibility to the pay-out phase of retirement, little is known about the characteristics of those who choose to annuitize their pension wealth and those who do not. I combine unique micro-data from a large Swedish occupational pension plan with rich national administrative data to study the choice between life annuities and fixed-term payouts with a minimum payout length of 5 years for 183,000 retiring white-collar workers. I find that low accumulation of assets is strongly associated with the choice of the 5-year payout. Consistent with individuals selecting payout length based on private information about their mortality prospects, individuals who choose the 5-year payout are in worse health, exhibit higher ex-post mortality rates and have shorter-lived parents than annuitants. Individuals also seem to respond to large, tax-induced changes in annuity prices.
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Notes
With lump sums, individuals receive the entire value of the accumulated retirement as a single payment, whereas phased withdrawals allow individuals to agree on a schedule of period fixed or variable payments (Antolin 2008).
In DC schemes, an individual can buy survivor insurance, which means that the remaining pension capital will be paid out to his or her partner or children. The combination between a fixed-term payout and survivor insurance is sometimes referred to as a fixed-term annuity.
Annuitization rates in US DB pension plans that offer a lump sum are typically lower than this, ranging from 25 to 50 % (Mottola and Utkus 2007; Benartzi et al. 2011; Previtero 2014; Banerjee 2013). Similar results are found in Brown et al. (2015) who study an irrevocable choice between a more immediate and a more deferred payment stream in Croatia, where 30 % choose the deferred payment.
A detailed description of the Swedish pension system can be found in Hagen (2013).
The ceiling is currently at 7.5 income base amounts (IBA). This means that no pension rights are earned for the monthly wage portion that exceeds SEK 35 375 (1 USD = 6.5 SEK in 2013).
For example, the pension plan for blue-collar workers, SAF-LO, only allows for fixed-term withdrawals of pension wealth accumulated after 1996.
The first cohort to be affected by the new DC pension plan, called ITP1, is those born in 1979.
Benefits from ITP2 are calculated based on the pensionable wage \(w\), which, in effect, is the final wage. Pensionable wage also incorporates benefits in kind, compensation for regular shift work, time on call and standby time at the time of retirement. The replacement rate is higher for pre-retirement income that exceeds the income ceiling in the public pension system. The ITP2 benefit is calculated according to the following equation, where \(w_{i}\) denotes the wage portion related to IBA \(i\):
$$\begin{aligned} \mathrm{ITP2}=0.1w_{<7.5 \; \mathrm{IBA}}+0,65w_{7.5-20 \; \mathrm{IBA}}+0.325w_{20-30 \; \mathrm{IBA}} \end{aligned}$$For full ITP2, 30 whole entitlement years are required. An entitlement year can be earned from age 28 and is earned if the individual worked at least 20 % of full time. Earned ITP2 entitlement years are transferred to the new employer if the individual changes job.
There is also a DC component within the ITP plan called ITPK. Similar to ITP2, ITPK assets can be paid out during a fixed number of years or as a life annuity. This study focus on payout choices in the DB component for two reasons. First, ITPK is less important and normally amounts to 10 % of the final wage if t is paid out over five years. Second, the data only contains information on ITPK assets that were accumulated prior to 2008 (Ursprunglig ITPK).
In practice, retirees are allowed to withdraw their pension during any number of years with a minimum of 5 years. However, only 1 % choose some other payout length than the pre-specified fixed-term payout lengths (5, 10, 15 and 20 years) and the life annuity.
See Edmark et al. (2012) for a detailed description of the Swedish income tax system.
From 2009, the basic deduction for individuals aged 65 and above is higher than for those below this age. This implies that the thresholds in the state income tax schedule are somewhat lower for individuals below age 65. In 2013, the basic deduction for individuals aged 65 and above was phased in between SEK 45,000 and SEK 166,900 and phased out between SEK 212,300 and 538,700.
Davidoff et al. (2005) extend Yaari (1965) and show that individuals benefit from converting a significant fraction of their assets into life annuities even in the presence of incomplete markets for life annuities. Feigenbaum et al. (2013), on the other hand, show that the welfare effect of annuitization is ambiguous in general equilibrium on account of pecuniary externalities.
Pension wealth in occupational pension plans other than the ITP plan can be viewed as pre-annuitized wealth since these plans only allow limited amounts of DC capital to be withdrawn as fixed-term payouts for the cohorts studied in this paper.
When estimating the expected present discounted value of each payout option, I use gender-specific mortality tables published by Statistics Sweden for years 2009–2013. To account for the fact that payments of different payout length might be discounted at different rates, I use the mean yield on 5-year Treasury notes in year t-1 for the 5-year payout option and the mean yield on 10-year notes for the remaining payout options. The mean yield on 10-year Treasury notes in 2012 was 1.59 % compared to 1.12 % for 5-year notes.
As mentioned in Sect. 2.3, from 2009 and onwards, the basic deduction is higher for individuals aged 65 or above than for those below. The tax paid, \(T\), should therefore be a function of both \(t\) and \(a\). However, because almost 90 % claim at age 65, I simplify by making the tax function independent of age.
When calculating individual MWRs, I take into account the tax system of the relevant year, pension income from other occupational pension plans and private pension accounts, public pension benefits, gender and the age at retirement. To simplify, I assume zero labor earnings after claiming.
Kopczuk and Lupton (2007) show that children are an imperfect proxy of bequest motives. An alternative proxy of bequest motives is the purchase of life or survivor insurance (Bernheim 1992). Survivor insurance in the ITP plan is optional. Unfortunately, the data do not include information on whether the individual has purchased this insurance or not.
This corresponds to a monthly income of SEK 7 400 or 30 % of the average permanent income. This measure also includes self-employment income.
12, 18 and 38 % receive income from the occupational pension plan for central government workers, local government workers and blue-collar workers in the private sector, respectively. As many as 82 % receive pension income that is not classified by LISA as coming from any of the four major occupational pension plans (variable “OvrTjp”).
Remember that the sample is restricted to retirees who claimed ITP benefits before 2011 when we look at non-ITP income sources (N \(=\) 82,066). The public pension claiming age is not observed for about 5 % which means that the true average claiming age might be somewhat higher than 64.2.
Includes co-habiting partners.
An employee that calls in sick receives sick pay from the employer the first 14 days of absence. After 14 days, the employer reports the case to the Swedish Social Insurance Agency (Försäkringskassan), who pays out a sickness benefit that amounts to about 80 % of the individual’s salary. The data in this study contain information on the number of days individuals receive sickness benefits from Försäkringskassan.
Complete cohort-specific mortality tables are available for cohorts born in 1910 or earlier (SCB 2010).
Various definitions of parent longevity are possible. I also create dummies for whether both (and any) of the parents are deceased/alive at age 65/90. The results turn out to be robust to these definitions.
Specifically, the account balance distribution refers to the monetary value of the pension payment under the life annuity. For each individual, I observe the monthly benefit under the preferred payout option. The monetary value of the life annuity is calculated as the product of the given benefit and the relevant conversion factor. For example, if the monthly benefit under the 5-year payout is SEK 2000 and the (hypothetical) conversion factor is 3.5, the value of the life annuity is equal to SEK 714.3 (\(2500\div 3.5=714.3 \)).
The demand for fixed-term payout options can also be estimated in an OLS framework. I estimate a logit model where the dependent variable equals one if individual \(i\) chooses fixed-term payout option \(k\) and zero otherwise. The OLS estimates turn out to be very similar in magnitude to the marginal effects from the multinomial logit regressions and the inferences are unchanged. I do not report the estimation results for the 20-year payout. The estimates are not informative because only 0.2 % choose this payout option.
All regression models restrict the sample to individuals for whom we know the date of birth of both biological parents. The results are similar when all individuals are included (excluding the variables of parent longevity from the model).
Finkelstein and Poterba (2004) apply a similar LPM model framework as well as a hazard model framework to study annuitant mortality in the UK annuity market.
Using the relative value of the 5-year payout to predict the demand for the 10- and 15-year payout is not ideal since there might be within-individual variation in the net MWR across payout options. The within-individual variation is too small to motivate the use of conditional logit or mixed logit models. Such models allow for the explanatory variables to include attributes of the choice alternatives, which in our case would be the payout-specific net MWRs.
As seen in Table 1, there is very limited variation in the net MWR across the income distribution. The relative value of the 5-year payout is therefore not a good proxy for the relative value of the 15-year payout.
Non-pension wealth is imperfectly proxied by permanent income if wealth is inherited, and ITP wealth might underestimate the overall wealth level of the individual if she is a member of multiple occupational pension plans.
OLS estimates from a linear probability model of ex-post mortality yield similar results.
Another way to isolate tax-induced variation in the net MWR is to use gender-independent mortality tables when calculating EPDVs according to Eq. 1. This yields similar marginal effects of \(-\)0.96.
Excluding the two retirement wealth variables from specification (1) yields a significant estimate of female of 0.035.
Summary statistics for these two groups are provided in the Online Appendix (Table A1). The online appendix also provides results from several predictions that are made to illustrate the findings in Table 5. Specifically, I use the coefficient estimates that underlie the marginal probability effects to predict probabilities of choosing each payout option for individuals with different attributes.
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Acknowledgments
This paper has benefited from comments by Sören Blomquist, Håkan Selin, James Poterba, Jeffrey Brown, Jonathan Reuter, Paolo Sodini, Mårten Palme, Svetlana Paschenko, Tarmo Valkonen, Raymond Gradus, Jacob Lundberg, Ponpoje Porapakkarm, Yuwei De Gosson de Varennes, Maria Polyakova, Jean-Marie Lozachmeur, Matthew Zaragoza-Watkins, Mikael Elinder, Per Johansson, Per Engström, Hannes Malmberg and seminar participants at the Swedish Social Insurance Inspectorate (ISF), the 2014 IIPF Congress, Uppsala Brown Bag, and the 2014 Topics in Public Economics in Uppsala. I also thank two anonymous reviewers and guest editor Monika Bütler. Special thanks to Alecta for providing data and to Pär Ola Grane, Nikolaj Lunin and Lars Callert for very helpful discussions. Financial support from the Jan Wallander and Tom Hedelius Foundation is gratefully acknowledged.
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Hagen, J. The determinants of annuitization: evidence from Sweden. Int Tax Public Finance 22, 549–578 (2015). https://doi.org/10.1007/s10797-015-9360-5
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DOI: https://doi.org/10.1007/s10797-015-9360-5