The Marshmallow Test and the Annuity Mindset

By: Steve Schaumberger

I have been in the insurance business for over three decades. Over the past few years, I have developed a strong understanding of annuities and personally purchased several as part of my own portfolio.

What I’ve learned during this process has truly been eye-opening. Specifically, annuities have a great deal in common with the famous marshmallow test which was conducted in the late 1960s.

Let me explain.

In the original experiment at Stanford University, a preschool-aged child was brought into a room and offered a marshmallow.  The child was given a choice:

• immediate reward: eat one marshmallow now

• delayed reward: wait for the proctor to return and receive two marshmallows

  
  

The proctor then left the child alone with a single marshmallow for ten to 15 minutes and observed what took place. Invariably, the child prioritized immediate gratification and ate the marshmallow.

Fast forward to adulthood, and immediate gratification still rules the day when it comes to annuities. Perhaps the message from the popular book “Everything I Really Know I Learned in Kindergarten” is true!

The Best of Intentions Often Go Astray

While I was well aware that most life insurance policies, including 98% of term policies, don’t pay a death claim, I wasn’t aware that the vast majority of deferred annuities do NOT annuitize.

Pertaining to life insurance policies:

• Individuals oftentimes let their life insurance lapse or surrender policies long before they would otherwise result in a death claim.

• Insurance companies know this and price life insurance policies with the expectation that most of them won’t pay a death claim.

• In other words, if all life insurance polices paid a death claim, they would be priced significantly higher.

Pertaining to deferred annuities:

• The vast majority of deferred annuities never annuitize

  • fewer than 5% of deferred annuities are turned into the lifetime income stream they were designed for

  • the remaining 95% of deferred annuities are cashed out, rolled over or withdrawn early

• There are several reasons, including behavioral, financial and market-based, for the low rate of annuitizing deferred annuities

• Similar to the pricing for life insurance policies, where actuaries expect most policy to lapse, annuities are priced with the expectation that most do NOT end in annuitization.

• In other words, if all deferred annuities were annuitized, the returns offered would be significantly lower.

The lesson is simple. While most people start with good intentions, life gets in the way. 

While individuals have the best of intentions planning for their long-term retirement, their immediate needs, such as buying a home, covering college expenses, or handling a medical bill, often take priority.

The lessons from the marshmallow test, which studied children’s patience, still hold true for adults. The lessons were not about marshmallows.  They were about human behavior.

• Individuals tend to forgo long-term plans in favor of short-term desires.

• People struggle with delayed gratification.

• We value what is right in front of us more than what is promised down the road.

The same psychology drives how adults treat their money. Deferred annuities are, in essence, a real-world marshmallow test. By waiting 10 to 15 years, or longer, individuals might be rewarded with significant ongoing income

Effectively, individuals with the patience and wherewithal to annuitize deferred annuities have the opportunity to obtain a bushelful of additional marshmallows!

Why People Cash Out Early

When individuals inquire why more people do not see the full benefit of their annuities, the answer often comes down to behavior, not math.

• Liquidity bias: People prefer having access to their money, even if it means giving up larger long-term income.

• Present bias: Today’s dollars feel more certain than tomorrow’s dollars.

• Loss of flexibility: Annuitization feels like a commitment, so many avoid it by taking withdrawals instead.

• Immediate needs: Life’s expenses such as homes, cars, kids, and healthcare make it tempting to take the money now.

These choices are understandable, but they come with a cost. Individuals who cash out their annuities early oftentimes miss out on bonuses, growth multipliers, and participation rates that reward patience.

Why the Numbers Look So Generous

Individuals often tell me, “This annuity looks too good to be true.”

They see guaranteed income and lifetime benefits that are unusually strong.

Alas, the bonuses, multipliers and participation rates which bolster the benefits are frequently available only if individuals stay the course and don’t bail out early.

If individuals stray, as invariably occurs, they oftentimes don’t receive these benefits. Insurance carriers design annuities knowing that only a small percentage of owners will have the persistence to realize the full potential. Those who persevere are rewarded handsomely. It is the same idea as the marshmallow test. The biggest rewards are reserved for those who wait.

The Real Lesson: Patience Pays

Annuities are not built for instant gratification. They are built for long-term stability and lifetime income. The challenge is resisting the temptation to “eat the first marshmallow” and cash out when life gets busy or uncertain.

If individuals can be patient, trust the process, and play the long game, the reward can be remarkable. Those who wait not only protect their income, but they also gain the financial peace of mind that few other tools can match, accumulating more marshmallows than they ever imagined possible!

At NFP Insurance Solutions, we help clients create strategies that align with both their goals and their behavior. We take the time to understand how life’s real demands can affect long-term plans and help structure annuity solutions that make patience easier to achieve.

Whether it is choosing the right product, layering income options, or building flexibility into the design, our role is to make sure that waiting for the second marshmallow truly pays off.

So when you think about your retirement plan, picture that marshmallow on the table. The real question is not whether you like marshmallows, it is whether you can wait for the second one.

If you can wait and if you have the right team guiding you, the payoff is worth every minute.