Longevity Risk Leading to Widening Retirement Income Gap

The Institute said its research found 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% chance of living to at least 90 and healthy women a 35% chance of living to 90.

Less than one-third of retirees included in the research said they are concerned about outliving their retirement savings, but 61% admitted they have not made a formal calculation of how much they can afford to spend monthly to prevent doing so. The most popular reported income planning strategy among those who have not calculated their monthly spending allowance is to “live as they did before retirement and make adjustments later if necessary.” Van Harlow, managing director, Fidelity Research Institute, said in the release that strategy would be riskier for pre-retirees.

According to the press release, the Institute’s report discusses how retirees can manage key retirement risks, such as increasing longevity, inflation, and market volatility and create a personally “optimal” retirement income stream by assessing combinations of three basic lifetime income options, including:

• 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 his or her chosen asset allocation mix.

In addition, the report gives five guidelines for structuring a sustainable retirement portfolio:

1. Retirement income plans should not only consider asset allocation among stocks bonds and cash but also 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, Structuring Income for Retirement, can be accessed at http://www.fidelityresearchinstitute.com/.