Retirement tontines: Using a classical finance mechanism as an alternative source of retirement income

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Editor's note:

This paper was written in conjunction with the New tools for a better retirement: Dashboards and tontine solutions for Americans event on September 17, 2020.

Households face two related but distinct financial challenges as they prepare for retirement: first accumulating enough retirement savings during their working years, and then spending down their assets wisely after retiring. A substantial literature reaching a wide range of conclusions examines the extent to which households are saving adequately for retirement.

But there is more consensus about the challenges households face when deciding how best to spend down their savings. People do not know how long they or their spouse will live (not to mention what their health care costs and investment returns will look like), which makes them prone either to consuming too much too soon, leaving them with insufficient resources as they age, or consuming too little and thus having a lower standard-of-living in retirement than they could have afforded.

Managing assets in retirement has become a more widespread problem over time as lifespans have increased and as more retirees depend on defined contribution (DC) retirement savings rather than defined benefit (DB) pensions. DB plans pay benefits at regular intervals, typically monthly, for a retiree’s lifetime. This pension annuity ensures that beneficiaries will not run out of income as they age. DC plans rarely provide annuities.

Despite these trends, take-up of private annuities remains low. Other financial products, such as managed payout funds, have certain advantages but are not yet available in most retirement plans. These circumstances leave many households without satisfactory ways to convert their retirement savings into income.

In this paper, we explore the potential for a different financial product—a tontine—to help people manage their assets in retirement. Tontines are investment pools where members commit funds irrevocably and where the resources and income claims of members who die are given to members who survive. Tontines can be adapted to a wide variety of financial structures. They have financed everything from European wars to colonial-era capital projects to Americans’ retirement. They were quite popular in the United States in the late 1800s and early 1900s until they were effectively (though not literally) outlawed in response to corrupt insurance company management.

The “tontine principle”—that surviving group members benefit financially from the death of other members—can evoke strong reactions, and has inspired murder plots in novels, movies, and even a Simpsons episode. But the mechanisms involved are not very different from how group annuities operate, and members of modern tontines would be mutually anonymous in any case.

In recent years, analysts have revisited tontines as a theoretical tool, and several countries have created pension plans that incorporate tontine principles. Some current retirement products in the United States have a tontine-style structure as well.

Our central premise is that tontine-style products could play a significantly broader role in financing the retirement of U.S. households, assuming that certain operational questions can be resolved. Such products could provide higher returns than annuities do, but with less security. They would be valuable to those seeking some insurance against their own longevity without requiring a certain level of future income.

Read the full report here and a policy brief here.