Order Code RS22439
Updated May 18, 2006
CRS Report for Congress
Received through the CRS Web
The Market for Retirement Annuities
Neela K. Ranade
Domestic Social Policy Division
A retirement annuity allows an individual to purchase a regular payment stream
from an insurance company to last his lifetime. Despite the ability of the product to
eliminate the risk that a retiree will outlive his assets, few retirement annuities have been
sold in the individual market. In addition, the number of individuals who annuitize their
defined contribution retirement plan balances remains small. New products are
emerging that would offer alternate annuity designs and make annuity prices more
attractive. Legislation has been proposed in the 109th Congress that would enhance the
tax treatment of annuities and encourage the growth of stand-alone annuity and
combined annuity and long-term care products. This report1 will be updated as
Types of Annuities. An annuity is a contract made by an insurance company in
exchange for a sum of money to make regular payments (usually monthly) for the life of
the annuitant. Annuities can be classified as follows:
Immediate Versus Deferred — Under an immediate annuity, an
individual pays an insurance company a sum of money and the insurance
company begins making regular monthly payments to the individual
immediately. Under a deferred annuity, an individual pays the insurance
company a sum of money and the insurance company begins making
regular monthly payments beginning at least a year after purchase. For
example, an individual at age 45 might buy a 20-year deferred annuity
that would start making monthly payments when the individual reaches
Fixed Versus Variable — A fixed annuity pays a flat monthly amount for
the life of the annuitant whereas a variable annuity pays a monthly
payment amount tied to the performance of an investment portfolio such
as corporate stocks and bonds. Under a variable annuity, the annuitant
bears the risk that the monthly annuity payment could go down.
The original author of this report is Neela Ranade, but it has been updated by Bob Lyke.
Congressional Research Service ˜ The Library of Congress
Level Payment Versus Graded Payment — In a level payment annuity,
the monthly payments remain level whereas in a graded annuity the
monthly payments increase each year. The payments may increase at a
specified rate such as 2% per year or may increase at the rate of inflation.
Single-Life Versus Joint-and-Survivor — A single-life annuity makes
regular monthly payments for the life of one person. A joint-andsurvivor annuity makes regular monthly payments for the lives of two
people, the primary annuitant and a secondary annuitant, typically the
spouse of the primary annuitant.
There are other annuity variations. A life annuity with a period-certain makes
monthly payments for the life of the annuitant or to a beneficiary for the remaining
specified period in the event that the annuitant dies before the end of the period.
Beginning in 1995, some insurers have started offering a hybrid type of annuity called the
index annuity that combines some of the characteristics of fixed and variable annuities.
In an equity indexed annuity, the annuity payment is based on the rate of return of a stock
index. However, there is a minimum return provision, often of 3%, that eliminates the
downside risk to the purchaser.
A qualified annuity is one for which the source of cash is funds that have been
“qualified” for exemption from federal income taxes until the time of purchase. These
could be payments from a defined benefit (DB) or defined contribution (DC) pension
plan. However, few DC plans make annuities available. In 2004, just 23.5% of DC plans
offered annuities as a distribution option, according to statistics from the Profit
Sharing/401(k) Council of America. Hewitt’s 2005 401(k) survey shows that on average,
just 6% of plan participants chose an annuity.2 A non-qualified annuity is one that is
purchased with funds that have not received any tax-sheltered status. Non-qualified
annuities are typically purchased by individuals investing their after-tax savings to buy
protection against outliving their assets.
To date, deferred annuities sold have been mostly of the variable type. Typically
they have been sold on the basis of their advantages as tax sheltered investment products
rather than as a way to protect against outliving one’s assets.3 This report will focus on
non-qualified immediate annuities.
Increased Need for Annuitization. On account of the shift from DB pensions
to DC pensions and the tendency for retirees to take pension benefits in a lump sum, many
retirees are facing the responsibility for making investment and spending decisions that
will ensure that their assets will last for their lifetime. Income from guaranteed sources
Susan Kelly, “Inventing the Stretchable Retirement Dollar,” Treasury and Risk Management,
Lately deferred variable annuities have come under attack from several state insurance
departments for alleged abusive sales practices such as selling annuities with high surrender
charges to individuals in their 70s and 80s who are probably too old to benefit from them, and
exchanging one deferred variable annuity for another for no added advantage.
such as DB pension plans and social security retirement benefits is projected to drop from
74% of total retirement income in 1974 to 24% in 2030.4
Many experts believe that average life expectancy for the population will continue
to increase. In addition, a specific individual could live well past the average. Although
the average 65-year-old man and woman can expect to live to age 81 and 85 respectively,
almost 20% of 65-year-old men and 33% of 65-year-old women will live to age 90 or
beyond.5 By purchasing an annuity, an individual can transfer the risk of managing assets
to produce an adequate income stream through retirement over to the insurance company.
Current Marketplace for Annuities. As Table 1 indicates, sales of immediate
annuities have been dwarfed by sales of deferred annuities (mostly of the variable type).
Table 1 also shows that sales of fixed immediate annuities are much greater than sales
of variable immediate annuities.
Table 1. Annuity Sales in Individual Market in 2004
(amounts in billions)
Assets at 12/31/2004
Sales in 2004
Source: Information obtained from LIMRA International in e-mail message from Matthew Drinkwater to
Neela Ranade dated Sept. 15, 2005. LIMRA International is an organization that provides research services
to insurance companies.
Table 2. Types of Immediate Annuities Sold in Individual Market by
Percent of Premium
Type of Annuity
Percent of Premium
Single Life (No Period Certain)
Joint and Survivor (No Period Certain)
Single Life with Period Certain
Joint and Survivor with Period Certain
Period Certain Only
Source: LIMRA International Study of immediate annuities sold in 2000 and 2001; information provided
by LIMRA International from Matthew Drinkwater to Neela Ranade dated Sept. 15, 2005.
Table 2 shows the distribution of types of immediate annuities sold in the individual
market. Single life annuities with no further payment guarantees for a minimum period
or to a surviving spouse have the lowest sales indicating that purchasers are leery about
paying a large sum that may lead to very little payoff in the case of premature death.
Jeff Mohrenweiser, “The Evolving U.S. Retirement System,” The Actuary, Mar. 2003.
J.R. Brown,“Life Annuities and Uncertain Lifetimes,” NBER, Spring 2004.
Annuity Pricing. The purchase price for an immediate annuity depends on the
mortality assumptions used in pricing. Although most insurers use sex-distinct mortality
tables to price non-qualified immediate annuities, some states require the use of unisex
mortality rates. When sex-distinct rates are used, the annuity price for a woman will
typically be greater than the price for a man at the same age because women live longer
than men. The annuity price will also depend on the interest rate assumed to be earned
by underlying investments. The interest rate used is typically the rate on long-term
corporate bonds of good quality. The annuity price will be lower when interest rates are
In the U.S. market, the annuity price generally does not depend on the health of the
applicant even though an individual in poor health could be expected to live fewer years
and therefore cost the insurer less. The vast majority of immediate annuity policies are
issued without underwriting. The pricing of these annuities assumes that the applicants
are very healthy and will live longer than the average population. Recently, some
progress has been made in the issuance of so-called “impaired life annuities,” which are
annuities sold to individuals in less than average health. Impaired life annuities were sold
initially only in connection with “structured settlements.” Structured settlements are
agreements to pay compensation in a series of payments often as a result of an award to
an accident victim.
Annuity prices for individuals in impaired health may come down as a result of the
issuance of actuarial guideline IX-C by the National Association of Insurance
Commissioners (NAIC).6 Actuarial Guideline IX-C, effective for annuity contracts issued
after January 1, 2001, allows the insurer to hold a significantly lower reserve, thereby
reducing the purchase price. For IX-C to apply, the annuity must be sold to an individual
with a medical condition that reduces the life expectancy of the individual by at least
Emerging Products. There has been considerable discussion of new types of
annuities that will meet market needs. Some insurers have released products. Many more
are likely to enter the market if there is favorable legislation.
Inflation-Indexed Annuities. An inflation-indexed annuity (a graded annuity
under which payments increase each year at the rate of inflation) would likely be of
interest to retirees if available at an attractive price. For inflation-indexed annuities to be
priced attractively and for a large market to develop, the U. S. Treasury may need to issue
inflation-indexed bonds in sufficient volume and of long enough duration. This would
allow an insurer that sells inflation-indexed annuities to invest underlying assets in
inflation-indexed Treasury bonds.
In an inflation-indexed annuity, an insurance company pays larger amounts at later
durations than a level payment annuity. For example, if the inflation rate turns out to be
3% per year, an inflation indexed annuity purchased by a retiree at age 65 for $1000 per
month would be paying the retiree $2,427 per month at age 95. This makes the financial
risk of entire population cohorts living longer than expected, greater for an insurer that
Actuarial Guideline IX-C is titled “Use of Substandard Annuity Mortality Tables in Valuing
Impaired Lives under Individual Single Premium Immediate Annuities.”
sells inflation indexed rather than level payment annuities. Some believe that for a large
inflation-indexed annuity market and indeed for any large annuity market to develop, it
would be necessary for the government to issue “mortality bonds” to underwrite the risk
of a cohort of the population living much longer than expected. The future coupons on
a mortality bond would depend on the percentage of population of retirement age on the
issue date who are still alive on the future coupon payment dates.
Although true inflation-indexed annuities are rare in the current marketplace, there
are some products that provide some inflation protection. Vanguard (through an
arrangement with American International Group Inc.) offers an annuity that provides
inflation indexing up to a maximum of 10% inflation.7 An equity indexed annuity should
provide a higher return in the long run than a fixed annuity because over the long run
stocks can be expected to out-perform bonds. However, stocks do not always move in
tandem with inflation.8
Longevity Insurance. The deferred variable annuities sold in the past were
designed to be investment vehicles rather than protection against outliving one’s assets.
Recently, some insurance companies such as New York Life and MetLife have started
offering deferred annuities designed to be true longevity insurance. New York Life’s
core product consists of a deferred annuity of the fixed payment type with payments
beginning at age 75.9
Whether an individual chooses to buy an immediate annuity or longevity insurance
depends on the degree of investment management that the individual wishes to take on.
An individual retiring at age 62 may decide that he or she can have his or her assets
managed to provide an income stream until age 75 and buy longevity insurance that will
provide an income stream to begin at age 75. A more risk averse individual might wish
to buy an immediate annuity that would begin income payments immediately at age 62.
Other Emerging Annuity Products. Some annuity products allow an individual
to buy a series of deferred annuities at different points in time, beginning at the retirement
age. This reduces the possibility of the investor investing a large sum of money in what
turns out to be a period of historically low interest rates.10 Another product that is in the
development stage is the combined annuity and long-term care product. The price of a
combined annuity and long-term care product could be 3%-5% lower than buying each
“The Inflation Protection You Can’t Get: In Search of an Indexed Annuity,” The Wall Street
Journal, May 25, 2005.
Mitchell, Brown, and Poterba, The Role of Real Annuities and Indexed Bonds in an Individual
Accounts Retirement Program, NBER Working Paper No. 7005, Mar. 2005.
“Longevity Insurance: New Products Attempt to Solve an Age-Old Problem,” The Wall Street
Journal, Aug. 10, 2005.
“Insurers Expand Annuity Products for 401(k) Plans,” The Wall Street Journal, Mar. 16, 2005.
See “Insurance Helps Balance Risk in Retirement” by David Wessel, The Wall Street Journal,
Nov. 17, 2005.
Legislation. Legislation has been introduced in the 109th Congress that would
encourage individuals to buy annuities for retirement income. Some of the legislative
proposals would also facilitate creation of products that combine annuity products with
long-term care, which should lead to increased sales of annuity products as well as added
coverage for long-term care.
The Retirement Security for Life Act of 2005 (H.R. 819, S. 381). This
legislation was introduced on February 15, 2005, by Representative Nancy Johnson and
Senator Smith and other members. It would provide incentives to encourage the purchase
of life annuities by excluding 50% of the annuity income (up to a maximum of $20,000
annually) that would otherwise be subject to federal income taxes under current law. The
$20,000 limit would be adjusted annually for inflation beginning in 2007. Income from
state and local government and nonprofit deferred compensation plans and from qualified
retirement plans (such as individual retirement accounts or 401(k) plans) would not be
eligible for this exclusion.
Lifetime Pension Annuity for You Act of 2005 (H.R. 2951). This legislation
was introduced on June 16, 2005, by Representative Earl Pomeroy. It is similar to H.R.
819 and S. 381 as described above but would also exclude 25% of the otherwise taxable
annuity income from qualified defined contribution retirement plans and from state and
local government (but not nonprofit) deferred compensation plans. Annual exclusions
would be limited to $5,000 (or $10,000 in the case of joint returns).
Flexible Retirement Security for Life Act of 2005 (H.R. 3912). This
legislation was introduced on September 27, 2005, by Representative Nancy Johnson and
other members. It is similar to H.R. 819 and S. 381 as described above, but would phase
in the exclusion over 10 years. The exclusion would be limited to $1,000 in 2006, rising
to $20,000 in 2015. The $20,000 limit would be adjusted annually for inflation beginning
H.R. 3912 would also provide enhanced tax treatment for combined annuity and
long-term care products. Under current law, long-term care benefits paid as part of a rider
to an annuity contract are considered taxable income. The bill would make such longterm care benefit payments exempt from federal tax. The exemption would not apply to
qualified retirement plans. H.R. 3912 would also allow individuals to exchange an
annuity for a long-term care policy on a tax-free basis. Under current law, an individual
exchanging an annuity for a long-term care policy would incur tax on the cash value of
Pension Protection Act of 2005 (H.R. 2830). The primary focus of H.R. 2830
is to reform funding rules for defined benefit pension plans. However, the legislation also
includes provisions to facilitate development of combination annuity and long-term care
products. For a nonqualified annuity contract with a long-term care rider, H.R. 2830
would make long-term care benefit payments nontaxable. It would also allow an
individual to exchange a nonqualified annuity for a long-term care policy on a tax-free
basis. The Senate counterpart of H.R. 2830 is S. 1783 and does not contain these
provisions. The two bills are currently in conference.