Social Security Benefits and Private Annuities: Compare and Contrast

The Social Security Administration (SSA) has released an issue paper that examines the similarities and differences between Social Security retirement benefits and annuities, and the factors that determine how much lifetime retirement income an individual would receive.

In “Social Security Retirement Benefits and Private Annuities,” Issue Paper No. 2017-01, Dale Kintzel explains some key features of Social Security retirement benefits; benefit payments to retired workers, their spouses, and survivors; and benefit taxation, as well as private annuities. The paper gives examples of the premiums needed to replicate Social Security retirement benefits and discusses the variables that affect the amount of annuity income. It also explains some of the risks of both the Social Security program and the private annuity industry.

Kintzel writes that because of the shift from defined benefit to defined contribution plans, workers have more responsibility for managing their income and assets so as to make sure they have sufficient funds for the duration of their retirement. And they must determine, he notes, whether to take the retirement savings accumulated in DC plans, IRAs, or other personal savings account as a lump sum, draw it down through disbursements as needed, or use some or all of it to purchase an annuity. Although privately purchased annuities seem similar to Social Security benefits because both offer a steady income stream, Kintzel argues that individuals may not understand how they differ.

Kintzel concludes that private annuities share some similarities with Social Security benefits; for instance, both provide a stream of lifetime income. However, he says, there are substantial differences:

• while Social Security provides benefits for survivors and fully indexes benefits each year to inflation, private annuities charge a higher upfront premium for similar protections;

• Social Security provides benefits that are not available in the private annuity market, such as benefits for ex-spouses and minor children;

• unlike private annuities, Social Security does not pay different benefit amounts to men and women because of their differing life expectancies; and

• the interest rate at the time of the annuity purchase affects an annuitant’s monthly payment, while Social Security bases the retirement benefit on an individual’s earnings and the age at which the individual claims benefits.

“As employer-sponsored retirement plans continue to shift from DB to DC plans, it is important for individuals and policymakers to understand both the significance of a steady income stream throughout retirement and the pros and cons of the various sources of retirement income,” Kintzel concludes.