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Boomers, Retirement Plans And Guaranteed Income

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Collectively, the baby boomer generation may be facing an uncertain retirement future due to escalating health care costs, increased longevity, fewer defined benefit pension plans, and uncertainty about Social Security and taxes. In fact, boomers bear greater responsibility for their own retirement destinies than any previous generation in the United States.

That opens up an opportunity for the retirement industry to influence the outcome by demonstrating how guaranteed lifetime benefits can fill an essential role within retirement plans.

This is being spurred along by the Obama administration’s recently announced retirement plan initiatives for 2010, calling for lifetime income guarantees in 401(k) plans.

While the retail annuity space has had much success with guaranteed living benefits, the defined contribution market is still in the early stages of testing what innovations would have the greatest appeal to plan participants.

But the core and trailing boomers within 10-20 years of retirement need an in-plan option now–one that will enable them to begin converting accumulated DC dollars to guaranteed lifetime income dollars.

Currently, the industry is focusing on a few different approaches. Here are some:

? Guaranteed lifetime withdrawal benefits. This is far and away the most popular income conversion feature available on the retail annuity side of the insurance business today. Originally, the appeal of the GLWB was its simplicity and lifetime guarantee, although designs have now grown a bit more complicated. But the original appeal may easily transfer into the DC market, especially when married to a target-date fund series (see below).

GLWBs retain market exposure and growth potential as a hedge against inflation. Example: A $1,000 contribution at age 55 may be convertible into a minimum guaranteed annual withdrawal of $55 at age 65. But if that $1,000 grows to, say, $1,800 by age 65, it may be convertible into a minimum guaranteed annual withdrawal of $99 at age 65.

The annual withdrawal is guaranteed for life. So even if the participant’s account balance is eventually exhausted by the guaranteed withdrawals, the annual amount will continue to be paid for life.

Considerations: Although GLWB riders within DC plans may be gaining in popularity, plan participants always need to consider the fees associated with them.

Also, if a market downturn occurs after the withdrawals begin, it becomes increasingly more difficult to grow the account balance. Such growth is needed if the minimum guaranteed annual withdrawal is ever to increase. Without it, the end result may be a level income that is unable to keep pace with inflation.

? Guaranteed minimum income benefits. These annuity features are distinctly different than GLWBs, but they have recently started looking like the GLWBs.

The GMIB guarantees a minimum value that can be converted to a fixed monthly benefit under a traditional lifetime annuity. This minimum value cannot be withdrawn but will not decrease for withdrawals from the account balance that do not exceed a certain amount.

Their use has been limited, as they are more complex than GLWBs and mandate annuitization.

Considerations: With GMIBs, participants need to consider that there are potentially low minimum conversion rates. They also need to weigh the potential loss of control of assets for the guarantee and the fees for the guarantee.

? Hybrid target date funds. These essentially are an in-plan approach that embeds the GLWB within the target date fund series offered in a DC plan.

Such funds are gaining traction and will likely be popular with participants due to their built-in investment strategy. The focus is on the investment and the lifetime income, not the annuity wrapper.

An important feature of this strategy keeps it simple for unsophisticated investors and plays to a wide range of investment styles, which would include the employee base for a large organization.

Considerations: Participants need to consider the fees associated with having a lifetime income guarantee embedded within a fund that is designed to become more and more conservative leading up to and through retirement.

? Guaranteed income purchase programs. A few providers are offering these GIPPs within DC retirement plans. This approach incrementally purchases a future fixed income, thereby enabling the plan participant to dollar cost average into a minimum guaranteed lifetime income.

Considerations. While GIPP has limited or no flexibility or liquidity, along with minimal income portability, it does provide greater leverage for retirement income. For employees who are simply looking for the highest source of fixed income, this option may be something to consider.

? Traditional and non-traditional annuity options. Any plan that is already annuity-based has traditional annuity options available to provide guaranteed lifetime income at the point of retirement. These traditional options are also available to any participant through a rollover out of the plan.

Considerations: While use of traditional annuity options is extremely low, they too offer greater leverage for retirement income. In addition, some retirement service providers are now offering non-traditional annuity options that provide access to the account balance, equity-based performance or inflation protection, greater flexibility, and death benefits.

Many providers have been slow to adopt options like those above due to inherent difficulties in portability and plan administration. Also, there are fiduciary liability issues and fee considerations. But changes to DC plans are happening, and providers need to offer essential tools and basic education.

Dan Herr is assistant vice president-product research and development for Retirement Solutions at Lincoln Financial Group, Hartford, Conn. He can be reached at [email protected].


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