Fidelity Research Institute Report Cautions Investors of Widening Guaranteed Income Gap and Poor Life Expectancy Planning When Approaching Retirement.

Institute Analyzes Role of Income Products in Retirement, Suggests Guidelines for Creating Sustainable Lifetime Income

BOSTON -- As the oldest of the Baby Boomers begin turning 62 years old on January 1, 2008 -- the average age for retirement in America today and the age at which they become eligible to receive Social Security -- a new report released today by the Fidelity Research Institute reveals that pre-retirees significantly underestimate the length of their retirement years and how long their savings will need to last.

This miscalculation will become increasingly problematic as the traditional guaranteed income sources of Social Security and defined benefit pensions begin to replace a smaller and smaller share of their pre-retirement income.

According to new research conducted by the Institute, pre-retirees believe they will need to make their retirement savings last until an average of age 83. Yet, estimates today give a healthy 65 year-old man a 24 percent chance of living to at least 90 and healthy women a 35 percent chance of reaching that same age. This discrepancy highlights how many pre-retirees underestimate their life spans, and therefore risk outliving their assets.

The report, "Structuring Income for Retirement," notes that pre-retirees will face a widening guaranteed income gap, which, at a national level, is likely to be billions of dollars a year. The report analyzes the emerging income gap, assesses three retirement income building block options and introduces five guidelines to consider when structuring an income portfolio for retirement.

"Many of today's retirees have the luxury of knowing that even if they overspend in their early retirement years, they still have a broader safety net of guaranteed income sources to help them get through," said Van Harlow, managing director, Fidelity Research Institute. "However, pre-retirees will have a much smaller net to catch them if they make a planning mistake, and even if they accumulate additional savings to compensate, they will still need to determine how best to structure their portfolio to reduce their personal guaranteed income gap."

The Institute report outlines a conceptual framework which addresses the complex interplay between the variability of future investment returns, the uncertainty around life expectancy and the role that guaranteed income can play in helping retirees to achieve a financially secure retirement. Additionally, it explores ways to structure income for retirement given the tradeoffs among spending rates, retirement risk, and bequest desires.

No longer will retirement planning be just about determining how to manage investment risks associated with the stock market's ups and downs and the unpredictability of how long retirees will live. It will take on a whole new dimension of planning sustainable guaranteed income streams for a retirement period that could stretch 20, 30 years or more.

Interestingly, the Institute's research found that fewer than one-third of retirees are concerned about outliving their retirement savings, yet the majority (61%) admit that they have not made a formal calculation of how much they can afford to spend each month to prevent outliving their savings1. For those who have no idea how much they can afford to spend, the most popular reported income planning strategy is simply to "live as they did before retirement and make adjustments later if necessary."

"For pre-retirees, over half (53%) of which are concerned about outliving their retirement savings, the "adjust as you go" planning approach will become even more risky," notes Harlow.

The Role of Income Products in Retirement Portfolios

The good news for anyone planning their retirement is that there are a wide array of investment options and income products that can help mitigate some of the key retirement risks, such as increasing longevity, inflation and market volatility.

The Institute's report discusses how retirees can manage these risks and create a personally "optimal" retirement income stream by assessing combinations of three basic lifetime income options.

* Lifetime Income Annuity (LIA) with fixed or variable payments -- These annuities provide lifetime payments to the purchaser, and therefore, represent longevity insurance.

* Variable annuity with guaranteed living income benefits for life, e.g. a Guaranteed Minimum Withdrawal Benefit (GMWB) -- Provides a guarantee of a minimum withdrawal payment for life with growth potential to increase future payments, while the annuity holder maintains some access to their account value and the potential to leave some bequest if they die "prematurely."

* Traditional Systematic Withdrawal Plan (SWP) with investments in stocks, bonds and cash -- A traditional way of self-funding retirement through a strategic asset allocation to stocks, bonds and cash. The retiree draws from this portfolio "systematically" -- generally a percent of the total assets per time period -- while maintaining their chosen asset allocation mix.

Each of the three investment options plays a different role within a portfolio designed to provide structured income in retirement. The report highlights how each can partially or fully hedge various retirement risks, but with different costs and tradeoffs. For example, if hedging against inflation is of critical importance, the SWP option should be a significant source for generating income. On the other hand, if providing a fixed payment every month, regardless of the performance of the stock and bond markets, is important, the LIA may be most suitable.

"It is important to note that no one investment option absolutely dominates the other," said Harlow. "Instead they vary based on the individual retiree's weighting of the peace of mind of the insurance protections provided versus asset and estate growth potential. Ultimately, this balance can be characterized as a tradeoff between the sustainability of one's retirement funding and the desire to provide an inheritance for your heirs."

Five Guidelines for Structuring a Sustainable Retirement Portfolio

Through the development of a Retirement Sustainability Quotient -- a measure of the likelihood that a given mix of income products and assets will provide sufficient retirement income spending over time -- the report suggests five general guidelines for structuring a portfolio to successfully meet lifetime income needs.

1. Retirement income plans should not only consider asset allocation -- among stocks bonds and cash -- but also "product allocation" that is, the possible inclusion of income products that can offer longevity insurance, inflation-hedging and assured payment streams.

2. When income products are being considered, investors should clearly understand that there are trade-offs between guaranteed lifelong income and inflation protection versus such values as investment control, liquidity, fees and costs and the potential size of bequests to heirs.

3. Those who have sufficient assets to sustain retirement incomes at very low rates of withdrawals may find that the additional longevity insurance they might gain by buying annuities or other income products costs more (in terms of much-reduced estates) than it is worth (in terms of minimally increased sustainability). Income products, in short, are not for all.

4. Those who need to draw higher percentages from their nest eggs may, by contrast, find that committing a portion of their assets to income products can substantially increase the sustainability of their retirement income plans -- albeit at the cost of reducing any possible bequests. If there is no need to plan for sizeable bequests, fixed annuities offer an attractive protection benefit. If there is a desire for more substantial bequests, variable annuities with GMWB features and traditional systematic withdrawal are more attractive.

5. Retirement income plans have a core trade-off: higher income or bequest targets mean lower chances for success. Higher targets for income or bequests generally also suggest larger allocations to variable annuities with GMWB features or to traditional SWP's -- both of which offer possible equity appreciation that fixed income annuity products do not.

The report concludes by calling for continued education and research on income products and innovation centered on making these products more flexible, transparent and cost-efficient.

"Currently, the trade-offs presented by many guaranteed income products are too complex, and the deterrent to purchase is exacerbated by the perception that these are irreversible decisions," said Harlow. "Until the importance of guaranteed income is more effectively communicated and its benefits to specific financial situations clearly demonstrated, investors' willingness to consider or purchase guaranteed income products will increase only at a measured pace.

"Growing consideration, acceptance and sales of income products will, however, be driven -- for decades to come -- by the emergence of a guaranteed income 'gap' that investors are only now beginning to see ahead of them," concluded Harlow.

About the Fidelity Research Institute

The Fidelity Research Institute is designed to advance knowledge of how proven investment theory and public policy can be put into practice to help Americans invest wisely to meet their financial needs. The Institute works with resources across Fidelity Investments as well as within the financial services industry and academia to accomplish its mission. Its reports are available at www.fidelityresearchinstitute.com.

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1 Fidelity Research Institute, "The Role of Guaranteed Income in Retirement Income Planning," July 2007.