Time inconsistent preferences and the annuitization decision

• We analyze the annuitization decision in a hyperbolic discounting framework.
• We show that in this context annuities should only be attractive for young people.
• We test the resulting hypotheses by conducting a large online survey.
• Results show that part of the annuity puzzle is driven by hyperbolic discounting.
• Pre-commitment devices could help to increase real life annuity demand.

When entering retirement, many people face the decision of whether they would like to receive their defined contribution account balance as a lump sum distribution or to annuitize the amount. The fact that people tend to choose a lump sum distribution even if economic reasons suggest otherwise is called the “annuity puzzle.” The results of a large online survey show that people behave in a time inconsistent manner: older people have a stronger tendency to choose the lump sum than younger people. This effect, and therefore, the low real life annuitization can be explained by hyperbolic discounting. The age effect is considerably stronger for participants that answer simple time preference questions inconsistently. Our findings suggest that commitment devices can help to increase annuitization rates.