A key challenge many households entering retire-ment face is how to use their savings as a source of income. As 401(k)s replace traditional defined benefit pensions and as Social Security replaces a smaller share of household pre-retirement earnings, draw-ing an income from savings becomes increasingly important. Households have three traditional options. First, they could put their savings in safe assets, preserving the value of their principal, and live on the interest. Second, they could invest their savings in a portfolio of stocks and bonds and draw out an income. Third, they could buy an annuity from an insurance compa-ny, giving up their savings in exchange for a lifetime income. In addition to these three traditional options, households could use their savings to “buy” an an-nuity from Social Security: they could delay claiming their Social Security benefits to get a higher monthly benefit at an older age, using their savings in the interim to pay current expenses. The savings used is the “price” and the increase in monthly benefits is the annuity it “buys.”
