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There is a pressing need for a better understanding of how access to various types of
financial products can impact retirement behavior, especially if this access comes from a
change in the incentive scheme through a reform of the current Social Security system.
This is especially important if we are to provide useful policy recommendations
regarding reform to the current social insurance system. In this paper I focus on the
“annuity puzzle,” the question as to why the annuity market is so narrow. I present a
model that endogenizes the annuity decision along with the consumption/saving and
labor supply decisions. This research enhances our understanding of how annuities work
in a life cycle model with more realistic characterizations of the choices and incentives
that individuals face. My results show that the low rates of annuitization can be the
product of optimal decision making by individuals in a life cycle model which
endogenizes the labor/leisure decision and accounts for Social Security. The government
should pay particular attention to the rules regarding withdrawal of benefits through
annuities or lump-sums when introducing individual retirement accounts or other
privatization schemes, given the interaction between retirement incentives and the
attractiveness of annuities.
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