Choice of taking annuity vs. lump-sum driven by individual plan rules, EBRI finds

The decision by retiring employees to take a stream of lifetime income, as opposed to cashing out the entire benefit, depends to a large extent on whether the individual plan allows or restricts lump-sum distributions, according to a recent survey by the Employee Benefit Research Institute (EBRI).

The EBRI’s research reveals that differences in defined benefit plan rules or features result in very different annuitization rates. The results show that the rate of annuitization—the rate at which workers choose to take their benefit as an annuity—varies directly with the degree to which plan rules restrict the ability to choose a partial or lump-sum distribution.

Lump-sum distribution options are key

Analyzing data from more than 80 different pension plans, the EBRI compared the “annuitization rate” among individuals at various age, tenure, and account balances, along with the rules and distribution choices within individual pension plans. The EBRI found that between 2005 and 2010, pension plans with no lump-sum distribution options had annuitization rates very close to 100%. In contrast, the annuitization rate for defined benefit and cash balance plans with no restrictions on lump-sum distributions was only 27.3%.

“Whether people annuitize depends to a large extent on whether or not they are allowed to choose some other option,” said Sudipto Banerjee, EBRI research associate and author of the study. “Any study of annuitization that fails to take into account the impact of plan design on participant choice will likely lead to misinterpretations.”

The report notes that through the 1960s DB plans offered mainly one distribution choice: a fixed-payment annuity. That changed beginning in the 1970s, as some DB plans began to offer the option of full or partial single sum distributions, and as “hybrid” pension plans expanded in the 1980s, so did distribution options. Today, most DB pension plans offer some type of single/lump-sum option, in addition to the traditional annuity choice.

Source: EBRI press release PR #1004, January 17, 2013.

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For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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