White Paper - University Conference Services

Lincoln Secured Retirement IncomeSM Solution: Addressing Participant Retirement Income Risks

A WHITE PAPER BYFRED REISH AND BRUCE ASHTON

Bruce L. Ashton(310) 203-4048

[email protected]/bashton

C. Frederick Reish(310) 203-4047

[email protected]/freish

INFORMATION IN THE PROSPECTUS FOR LINCOLN SECURED RETIREMENT INCOMESM IS NOT COMPLETE AND MAY BE CHANGED. LINCOLN MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT INCLUDING A PROSPECTUS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THE PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.

For plan sponsor use only. Not for use with plan participants.

hudsos2

Compliments of Lincoln Financial

Lincoln Secured Retirement IncomeSM Solution: Addressing Participant Retirement Income Risks 2

Retirees in the 21st Century face a stark reality: they may not have enough money to live on in their 80’s or 90’s. This White Paper discusses the reasons behind this problem, possible solutions offered by the insurance and investment industries and the way in which one product, the Lincoln Secured Retirement IncomeSM guarantee developed by Lincoln Financial Group, addresses the problem.

The problem of running out of money that many retirees face is due in large part to the continuing shift from defined benefit pension plans into the savings-based plans, such as 401(k) and 403(b) plans. Until the 1990s, employer-sponsored defined benefit pension plans, along with Social Security, provided retirement income for a large segment of the workforce (and this continues to be the case for most government and union workers). Employees enjoyed the security of a stream of income for life guaranteed by their pension plan, their employer and ultimately by the Pension Benefit Guarantee Corporation (PBGC). In contrast, today defined contribution plans and rollover IRAs dominate the landscape. In these plans, workers typically receive a lump sum of money at retirement and are largely left on their own to figure out how to invest it, how to withdraw it and how to make it last for their lifetimes.

This shift has exposed retirees to a number of risks. The risks include living for 20, 30 or more years in retirement – so-called longevity risk; sequence of returns risks; the risk of excessive withdrawals; inflation; cognitive impairment risk; and the risk of exhaustion of benefits. Each of these risks can be summarized in a question:

• How much replacement income does a retiree need to pay his bills, both monthly and unanticipated? Studies suggest that retirees will need 75% to 85% of their final pre-retirement pay to live on, more than most plan participants anticipate. Other than participant education and plan design features, there is little that can be done to address this “savings” issue.

• How long will the retiree (and perhaps the retiree’s spouse) live? There is a substantial probability that retirees or their spouses will live 30 or more years after retirement. (The probability is 25% to 50%, depending on the study.) This obviously means that retirement income needs to last for many years.

• Howdoesaretireecopewithinvestmentmarketdownturnsafterhe begins to withdraw from his investments? Called “sequence of returns” risk, the impact of market downturns at the

Summary

MARCH 2013

TABLE OF CONTENTS

Summary 2

Identifying the Retiree Risks 5

Possible Solutions 8

Introduction 8

Available Products 8

In-Plan versus Out-of-Plan Options 11

The Portability Issues 12

The Lincoln Secured Retirement IncomeSM Solution 13

Description of the Product 13

Addressing the Portability Issues 15

Addressing Retiree Risks 15

Summary of the Lincoln Secured Retirement IncomeSM Features 16

Conclusion 18

Endnotes 19

Lincoln Financial Group believes that plan sponsors considering a guaranteed withdrawal benefit solution should have a full understanding of the product and other alternatives, including the Lincoln Secured Retirement IncomeSM solution. In particular, Lincoln Financial Group believes it would be especially helpful for the plan sponsor to receive this information from an independent and experienced source. Accordingly, Lincoln Financial Group has commissioned Drinker, Biddle & Reath, LLP to prepare this white paper, and a companion white paper entitled, “Lincoln Secured Retirement IncomeSM

Solution: Fiduciary Process in Evaluating In-Plan Guarantees.”


wrong time is two-fold. First, it reduces the money available to live on. Second, because the losses are fully realized as investments are liquidated to provide for living expenses, it is difficult to recover even if the market makes substantial gains in the future.

• How much money can a retiree safely take out of his retirement savings each month? Economic models suggest that withdrawal rates of between 4.5% and 5% of a 65-year old retiree’s initial account balance are “safe.” Based on surveys of retirees, many people unrealistically believe they can withdraw as much as 10% each year.

• How does a retiree invest and withdraw his retirementsavingsinanticipationofinflation? Though inflation in the United States has been low over the last few years, it may again become a serious factor, which will erode the value of retirement savings. Few market solutions address this issue.

• How should a retiree arrange his retirement assets to deal with impairment in his ability to make sound financialdecisionsashegetsolder? This is an emerging issue. Cognitive ability, especially related to financial issues, degrades as people age and particularly in their 80’s. This exposes them to either poor decisions or unprincipled or ill-advised “intermediaries,” which can rob them of their savings at a time when they are especially vulnerable.

The retirement community has devised a number of approaches to these issues. Some are investment based, some are annuity based and some are a blend of both. In the first category are managed payout and retirement income mutual funds and managed account services. These investment products and services offer a partial solution to the withdrawal rate issue, in that they provide for specific distribution amounts or a specified rate of distribution and may offer inflation protection when the stock market advances. Unfortunately, they cannot address the longevity risk; they cannot guarantee that the funds will last for the retiree’s lifetime, since only an insurance company can offer such a guarantee.

Traditional annuities provide a solution for the longevity, withdrawal rate and cognitive impairment risks and may in some cases address (or partially address) the inflation risk. A perceived drawback of an annuity is that the retiree loses control of his funds. He is locked into a distribution rate and cannot withdraw additional amounts if needed. And

when he dies, the payments stop. (In the case of a joint and survivor annuity, the payments would only stop at the death of the spouse, while for an annuity with a fixed period guarantee, the payments would continue until the end of the fixed period.) Another approach is the deferred annuity, sometimes referred to as longevity insurance. Here, annuity payments begin, if – but only if – a retiree reaches a specified age, often 85. While the premium cost is lower than for traditional annuities, if the retiree dies before reaching the specified age, the money is lost.

The blended solution, and the one chosen by Lincoln, is the guaranteed minimum withdrawal benefit (GMWB) product. (GMWB products are also referred to as “guaranteed withdrawal benefit” or GWB products, which is the term used throughout the remainder of this White Paper.) In such a product, a participant invests money in his account in an investment that includes a GWB guarantee. At retirement, the participant begins to take withdrawals from his account (either in the plan or after it has been rolled over to an IRA) at a specified rate (depending on the retiree’s age and whether the guarantee also covers his spouse). If the money in his account runs out, the insurance company will continue to make payments at the same rate.

A second aspect of the guarantee is that the insurance company uses an “income base” to determine a participant’s withdrawal rate. While the income (or benefit) base may be calculated differently depending on the insurance company, in the case of the Lincoln GWB, the income base is equal to the greater of (1) the prior year income base plus contributions or (2) the current market value of the investment, and is recalculated annually by Lincoln. Withdrawals are a specified percentage of the income base (and not the actual account balance). Assuming a participant does not take withdrawals in excess of this percentage, the income base can only increase; it cannot go down. As a result, the participant’s withdrawals are guaranteed, even if the value of his account is reduced through, for example, market losses. In exchange for these guarantees, the participant pays a premium each year.

The GWB solves the longevity issue by providing a guarantee of lifetime income. It also helps address the withdrawal rate issue by establishing a set rate at which funds may be withdrawn. It may address inflation to the extent the account continues to have investment gains and the income base increases. It may help address the cognitive risk issue by


establishing a pattern of withdrawals that are put in place when the participant retires. And unlike the annuity, it leaves control of the funds in the hands of the retiree, so that he has access in the event of emergency. If the retiree dies before the account runs out, the balance can be left to his beneficiaries.

The Lincoln Secured Retirement Income® product contains all of the features and offers all of the solutions described above for GWBs. In addition, it also minimizes the cost to the participant during the accumulation phase by gradually phasing in the guarantee, beginning 10 years before the participant’s target retirement date.

In this Paper, we discuss the retirement income risks in detail, identify alternatives for dealing with the risks and assess in more detail how the Lincoln Secured Retirement IncomeSM product being offered by Lincoln Financial Group helps answer the questions raised earlier. In a companion White Paper that is under development, entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees,” we analyze the prudent process that plan fiduciaries need to follow in selecting a guaranteed lifetime income product and how that process can be applied to the Lincoln product.


American workers have longer life expectancies than prior generations, and our children may have a reasonable expectation of living to 100 or more. This fact adds stress to a system that relies on plans based primarily on employee deferrals, such as 401(k) and 403(b) plans1 -- plans that were not designed to be the primary source of retirement income. This is not to suggest that 401(k) and 403(b) plans are flawed retirement vehicles, but instead that they need to evolve to take on a role that was not contemplated when they were created.

Unfortunately, many working Americans approach retirement without fundamental knowledge of the risks they face in a defined contribution system – some are even calling this the post-retirement crisis.2 Government regulators and the retirement plan marketplace are only beginning to understand and address the issues created by the shift to savings plans.3 Education is needed for plan sponsors and participants about the need for sustainable lifetime income – that is, monthly income guaranteed to last for a retiree’s life.

To appreciate the changes that are happening, it is important to understand the problems that fuel the need for change. One change is the lengthening of retirement because of increasing life expectancies. When workers retire at age 65 or 67, they have a significant chance of living 20 or 25 or even 30 more years. This means that retirees need to save more money than was needed in prior generations – because the money must last longer than most expect.4 It also means, as studies have shown, that most Americans are not saving enough to meet their retirement needs.5

Participant awareness of the retirement dilemma has also increased, with a majority of participants stating they need help with these issues. In a recent study6, 82% of participants indicated that they believe investment products with guaranteed features would be a welcome addition to their retirement portfolio. Additionally, 84% of participants said they would remain invested in equities even if they were to experience a loss due to a market downturn, so long as their assets had insurance or protection from market volatility and declines. In a separate participant research study7, the findings indicate retirement security has increased in importance over the last three years for almost 90% of all participants – and more so for participants over the age of 50. Most mid-career participants have indicated that

their D.C. retirement plan will be the primary source for their retirement income. Most importantly, 77% of participants indicate that they either partially agree, agree or strongly agree that they would be willing to pay additional amounts for guaranteed retirement income.

The complexity of these issues leads to the conclusion that 401(k) and 403(b) participants need help in figuring out how much to save during their working years, how to invest their savings both before and after retirement and how to withdraw their savings in retirement. There are a number of solutions being addressed by insurance companies, mutual fund complexes and investment professionals, but only one group – the insurance companies – is able to offer a guaranteed solution.

Retiree RisksThe “post-retirement crisis” has grown out of a combination of factors that, taken together, can cause retirees to run out of money at a time when they have little chance of replacing it (i.e., in their 80’s or 90’s). Here are the key issues:

1. How Much to Save.

This may be referred to as the replacement income risk. The major aspect of this risk is that workers do not know how much money they need to accumulate to provide adequate income in retirement. Studies indicate that the amount needed to sustain a retiree’s lifestyle is between 75% and 85% of his final pre-retirement pay, including his Social Security retirement income.8 But how does a plan participant know the amount he needs at retirement to provide that much income? And, once a participant knows that amount, how can he know how much to defer each pay period in order to reach that goal? There are a number of services that help answer this question through “gap analysis,” that is, measuring the amount the participant has today against projected need, and then giving the participant an idea of how much more he should save each pay period to reach that goal.

In addition, the Department of Labor (DOL) is working on a proposed regulation that would require that monthly income projections be included on participant statements. (Many providers already offer this service if plan sponsors select it.) This should help participants grasp the concept of converting their account balances into future streams

Identifying the Retiree Risks


of retirement income. Nevertheless, participants are still faced with the difficult task of figuring out how much they will need and how to get there.

2. Life Expectancy.

In our experience, few participants appreciate how long they will probably live after they retire.9 The reality is that there is a 50% probability, for a married couple aged 65, that at least one spouse will live another 27 years and a 25% probability that one will live at least 30 years after retirement.10 (Indeed, some studies suggest that the probability of living to age 95 is closer to 50%.11) In other words, there is a substantial probability that a participant who retires at 65 will need retirement funds to last for 20, 30 or more years. Consider the following: if the typical worker begins his or her career at age 25, he will have worked for 40 years when he retires at age 65. In that period, he will need to have paid all his current expenses – providing food, shelter, transportation and entertainment for himself and his family – and created a nest egg that may need to last for 30 years or more.

The longevity risk is compounded by the fact that there is no pooling element in defined contribution plans – as there is in a defined benefit pension plan where the entire pool of assets is available to pay benefits – so that the retiree must look solely to his own retirement savings (plus Social Security) to fund his retirement – at least in the absence of a product that guarantees lifetime income.

The longevity risk leads to what we are calling the “longevity assumption.” That is, as a practical matter, all participants need to assume that they will live for 30 years in retirement (or at least they need to consider the possibility). As one report stated, “An estimate of age 95 is a reasonable default, given today’s longer life expectancies.”12 Of course, not everyone will – that is why the statistical probability is only 25%. But it is virtually impossible to determine how long any particular person will live, and the consequence of assuming a shorter life expectancy could be disastrous.

3. Sequence-of-Returns Risk.

“Sequence of returns” refers to the order in which investment returns occur. Are the first few year after retirement good years in the securities markets – or bad years? This risk exists when assets begin to be liquidated – to provide income to the retiree – in a portfolio that is depreciating in value. Losses caused by market downturns are locked in, and it becomes impossible to recoup the losses on the money that was withdrawn and spent, even when

the market goes up again. So, for example, if a participant retired in the early 2000’s or in 2007, during the market downturns of the last decade, his retirement savings would have been reduced by both the withdrawals for income and the losses in the markets, endangering the stability of his income for life. Therefore, retirees need to protect their investments to reduce the risk of a bad sequence of returns.

4. Withdrawal rate issue.

Conventional wisdom is that a 4% withdrawal rate is “safe,” that is, 4% of a retiree’s initial account balance, adjusted annually for inflation. (Note that it is the dollar amount, not the 4% withdrawal rate, that is increased for inflation.) This is based on various studies that have shown there is a 90% probability that, if retirement savings are withdrawn at a rate of about 4% per year, inflation adjusted, the withdrawals will last for 30 years.13 Other studies suggest that the rate needs to be lower than 4%.14 Regardless of which study you believe, the fact remains that there has been little participant education about withdrawal rates. As a result, participants are at risk of withdrawing their funds too quickly and outliving their retirement savings. In fact, one recent study showed that more than 33% of those interviewed had no idea how much they could safely withdraw and roughly 25% expected to be able to withdraw more than 10% of their retirement savings each year.15 Given this failure to understand sustainable withdrawal rates and the need for a disciplined approach in spending retirement savings, there may be a tendency for retirees to take withdrawals at a rate that will exhaust their savings when they are in their late 70’s or 80’s.

There are several potential solutions to this problem, one of which is greater education on the withdrawal rate issue. Another is for plans to offer products with a built-in withdrawal rate “discipline” that mitigates or eliminates the risk of withdrawing funds too rapidly.

5. Inflation risk.

Inflation has not been a significant economic factor in the United States for many years, but in the past, it has been a problem. Even modest increases in the cost of living will erode the spending power of a retiree’s savings over the years, making it necessary to withdraw more money to buy the same goods and services. The obvious impact is that retirees would need to reduce their standard of living or, alternatively, that retirement savings will run out sooner. There are retirement programs, like Social


Security and some government defined benefit pension plans, with built-in inflation adjustments. But 401(k), 403(b) and 457 plans and rollover IRAs do not – and very few retirement income solutions – have inflation protection, except to the extent that the investments appreciate faster than inflation and the amounts being withdrawn each year.

6. Cognitive risk.

This is a problem that is only beginning to be recognized in the context of retirement income. “Cognitive risk” is the probability that, as we age, we become more prone to dementia or other cognitive disorders.16 In the context of retirement savings, studies have shown that as people age, they experience some degree of decision-making deterioration; this deterioration affects their ability to make sound financial decisions for themselves, such as those involving investments and sustainable distribution rates.17

Retirees are more prone to suffer cognitive impairment as they reach their mid-80s.18 This suggests that difficult or complex decisions, for example, about how to invest and withdraw retirement savings so that they last for 25 to 30 years, while protecting against sequence-of-returns and inflation risks, should happen at or near retirement. It also suggests that, where possible, retirees should select products that reduce or eliminate the need to make new investment and distribution decisions at a time when they may be less capable of doing so, in order to minimize the risk of running out of funds.

In the next section of this White Paper, we discuss currently available products and services that are designed to mitigate or eliminate the post-retirement crisis and then we focus on the Lincoln Secured Retirement IncomeSM product and how it addresses each of these risks.

Defined contribution participants face real risks as they near or enter retirement. These include concerns about how much savings are needed to retire comfortably, how long the funds will need to last, how to manage the investment and withdrawal of the money to increase the likelihood of it lasting for a lifetime, how to guard against inflation and sequence-of-returns risks, and how to protect oneself against later life cognitive impairment.

Fortunately, the retirement community has recognized that these risks exist and is taking steps to address them…through education, services, investments and guaranteed products.


Possible Solutions

IntroductionWe now turn to solutions currently being offered in the market place for the lifetime income problems and risks that retirees face. First, we discuss the most common products and services designed to solve the problem. Then we discuss the benefits and certain obstacles facing retirement plans that want to offer a solution. (The fiduciary considerations are discussed in a companion White Paper being developed, entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees.”) Finally, we talk about the practical concerns related to “portability” of the solutions.

The solutions offered in the marketplace fall into three broad categories. For each category, we discuss the key factors of cost, availability of a guarantee and access to upside potential in the securities markets.

• The first category covers the “securities” solutions. These investments help participants achieve retirement income at a lower cost and access to the potential upside in the market (as well as its downside risk), but without a guarantee that the money will last for a participant’s lifetime.

• The second category includes traditional insurance solutions that have an additional cost, because the insurance company charges for the income guarantee. These solutions provide a guarantee of lifetime income that avoids market losses, but restricts the opportunity to capture market gains (because the rate of return is guaranteed and fixed).

• The third is a blended solution. These are guaranteed minimum withdrawal benefit (GWB) products that are more expensive than the securities solution because of the fee – or premium – charged for the guarantee in addition to the expense of the investment; that provide full access to market upside, while offering protection from market losses; and that offer a guarantee of lifetime income.

In a companion White Paper, entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees,” we discuss the fiduciary issues under ERISA that may affect the selection of these products or investments.

In the discussion that follows, for each type of product we discuss the extent to which it addresses

the retirement income risks described in this paper. None of the solutions is able to solve the benefit adequacy issue – that is, the accumulation of sufficient retirement savings to provide replacement income adequate to maintain a retiree’s lifestyle – since that is largely a function of how much participants defer, or save, during their working years. In our experience, the solutions to the benefit adequacy issue may be best achieved through participant education and/or providing participants with access to advice from a retirement plan adviser or through plan design, e.g., providing for automatic enrollment and automatic increases of deferrals (both of which are outside the scope of this White Paper).

One final introductory note: we assume that the products discussed below are offered inside a 401(k), 403(b) or 457 governmental plan.

Available ProductsSecurities Solutions

Managed payout and retirement income mutual funds. These mutual funds are designed to provide a steady stream of retirement income while still allowing retirees access to their money during their lifetime and the ability to pass it onto their heirs upon death. Managed payout funds emphasize the decumulation phase – they make periodic distributions (often monthly) at a specified annual rate (3%-7% of investor’s account balance is the typical range). Nevertheless, because these are mutual funds and not insurance products, they cannot offer a guarantee that payments will continue for a specified period or the life of the retiree.

There are essentially two types of managed payout funds, those that have a specific duration or payout period and those that offer a defined payout amount:

• In the case of specific duration, or a defined term, fund, the mutual fund establishes a set time period over which payments will be made. The payments are based on the invested principal and any investment returns. Payments may fluctuate over time, depending on the gains or losses in the fund. At the end of the defined term, the remaining value of the fund, if any, is returned to the retiree. As a result, retirees remain subject to the sequence of returns risk and may not have enough to live on if losses deplete the fund too quickly or if, alternatively, the payments are reduced in order to sustain the


fund for the defined term. They also remain subject to inflation risk if the returns of the fund are not sufficient to offset the effects of inflation.

• Defined payout mutual funds are designed to pay a specified percentage of the retiree’s value in the fund. Generally, the percentage is constant, which means that the amount can vary from year to year due, for example, to market changes. The fund is designed to make payments only out of earnings, though the fund manager has the discretion to pay out principal in order to meet the defined or targeted payout amount. These funds do not have a specified time horizon. That is, the time period over which the payments will be made may be affected by the investment gains or losses of the fund. As a result, retirees remain subject to the longevity and sequence of returns risks.

Any mutual fund’s ability to meet its distribution objectives is dependent on the performance of the underlying investments, and even those that are designed to make distributions from earnings may reduce the payout rate or even deplete principal if the investments perform poorly.

While these types of funds are designed to provide monthly payments, they are not guaranteed and cannot promise a lifetime income stream. Unless the securities markets perform as well as anticipated during the payout period, these types of mutual funds do not solve the longevity, sequence of returns or withdrawal rate risks.

Managed retirement income accounts. Unlike annuities and managed payout mutual funds, managed retirement income accounts are a service rather than a product. That is, a professional investment adviser manages the account of the participant with the dual objectives of preserving capital and paying income.

An advantage of these services is that, while they are professionally managed, the participant nevertheless retains control over his account and can begin or cease payouts at any time and take additional withdrawals if desired. This service can offer monthly payouts, but like the managed payout mutual funds, they are not guaranteed. They do not solve the longevity, sequence of returns or inflation risks unless the securities markets perform well during the payout period (except to the extent the retiree purchases longevity insurance).

Insurance Solutions

Traditional annuities. Annuities have been available for many years and have been used both in and

outside retirement plans. As a result, traditional annuities may be the most recognized and used of the products. The concept is straightforward: the participant deposits the premium money with an insurance company in exchange for the company’s agreement to provide the participant with income for life.

The insurance company that issues the annuity is essentially pooling the risk. That is, some annuitants will live to their life expectancy, some will live longer and some will die earlier. For those that live to their life expectancy, the amounts deposited for the annuity plus investment returns will be adequate to make all required monthly payments. For those who live longer, the insurance company will have to use additional money from its account to make the guaranteed payments, but for those who die before their projected life expectancy, the amounts they paid will exceed the required payouts, thus providing an offset against the payments for those who live longer.

The principal advantage of traditional annuity contracts is that they guarantee income payments for the life of the participant (and possibly his or her spouse). In other words, a life annuity addresses the longevity assumption that participants need to make sure the participant will receive income payments however long he lives.

The principal disadvantage of annuities is that the participant relinquishes his retirement account (and access to its value during life) in return for the guaranteed payments (but, the loss of access to principal and the pooling of risk enables the insurance company to pay larger amounts of income). Further, once a contract is annuitized, there may be no residual cash value that can be passed on to the participant’s heirs (other than his or her spouse in the case of a joint and survivor annuity). However, a participant can elect a guaranteed period (for example, 10 years), so that, if the retiree dies during that period, the balance of the payments will go to a beneficiary.

In a traditional fixed annuity, the insurance company assumes the longevity risk, effectively eliminates the sequence of returns and cognitive risks and solves the withdrawal rate question. Some annuities may partially address the inflation risk by offering increased payments based on the rate of inflation (typically, subject to a cap). However, that additional protection comes at a cost in terms of lower initial payments. The annuity also solves the critical issue of lifetime income, that is, the guarantee that income will be available for the life of the retiree and possibly


for the life of his or her spouse. Only an insurance company can legally offer this type of guarantee.

Because annuities are typically backed by the general account of the insurance company, an important issue for a plan sponsor is the creditworthiness and long-term ability of the insurance company to pay the benefits. That issue is addressed in our companion White Paper entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees.”

Longevity insurance. Another type of insurance solution is commonly called longevity insurance (but is, more accurately, a deferred annuity). That name applies to a type of annuity that starts payments when the retiree reaches a specified age, often 85. Longevity insurance is sometimes combined with other retirement income approaches to act as a “safety net” to address longevity risk and the risk that the retirement savings will be prematurely exhausted. The obvious drawback to longevity insurance is that, as in any form of insurance, it only provides a benefit to a retiree if the covered risk occurs – in this case, if the retiree lives beyond the stated age. If he dies before reaching that age, the benefit – and the cost – of the annuity is lost. However, the cost of longevity insurance is less than traditional annuities for two reasons. First, the insurance company will be able to invest the funds it receives for a number of years before being required to make payments. Second, there is a statistical likelihood that a number of the purchasers will die before reaching the age at which payments begin, and, even if they survive to that age (e.g., 85), that most of those will not live for many years thereafter.

These products address the longevity risk, in that they provide income starting at the point where a retiree may be running out of other retirement savings, and once the payments start, eliminate the sequence of returns, cognitive and withdrawal rate risks. They do not, however, typically address the inflation risk, so that a payment purchased today may have reduced purchasing power 15 or 20 years later.

The Blended Solution

Guaranteedminimumwithdrawalbenefits. Guaranteed minimum withdrawal benefits (“GWBs”) are ordinarily combined, or “hybrid,” products that consist of a mutual fund, such as a balanced or target date fund (or similar diversified investment vehicle), and a GWB feature, which is issued by an insurance company.

With a GWB, the insurer guarantees – in exchange for premium payments – that it will pay a retired participant an annual percentage of his “income base” (which is usually the highest value of his account) if the money in his account runs out during the retiree’s life.19 This guarantee is conditioned on the requirement that the retiree not withdraw more than a specified amount per year. If withdrawals begin at age 65, a common rate is 5% of the benefit base or 4.5% if the participant selects a joint and survivor guarantee with his spouse; those withdrawal rates typically go up to 6% and 5.5% if withdrawals start at age 70. Withdrawals in excess of the stipulated amount are permitted but will reduce the income base – and, therefore, reduce the future guaranteed payments.

One respect in which a GWB is similar to an annuity is the pooling of risk element. This is an important factor. As the American Academy of Actuaries has pointed out,

“It is significantly more cost effective for a person to insure longevity risk through risk pooling (whether through purchasing an annuity or other lifetime income guarantee…) than to bear that risk alone (‘self-insuring’) it….In contrast, depending on the method used to ‘self-insure,’ 50 percent to 75 percent more money would need to be set aside than if an individual participated in a risk-pooling arrangement, a comparatively inefficient use of scare retirement resources.”20

The additional 50% to 75% needed by a participant who “self-insures” is based on the longevity assumption described earlier. That is, given the statistical probabilities, every participant must assume he will live for 30 years or more in retirement.

An important difference between an annuity and a GWB, however, is that, in the GWB arrangement, a retiree makes periodic withdrawals from his own investments until the money is exhausted. Only at that point does the insurance company begin making payments. If the retiree’s account balance is not exhausted during his lifetime, the insurance company will not need to make any payments. Correspondingly, that means the participant will not have run out of retirement income in his lifetime and that the remaining money can be left to the participant’s beneficiaries.

Advantages of a GWB are that participants retain ownership of and access to their accounts, continue to take advantage of investment appreciation while being protected from downside risk, and can leave


any remaining balance to their heirs. At the same time, so long as the retiree observes the terms of the arrangement (such as the limits on annual withdrawals), the account balance and the GWB provide a guaranteed stream of lifetime payments. The GWB feature addresses the longevity risk, as well as the sequence of returns risk and the withdrawal rate question.

Inflation risk may be addressed indirectly through the investment returns on the account balance. In most GWB products, the benefit base may increase post-retirement as a result of positive investment returns, net of withdrawals. Like an annuity, a GWB feature also solves the lifetime income guarantee concern, but may leave the participant at least somewhat vulnerable to the cognitive risk issue. For example, a retiree could possibly be persuaded to withdraw all of his money and invest it elsewhere, thereby losing the GWB guarantee and possibly losing money in more speculative investments. At the same time, having a pre-set withdrawal rate over a number of years may prove helpful in avoiding the cognitive risk.

In-Plan versus Out-of-Plan OptionsPlan fiduciaries must decide whether to offer lifetime income products and, if so, whether to offer the product as an option in the plan (referred to as an “in-plan” solution), to offer it only as a distribution option (referred to as an “on-the-way-out-of-the-plan” or distribution solution). If the plan does not offer a retirement income product, the participants are left on their own to determine how best to deal with the lifetime income issue, though the plan sponsor may provide education for employees while they are participating in the plan to help them understand the retirement risks and potential solutions. In addition, in the absence of an in-plan solution, all of the participants – with the possible exception of those with very large account balances – will end up paying “retail” for their income investments or products. In that case, they will likely pay much more than for products offered inside a plan.21

This White Paper focuses on the “in plan” solution, since it is likely to be the most advantageous to participants. That is, if a retirement income product or service is offered in a plan, the cost to participants may be substantially reduced because the plan can obtain better pricing. Further, the retail cost of an out-of-plan product or service will vary depending

on the account size, so that for participants with small accounts, it is significantly more expensive to obtain lifetime income protection outside the plan. With an in-plan solution, all participants can pay the same relative cost (for example, the same percentage of assets in their account), so that participants with smaller account balances pay the same relative cost as those with large account balances. In addition, some studies have shown that if participants contribute to an annuity (or, presumably, other forms of lifetime income products), they are more likely to annuitize their retirement savings and thus receive their retirement income in periodic installments.22 On the other hand, we understand that the take-up rate of on-the-way-out-of-the-plan products is relatively low.

Insured in plan solutions also have the advantage of providing protection against the sequence of returns risk …especially if they are purchased during the “red zone” (i.e., the 10 year period immediately preceding retirement). As discussed earlier, “sequence of returns risk” refers to the fact that losses caused by market downturns during the withdrawal phase become locked in, and it becomes impossible to recoup those losses regardless of how well the market does thereafter. In the case of insured in-plan products, especially GWBs that provide income base protection, this risk is effectively eliminated. This is true because the income base grows during up markets but does not decrease during down markets. This same protection is not available on investment products, unless they are substantially allocated to short-term bonds, but to the extent there is any equity exposure, the risk will still exist. And an out-of-plan solution, even an insured one, would only provide sequence of returns protection if it is purchased before a market downturn begins.

A perceived drawback to the “in plan” solution is that it imposes a fiduciary obligation on the part of the plan sponsor or plan committee to prudently select the guaranteed income product and the insurance company. Even in the on-the-way-out-of-the-plan distribution solution (where the insurance guarantee is made available to participants who take distributions of their accounts), participants must select among alternatives made available by the plan, which raises the same fiduciary concern because the plan sponsor, in effect, provides those alternatives. While this may or may not be an ERISA fiduciary issue, good risk management practices suggest that the fiduciaries should undertake reasonable efforts to evaluate the product and the provider.

Where a plan offers either an in-plan guarantee product or an on-the-way-out-of-the-plan guaranteed


product, the plan sponsor must engage in a prudent process to select and monitor the product itself and the GWB and the insurance company. Our companion White Paper, entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees,” discusses the legal framework for this obligation and offers possible solutions.

The Portability Issues

A concern about products that offer retirement income is the “portability issue.” The concern arises where the GWB is offered in a plan and the participants pay fees for the GWB protection. The issue is this: what happens if there is a change in circumstances affecting the participant or the plan? By change in circumstances, we mean a participant’s termination of employment or an election by the plan sponsor to move the plan assets to another provider, where the GWB is not offered.

Thus, there are two important portability issues. The first occurs where a participant ends his employment. In that case, the participant may rollover the GWB to an IRA under a program maintained by the insurance company that issued the GWB. Where a plan sponsor changes providers, the participant’s payments for the GWB may be lost because the new provider may not offer similar products or may not provide recordkeeping services for GWBs issued by a different provider.

While the portability issues for participant distributions can be solved through IRAs maintained by GWB providers, the issues related to a change in recordkeeper are more complex. However, the D.C. plan industry is working on solutions to that problem. We will discuss the ERISA fiduciary issues associated with portability in the companion White Paper, entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees.”


Description of the Product

The information contained in this section has been provided by Lincoln Financial Group.

The Secured Retirement IncomeSM product offered by Lincoln Financial Group (“Lincoln”) is a next generation guaranteed minimum withdrawal benefit feature. It is available as part of a group variable annuity contract between Lincoln and a retirement plan. The group variable annuity has a balanced fund as the underlying investment, which is available as an investment option in a defined contribution plan under the Lincoln Alliance program. (This program offers an open architecture platform for a plan’s investment options.)

The assets in the annuity contract are invested in a separate account held by Lincoln Financial Group with the Protected Profile Moderate Fund (the “Moderate Fund”) as the underlying investment. (Lincoln Protected Profile funds employ a hedging strategy designed by Milliman Inc. that attempts to reduce volatility and limit losses when markets go down.) Assets in the Moderate Fund are invested approximately 60% in equities and 40% in fixed income investments with an emphasis on a passively managed investment style. The Moderate Fund also employs an actively managed risk-management overlay designed to manage overall portfolio volatility. The Lincoln Secured Retirement IncomeSM guarantee will automatically attach to all assets invested in the Moderate Fund; it is not available as a feature associated with any other investment option.

The Lincoln Secured Retirement IncomeSM guarantee is offered only with the Moderate Fund; it is not available on any other investment. Further, the Moderate Fund is not available to plans without also utilizing the guarantee. All references to the Moderate Fund in this Paper should be read to include the Lincoln Secured Retirement IncomeSM guarantee.

The Moderate Fund and Lincoln Secured Retirement IncomeSM guarantee will be available as a standalone investment option that may be selected by individual participants. However, the primary use of the Lincoln Secured Retirement IncomeSM solution will be in cases where a plan selects the Lincoln LifeSpan asset allocation models. The LifeSpan models are a suite of target date asset allocation models consisting of funds available in a plan’s investment menu that would include the Moderate Fund with the Lincoln

Secured Retirement IncomeSM guarantee. Under the glide path of these models (designed by Ibbotson Associates, which acts as a discretionary investment manager of the models), at a point beginning 10 years from the target retirement date of the model, 10% of a participant’s account balance will be allocated to the Moderate Fund. The participant will thus automatically receive the Lincoln Secured Retirement IncomeSM guarantee on that portion of the participant’s assets allocated to the Moderate Fund. Each year thereafter, under the model’s glide path, an additional 10% of a participant’s account balance will be allocated to the Moderate Fund. As a result, by the time the participant reaches his target retirement date, up to 100% of his account balance will have the benefit of the Lincoln Secured Retirement Income® guarantee. Quarterly participant statements will provide an explanation of the guarantee and will show the accrual of the additional guarantee as the glide path allocates additional assets to the Moderate Fund. The participant website provided by Lincoln will also show the guarantee using various calculations and projections so that participants can gauge the level of retirement income they will receive.

Plan sponsors may choose from among four different alternatives in offering the Lincoln Secured Retirement IncomeSM guarantee to their participants. In these alternatives, the final allocation of participant account balances to the Moderate Fund will vary from a high of 100% to a low of 25%. In the 100% alternative, at the end of 10 years, an electing participant’s entire account balance will be invested in the Moderate Fund and thus have the benefit of the Lincoln Secured Retirement IncomeSM guarantee. In the 75% alternative, only 75% of the account balance will have the guarantee. The other alternatives offer a 50% and 25% final Moderate Fund – and thus Lincoln Secured Retirement IncomeSM guarantee – allocation.

The expense or cost for the Lincoln Secured Retirement IncomeSM guarantee payable out of a participant’s account is 100 basis points (1.0%) on the Income Base (described below) attributable to the portion of the account invested in the Moderate Fund.23 In addition, the Moderate Fund bears an 80 basis point (.80%) management fee, a portion of which is used to offset the recordkeeping costs otherwise allocated to the participant’s account. By tying the premium to the Income Base related to the amount invested in the Moderate Fund, the premium paid by the

The Lincoln Secured Retirement IncomeSM Solution


participant will gradually increase as the allocation to the Moderate Fund increases under the LifeSpan model glide path. This results in lower cost to the participant as compared to other GWB products that place the guarantee on all the assets in a target date fund to which a GWB guarantee attaches. The slower integration of participant account balances into the Moderate Fund, beginning 10 years from the target retirement date, also means that the guarantee increases as the participant approaches retirement when the guarantee is most needed.

In exchange for this premium, Lincoln guarantees that it will pay the plan participant a specified percentage of his “Income Base” (discussed below) if his account balance runs out during his retirement. This amount is referred to as the Guaranteed Annual Income or GAI. Payment of the GAI is conditioned on the requirement that the retiree not withdraw more than a specified amount per Benefit Year. So long as the participant’s withdrawals are not more than the GAI, the Income Base will never decrease. Withdrawals may be made on either a single life or joint and survivor basis and may start as early as age 55. If withdrawals begin at between age 55 and 64, the current annual withdrawal amount and the GAI will be 4% of the Income Base on a single life basis and 3.5% on a joint and survivor basis. Between 65 and 70, the amounts will be 5% and 4.5%, and from age 71 and older, 6% and 5.5%. Withdrawals before guaranteed payments begin are permitted but will decrease the Income Base.

Suppose that inflation or interest rates rise, such that the payout rates described in the prior paragraph are no longer appropriate or that other providers in the GWB market increase their payout rates. These factors could make it difficult for a plan sponsor to continue to offer the Lincoln product. One of the design features built into the Lincoln Secured Retirement IncomeSM guarantee is the weighted average GAI calculation. Under this feature, Lincoln is able to change the GAI rate (higher or lower) based on the current interest rate environment, so that if payout rates generally change while a participant makes contributions to the Lincoln Secured Retirement IncomeSM guarantee, the GAI calculation for that participant would be a weighted average of the different GAI payout rates available in the marketplace. This provides protection to both the participant and to the plan sponsor that has selected the product.

The Benefit Year is a 12 month period measured from the anniversary of the beginning date. The beginning date is the date that assets are first transferred or contributed into the Moderate Fund, i.e., generally 10 years before the target retirement date if the participant is in a LifeSpan model that incorporates the Moderate Fund into the glide path. The initial Income Base is the market value of the assets in the Fund on the beginning date. Assuming there are no liquidations from the Moderate Fund, the Income Base can only go up; it cannot go down. Each year, on the anniversary of the beginning date, the Income Base is re-calculated and reset to equal the greater of:

(1) the prior Income Base plus all deposits into the Moderate Fund and less any excess withdrawals; or

(2) the market value of the assets in the Moderate Fund on the anniversary date.

The increases in the Income Base are called a “step up.”

The following example illustrates how the GAI works: Joan is a participant in the ABC Co retirement plan. Joan is 64 years old and has invested her account in a LifeSpan model that includes the Moderate Fund with the Lincoln Secured Retirement IncomeSM guarantee. Her current account balance is $200,000, and her Income Base is $250,000. At age 65, Joan takes a single life payout from the fund, i.e., 5% of the Income Base or $12,500. If the market value of her account goes down to zero, so long as she has not taken excess distributions, Joan will continue to receive $12,500 per year for the rest of her life. At any time, Joan could take a distribution in excess of the 5% GAI, but that would reduce her annual payout once her account is exhausted (or eliminate it if Joan decided to take all of her remaining account value).

For example, assume the following: The value of the Moderate Fund allocation at the beginning of the year is $100,000; the Income Base at that point is $100,000. During the year, the sum of the contributions and other additions is $10,000. At the one year anniversary, the market value of the


Moderate Fund allocation at the beginning of the year is $100,000; the Income Base at that point is $100,000. During the year, the sum of the contributions and other additions is $10,000. At the one year anniversary, the market value of the fund is $120,000. Since the market value ($120,000) is greater than the sum of the previous market value plus contributions ($110,000), the new Income Base will be $120,000. However, if the market had declined, so that the value of the Moderate Fund value at the end of the year

fund is $120,000. Since the market value ($120,000) is greater than the sum of the previous market value plus contributions ($110,000), the new Income Base will be $120,000. However, if the market had declined, so that the value of the Moderate Fund value at the end of the year (even after taking into account the $10,000 in additions) is only $95,000, the Income Base will be $110,000 (the prior Income Base plus contributions).

The Income Base may continue to grow post-retirement (up to age 86) with increases in market value year-over-year after taking into account purchases and withdrawals. However, if withdrawals exceed the GAI amount (i.e., the set percentage of permitted withdrawals), the Income Base will decline proportionately to the reduction in market value of the participant’s account. Thus, for example, assume that a participant’s Income Base is $500,000 and his account has a market value of $400,000. If the participant takes an excess withdrawal of $50,000, the market value of the account declines by 12.5%. This same percentage is applied to reduce the Income Base to $437,500 ($500,000 x 12.5% = $62,500).

Under the Lincoln Secured Retirement IncomeSM guarantee, if a participant began taking GAI withdrawals on a single life basis at age 66, that is, at 5% of the Income Base, he may be entitled to increase his GAI withdrawal rate to 6% when he reaches age 71. This increase is automatically applied to a participant if (and only if) the participant has a step up in his Income Base in the year after he turns 71. If no step up occurs, the GAI will continue to be 5%.

As with any GWB product, to the extent funds remain in the participant’s account at his death, the remainder may be paid to his beneficiary. Conversely, if the account balance is exhausted during the participant’s lifetime, Lincoln will begin making payments at the GAI amount, assuming that the conditions of the guarantee have been observed by the participant.

Addressing the Portability IssuesA concern raised with respect to GWB features is referred to as the “portability issue.” To summarize the earlier discussion, the concern is that, after the participant has a portion of his account balance invested in the fund to which the rider is attached and after he has paid premiums for the guarantee, there is a change in circumstances affecting the participant or the plan. That is, what happens to the guarantee if a participant terminates employment, whether at retirement or

otherwise? And what happens to the guarantee if the plan sponsor elects to transfer the plan assets to another provider, such that the investment option to which the guarantee is attached is no longer available in the plan?

Lincoln has taken steps to address both aspects of the issue. Respecting portability as it affects departing participants, Lincoln permits participants to roll over the Moderate Fund and the Lincoln Secured Retirement IncomeSM feature to an individual retirement account custodied by Lincoln Financial Group Trust Company. This will preserve the Lincoln Secured Retirement IncomeSM guarantee without disruption.

With respect to a transfer of the plan to a new provider, Lincoln has made a significant investment in its recordkeeping system to permit portability. First, it has subscribed to the data transfer protocols established by the SPARK Institute,24 which have been or will be adopted by roughly 80% of the recordkeeping industry.25 Second, it has invested in a recordkeeping integration implementation model developed by a provider called DST that will facilitate the transfer of data and permit participants to continue to be able to access information about and make contributions to the Moderate Fund investment, with the guarantee, in their account even after the account is being recordkept by a new provider. This system, called the Retirement Income Information Clearing and Calculation system (or RICC) has been acquired by several of the largest providers of GWB features.

If a plan sponsor elects to move the plan to a new provider that subscribes to the SPARK data feeds or has acquired the RICC system, participant investments in the Moderate Fund and thus the Lincoln Secured Retirement IncomeSM guarantee will be preserved so long as the plan sponsor requests that the Moderate Fund be retained as an “outside” plan asset.

Addressing Retiree RisksBriefly, the retiree risks are: replacement income, longevity, sequence of return, inflation, withdrawal rate and cognitive impairment. In this section, we explore how the Lincoln Secured Retirement IncomeSM guarantee addresses these risks.

The Lincoln Secured Retirement IncomeSM guarantee does not address the issue of replacement income. That said, no product of which we are aware addresses that risk. If the participant fails to defer enough of his income during his working years – whether through inability, ignorance or unwillingness -- he will not have enough replacement income when he retires, absent unprecedented market


gains which are unlikely to occur, regardless of the solution that is offered. This risk must be addressed by the plan sponsor during the retirement savings accumulation phase through education or plan design (such as automatic enrollment and automatic deferral increases).

That said, the Lincoln Secured Retirement IncomeSM guarantee will address the other risks faced by retirees. As noted earlier, an advantage of a GWB feature is that participants retain ownership of and access to their accounts. Since their retirement income is paid, initially, out of their account (either in the employer plan or a rollover IRA), the retiree can continue to take advantage of investment appreciation, but so long as the retiree observes the conditions of the guarantee, he is protected from downside risk through the guarantee of the Income Base. And at death, any remaining value in the account passes to his beneficiary. The Income Base guarantee provides protection against sequence of return risk and inflation risk, at least to the extent any increase in value (and the Income Base) keeps pace with inflation.

Longevity risk is also solved through the Lincoln Secured Retirement IncomeSM guarantee in that the retiree who observes the GAI withdrawal rate restrictions will receive a guaranteed stream of retirement income payments even if his account is exhausted. In a sense, the Lincoln Secured Retirement IncomeSM guarantee also addresses the withdrawal rate risk by establishing for the retiree a predetermined level of annual withdrawals, though the product does require a retiree to exercise self-constraint over fund withdrawals since the retiree continues to have full access to his account. At one level, this access is a benefit in case the retiree experiences a significant unanticipated event, but at the same time, there is no built in constraint on taking distributions, so that the retiree is subject to a degree of risk.

In the same sense that the specified GAI withdrawal rate provides a degree of protection on the withdrawal rate risk, it also provides protection against cognitive risk. A retiree who still has an account balance when he reaches his mid-eighties can always make foolish decisions (or be duped by an unprincipled or ill advised “intermediary”) about his funds. But two aspects of the Lincoln Secured Retirement IncomeSM guarantee may help protect against that. First, a pattern of withdrawal established over a 15 to 20 year period may become so habitual that the retiree will be disinclined to deviate from it. Second, the account balance may have been exhausted by that point, in which case guaranteed payments by Lincoln will have begun, effectively removing any ability of the retiree to change the withdrawal rate.

The Lincoln Secured Retirement IncomeSM solution offered by Lincoln solves two of the most significant of the retiree risks, sequence of returns issues and longevity. It helps in dealing with inflation risk and will tend to mitigate the withdrawal rate and cognitive impairment risks by helping to foster a pattern of behavior that should prove beneficial to retirees.

Summary of Lincoln Secured Retirement IncomeSM FeaturesThe following summarizes the Lincoln Secured Retirement IncomeSM solution:

» The Lincoln Secured Retirement IncomeSM guarantee is available through a group variable annuity contract with an underlying separate account with the Protected Profile Moderate Fund (the “Moderate Fund”) as the underlying investment.

• Assets are invested approximately 60% in equities and 40% in fixed income investments, with an emphasis on passive management but with an actively managed overlay designed to manage overall portfolio volatility.

» Primary use of the Lincoln Secured Retirement IncomeSM solution will be in plans that select the Lincoln LifeSpan asset allocation models, a suite of target date asset allocation models that include the Moderate Fund with the Lincoln Secured Retirement IncomeSM guarantee.

• The glide path of the models (designed and managed by Ibbotson), allocates 10% of a participant’s account balance in the model to the Moderate Fund beginning 10 years from the target retirement date of the model.

• Each year under the glide path, an additional 10% of the account balance is allocated to the Moderate Fund, so that when the participant reaches his target retirement date, up to 100% of his account balance will have the Lincoln Secured Retirement IncomeSM guarantee.

• Plan sponsors may choose a final allocation of participant account balances to the Moderate Fund of 100%, 75%, 50% or 25%.


• These GAI rates may change under the weighted average feature of the product.

» The expenses paid out of the participants account are:

• for the Lincoln Secured Retirement IncomeSM guarantee, 100 basis points on the Income Base, but only the portion attributable to the amount then invested in the Moderate Fund.

• for fund management, 80 basis points, a portion of which is used to offset the recordkeeping costs otherwise allocated to the participant’s account.

» In exchange, Lincoln guarantees payment to the participant of a specified percentage (referred to as the Guaranteed Annual Income or GAI) of his “Income Base” if his account balance runs out during retirement,

• Payment of the GAI is conditioned on the retiree not withdrawing more than a specified amount per Benefit Year.

• Withdrawals may be made on a single life or joint and survivor basis

• Withdrawals may start at age 55, with a single life GAI of 4% of the Income Base and 3.5% on a joint and survivor basis.

• Between 65 and 70, the amounts will be 5% and 4.5%

• From age 71 and older, 6% and 5.5%.

» The Benefit Year is a 12 month period measured from the anniversary of the beginning date. The beginning date is the date that assets are first transferred or contributed into the Moderate Fund.

» The Income Base:

• The initial amount is the market value of the assets in the Moderate Fund on the beginning date.

• Assuming there are no liquidations from the Moderate Fund, the Income Base can only go up; it cannot go down.

• Each year, on the anniversary of the beginning date, the Income Base is re-calculated and reset to equal the greater of:

– the prior Income Base plus all deposits into the Moderate Fund and less any excess withdrawals; or

– the market value of the assets in the Moderate Fund on the anniversary date.

• The Income Base may grow post-retirement (up to age 86) with increases in market value year-over-year after taking into account purchases and withdrawals

• If withdrawals exceed the GAI, the Income Base will decline proportionately to the reduction in market value of the participant’s account.

» Both aspects of portability are addressed:

• Participants may rollover their Lincoln Secured Retirement IncomeSM guarantee to a Lincoln IRA;

• If a plan sponsor elects to move the plan to a new provider that subscribes to the SPARK data feeds or has acquired the RICC system, participant investments in the Moderate Fund and thus the Lincoln Secured Retirement IncomeSM guarantee will be preserved so long as the plan sponsor requests that the Moderate Fund be retained as an “outside” plan asset.

» The Lincoln Secured Retirement IncomeSM solution solves the longevity and sequence of returns risks, helps deal with inflation risk and tends to mitigate withdrawal rate and cognitive impairment risks.


The law and Drinker Biddle’s analysis contained in this White Paper are general in nature and do not constitute a legal opinion or legal advice that may be relied on by third parties. Readers should consult their own legal counsel for information on how these issues apply to their individual circumstances. Further, the law and analysis in this White Paper are current as of March 2013. Changes may have occurred in the law since this paper was drafted. As a result, readers may want to consult with their legal advisers to determine if there have been any relevant developments since then.

© 2013 Drinker Biddle & Reath LLP. All rights reserved.

A Delaware limited liability partnership | One Logan Square, Ste. 2000 | Philadelphia, PA 19103-6996 | (215) 988-2700 | (215) 988-2757 faxJonathan I. Epstein and Andrew B. Joseph, partners in charge of the Princeton and Florham Park, N.J., offices, respectively.

www.drinkerbiddle.com

CALIFORNIA | DELAWARE | ILLINOIS | NEW JERSEY | NEW YORK | PENNSYLVANIA | WASHINGTON DC | WISCONSIN

ConclusionParticipants in defined contribution plans face a number of risks in retirement because they must rely, to a large degree, on their own deferrals and investment decisions to accumulate retirement savings. Are they accumulating enough? How should they “spend” their nest egg? If they establish a spending plan, how much can they afford to take out each month? How long must the funds last and what happens if the markets go down at the wrong time or inflation begins to go up after they retire? Finally, how will they make sure they do not run out of money?

Unfortunately, many participants seem to lack the education, experience and access to information needed to answer these questions. Fortunately, the retirement plan market place has begun to offer solutions. Now it is up to plan sponsors to decide

whether to offer their participants the products and services that will help with the risks.

One solution is a GWB, which affords flexibility but also offers protection against market losses and outliving an individual’s retirement savings. The Lincoln Secured Retirement IncomeSM guarantee offered by Lincoln is a GWB that was created to enable plan sponsors to offer a solution to their participants and to help them reduce their risk.

Our companion White Paper entitled “Lincoln Secured Retirement IncomeSM Solution: Fiduciary Process in Evaluating In-Plan Guarantees,” addresses the legal issues for the selection of a GWB product and discusses the application of those legal principals to selection of Lincoln and the Lincoln Secured Retirement IncomeSM solution.


Endnotes1 “Defined contribution plans dominate the retirement plan scene today.” LaRuev.DeWolff,Boberg&Associates, 128 S.Ct. 1020, 1025 (2008).

2 See AllianzofAmerica,BehavioralFinanceandthePost-RetirementCrisis(AResponsetotheDepartmentoftheTreasury/DepartmentofLaborRequestforInformationRegardingLifetimeIncomeOptionsforParticipantsandBeneficiariesinRetirementPlans), prepared by Prof. Shlomo Benartzi, UCLA, at page 4 (April 29, 2010) (the “Allianz RFI Response”); see also, Jack VanDerhei and Craig Copeland, “The EBRI Retirement Readiness Rating:TM Retirement Income Preparation and Future Prospects,” EBRIIssueBrief, no 344 (July 2010).

3 See, for example, Rev. Rul. 2012-3, Rev. Rul. 2012-4, and proposed Treasury Regulation amendments regarding longevity annuity contracts.

4 See, Cantore, Tara, “MetLife Finds Too Many Pre-Retirees with Faulty Math,” Plan Adviser (October 2011).

5 See, for example, “Workforce Management and Retirement in a 401(k) World,” Watson Wyatt Insider (September 11, 2007).

6 See “Changing Attitudes About Retirement Income” Prudential Sept. 2011.

7 See “American Workers Seek More Security In Retirement and Health Plans” Towers Watson Feb 2012.

8 See, for example, Aon Consulting, “Aon Consulting/Georgia State 2008 University Replacement Ratio Study.”

9 See “2011 Risks and Process of Retirement Survey Report of Findings,” Sponsored by the Society of Actuaries, prepared by Mathew Greenwald & Associates, Inc. and the Employee Benefit Research Institute, March 2012.

10 Reish, Fred, Ashton, Bruce and Byrnes, Pat, “The Problem with Living Too Long,” Institutional Retirement Income Council (2010), http://www.iricouncil.org/docs/The%20Problem%20With%20Living%20Too%20Long.pdf.

11 See “Building Your Future,” Insured Retirement Institute, 2011.12 See “Revisiting the ‘4% spending rule’”, The Vanguard Group, Inc., 2012

at page 5.13 William P. Bengen, “Determining Withdrawal Rates Using Historical

Data,” JournalofFinancialPlanning, October 1994, pages 171-180.14 See Bruno, Maria A., Jaconetti, Colleen M. and Zilbering, Yan,

“Revisiting the ‘4% spending rule,’” The Vanguard Group, Inc., 2012. Some studies have suggested that higher withdrawal rates may be acceptable, but also may require that the rate be cut in some situations or that caution be used in applying the concepts. See, for example, Lieber, Ron, “How Retirees Can Spend Enough, but Not Too Much,” The New York Times, August 28, 2009; and Skinner, Liz, “Research supports withdrawal rate of 4% or higher,” Investment News, March 25, 2012 (interview with Joseph Guyton).

15 See, Lee Barney, “Americans All Over the Map on Retirement Drawdown Rates,” Money Management Executive (October 13, 2011).

16 See Allianz RFI Response, at page 9; see also BMO Retirement Institute, Financialdecision-making:Whowillmangeyourmoneywhenyoucan’t?, July 2011, which reached similar conclusions based on studies of the Canadian population.

17 See, David Laibson, “Cognitive Impairment: Precipitous Declines in Cognition Can Set the Stage for Poor Decisions About Retirement Finances,” which appears in the Allianz RFI Response, http://www.dol.gov/ebsa/pdf/1210-AB33-617.pdf. Professor Laibson’s research showed a significant decrease in “analytic cognitive functioning” as people age and that older adults make financial mistakes. In effect, older people are less able to make cogent financial decisions, to analyze financial data and properly consider risks, which suggests that they are less able to make sound decisions about their financial security once they reach their 80s…a point when they may live another 10 or more years.

18 Id. 19 One study prepared by Ibbotson notes that “The lifetime GWB acts as a

form of portfolio insurance protecting the investor from downside risk. Conceptually, this is similar to a put option that provides downside protection to a traditional portfolio.” The study also states that “The GWB alters the behavior of a portfolio making the ‘effective’ asset allocation more conservative.” Xiong, James X.;’ Idzorek, Thomas and Chen, Peng, “Allocation to Deferred Variable Annuities with GWB for Life,” Ibbotson, 2010.

20 Response of the American Academy of Actuaries to the joint Department of Labor and Department of the Treasury Request for Information RegardingLifetimeIncomeOptionsforParticipantsandBeneficiariesinRetirementPlans, May 3, 2010.

21 See “The growing demand for retirement income solutions: Options for the plan sponsor,” Institutional Retirement and Trust, Wells Fargo, 2010, which notes: “Retail annuities can be very expensive – some charge as much as 3-4% annually. However, this can be mitigated in institutionally-priced annuity programs.” The latter would generally be associated with in-plan solutions.

22 See Yakoboski, Paul J, “Retirees, Annuitization and Defined Contribution Plans,” Trends and Issues, TIAA-CREF Institute, April 2010.

23 The guarantee fees for products with a design similar to Lincoln Secured Retirement Income® range between 90 and 100 basis points, though the timing of when this fee is applied and the assets to which it applies (as described in the text) varies. This tightly bunched pricing suggests the functioning of an efficient market and appears to establish a type of benchmark for the guarantee fee.

24 The SPARK Institute is an industry organization that, according to its website, “helps to shape national retirement policy by providing research, education, testimony and comments on pending legislative and regulatory issues to members of Congress and relevant government agency officials. Our members play a key role in identifying our priorities and in developing the positions we take on critical issues.”

25 See SPARK survey regarding SPARK data standards on Guaranteed Income Products, 2010.


This material was prepared to support the promotion and marketing of a group variable annuity product. Lincoln Financial Group® affiliates, their distributors, and their respective employees, representatives, and/or insurance agents do not provide tax, accounting, or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Please consult your own independent advisor as to any tax, accounting, or legal statements made herein.

A group variable annuity is a long-term investment product designed particularly for retirement purposes. Group annuities contain both investment and insurance components and have fees and expenses, including administrative and advisory fees. The annuity’s value fluctuates with the market value of the underlying investment option, and all assets accumulate tax-deferred. Withdrawals may carry tax consequences, including possible tax penalties.

The LVIP Protected Profile Fund is not guaranteed or insured by Lincoln or any other insurance company or entity, and shareholders may experience losses. The protection strategy used by this fund is separate and distinct from any annuity or insurance contract rider or features.

The target date is the approximate date when investors plan to retire or start withdrawing their money. Some target-date models make no changes in asset allocation after the target date is reached; other target-date models continue to make asset allocation changes following the target date. In a typical target-date model, the principal value is not guaranteed at any time, including at the target date. In a typical target-date model, an asset allocation strategy doesn’t guarantee performance or protect against investment losses.

Investors are advised to consider the investment objectives, risks, and charges and expenses of the group variable annuity and its underlying investment option carefully before investing. The applicable variable annuity prospectus contains this and other important information about the variable annuity and its underlying investment option. Please call 888-868-2583 for a free prospectus. Read it carefully before investing or sending money. Products and features are subject to state availability.

Lincoln Secured Retirement IncomeSM group variable annuity contracts (contract form AN-701 and state variations) are issued by The Lincoln National Life Insurance Company, Fort Wayne, IN, and distributed by Lincoln Financial Distributors, Inc., a broker/dealer. The Lincoln National Life Insurance Company does not solicit business in the state of New York, nor is it authorized to do so.

All contract guarantees, including those for guaranteed income, or annuity payout rates, are subject to the claims-paying ability of the issuing insurance company. They are not backed by the broker/dealer or insurance agency from which this annuity is purchased, or any affiliates of those entities other than the issuing company affiliates, and none makes any representations or guarantees regarding the claims-paying ability of the issuer.

There is no additional tax-deferral benefit for an annuity contract purchased in an IRA or other tax-qualified plan.

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