Pre-retirees significantly underestimate the length of their retirement years and how long their savings will need to last, according to a report released Wednesday by the Fidelity Research Institute in Boston. That's potentially a big problem for many folks, particularly as the traditional guaranteed incomes sources of Social Security and defined benefit pensions comprise smaller chunks of their pre-retirement income.

According to the Institute's research, 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 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 guidelines to consider when structuring an income portfolio for retirement.

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 they have not made a formal calculation of how much they can afford to spend each month to prevent outliving their savings. 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."

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.

The first is a Lifetime Income Annuity (LIA) with fixed or variable payments. These annuities provide lifetime payments to the purchaser and represent longevity insurance.
The second is a variable annuity with guaranteed living income benefits for life-for example, a Guaranteed Minimum Withdrawal Benefit. These provide 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."

The third option is a Traditional Systematic Withdrawal Plan (SWP) with investments in stocks, bonds and cash. This is 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.

The report suggests that retirement income plans should not only consider asset allocation among stocks bonds and cash, but also "product allocation" such as income products that can offer longevity insurance, inflation-hedging and assured payment streams. At the same time, investors need to realize 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.