October 6, 2024 — Retirees may be hurting their long-term financial security by cashing out smaller retirement accounts instead of turning them into steady income streams, according to a new study from the Hebrew University of Jerusalem.

The research published in Management Science 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. Many individuals in different countries keep their retirement assets (e.g., 401k) in multiple accounts of different sizes at different companies. This choice can hurt their long-term financial security, leaving them with less stable income in retirement. For financial companies, this behavior has implications for their ability to manage assets liabilities risks (ALM).

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

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, Dean, Department of Finance, Albertson-Waltuch Chair in Business Administration at the Hebrew University Business School. “It is vital for asset and liability management strategies, especially as these decisions directly impact the future reserves required for annuity providers.”

The study draws on proprietary insurance company data along with an online survey and lab experiment. The researchers used occupation as a proxy for wealth and found 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.

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 research paper titled “Is One Plus One Always Two? Insuring Longevity Risk While Having Multiple Savings Accounts” is now available at Management Science and can be accessed here.

Funding

Funded by the Albertson-Waltuch Chair in Business Administration, the Kruger Center at the Hebrew University, the Think Forward Initiative, the German Israeli Foundation for Scientific Research, and the Robert H. Smith Faculty for Agriculture, Environment and Natural Resources at the Hebrew University of Jerusalem.

Researchers:

Abigail Hurwitz1, Orly Sade2

Institution:

1. Environmental Economics and Management, Institute of Environmental Sciences, Robert H. Smith Faculty of Agriculture, Food, and Environment, The Hebrew University of Jerusalem

2. Dean, Department of Finance, Albertson-Waltuch Chair in Business Administration Hebrew University Business School (HUBS), The Hebrew University of Jerusalem