Default and Naïve Diversification Heuristics in Annuity Choice

Retirement income stream products are difficult for consumers to choose because of their high perceived risk, irreversibility, and high expenditure; little opportunity for social learning; and distant consequences. Yet many countries have shifted more responsibility for these choices to consumers, increasing their likelihood of using suboptimal heuristics without carefully evaluating alternatives. Prior literature is unclear about consumers' use of heuristics in decumulation decisions or whether sociodemographics can help identify vulnerable consumers. The purpose of this paper is to address some of these gaps by examining choices of life annuities and phased withdrawal products and identifying use of default options and the diversification (1/n or 50:50) heuristic using a novel finite mixture modeling approach. We show that more than 30% of decumulation choices rely on these two heuristics and that cognitive and product knowledge limitations contribute to using such heuristics. The results have implications for public policy on decumulation of retirement savings, regulation of product disclosures, and marketing of annuity and phased withdrawal products. More generally, the model we develop and apply has the potential to provide better understanding of the use of heuristics in consumer decisions