Are Retirement Income Funds Right for You?
They can provide steady, reliable cash but aren't right for everyone
(This article appeared previously on MarketWatch.)
With all the back and forth in the financial planning community over whether to withdraw 4 percent from your portfolio in your golden years, few would blame you if you simply threw in the towel and put your money in a managed-payout fund.
Those are funds that — at least on paper — are supposed to provide you with a steady stream of income, say 4 percent, over the course of your retirement. And in doing so, you presumably wouldn’t have to worry about asset allocation or outliving your money or any of the other issues that plague retirees trying to use what’s called a systematic withdrawal plan or SWiP.
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Managed-payout funds were introduced about the same time target-date funds hit the scene. They were designed to pick up where target-date funds left off. Target-date funds would get you to retirement and managed-payout, also known as retirement-income, funds would take you the rest of the way, till death do you part.
If you’re overwhelmed by the prospect of deciding how much to withdraw from your investment accounts during retirement or worried about outliving your assets, should you consider these funds?
Well, as with most things having to do with money, the answer really depends on your household’s individual situation. But, what we can tell you is this:
- You’ll have to decide which, among the three main types of retirement-income funds, is right for you.
- You’ll have to examine the pros and cons of these funds.
- You’ll have to figure out which specific fund is best for you.
Three Main Types of Retirement-Income Funds
According to Morningstar, retirement-income funds come in three flavors: Target-date retirement funds, some of which are designed to help investors get through retirement and others of which are designed to get investors to retirement; income-replacement funds and managed-payout funds.
Here’s how Kathryn Spica, a chartered financial analyst and senior analyst at Morningstar in Chicago, described these funds in 2014:
“Income-replacement funds are perhaps best described as reverse target-date funds. They will gradually return your money plus any income and capital gains before liquidating in a designated year... These funds can have extremely high yields, but can also deliver steep losses.
“Managed-payout funds provide monthly income with room for investment growth. When the market slows or drops, however, the fund can cut its payout or return your capital. The 12-month yield of each fund provides an idea of just how much income these funds have doled out.
What’s So Great About These Funds?
In general, managed-payout funds are professionally managed; you don’t have to worry about asset allocation, rebalancing or the distribution strategy, said Joe Tomlinson, a certified financial planner, actuary and managing member at Tomlinson Financial Planning in Greenville, Maine. Plus, expenses — though not rock-bottom — are low, Tomlinson said.
These funds also help you address the anxiety that comes with figuring out a safe withdrawal rate. “They take away the potentially difficult process of figuring out your own drawdown amount,” said Spica.
What’s more, Tomlinson said, these funds are designed to deliver not just a stable payout, but one that keeps pace with inflation.
Plus, managed-payout funds work well for do-it-yourselfers, retirees who want to generate income from their portfolio but aren’t interested in working with an adviser, said David Blanchett, head of retirement research at Morningstar Investment. “Similar to target-date funds, managed payout funds simplify the investment decisions for investors, which in general is a good thing,” he said.
And perhaps best of all, you’ll get monthly income without giving up control of your assets, as you would with annuities, Tomlinson said.
Be Familiar with the Risks
One big negative is that there are no guarantees for these products; they can lose money and/or cut their payouts at any time, Spica said.
Plus, such funds don’t really address the complexities of retirement and how retirees typically spend money in retirement. “Retirement is much more complex than accumulation,” Blanchett said. “I think that target-date funds can work for many investors in accumulation, and while there are differences in the glide paths for different target-date series, the largest glide paths and allocations are relatively similar.”
In contrast, retirement is far more complex than accumulation, and there are significant differences in funds geared toward generating retirement income, said Blanchett, who noted that Morningstar’s “retirement-income” category is the most diverse category that exists from an allocation difference perspective across funds.
Consider: The Vanguard Managed Payout funds has an allocation that is about 77 percent equities, he said. “This is an incredibly aggressive allocation for a retiree, and one that many investors may not be aware of,” Blanchett said. “That is, they would think that since it’s targeted toward retirees and generating a payout, it would be more conservative.”
In other words, picking the right fund requires much more due diligence than retirees might think is required at first blush. And that, said Blanchett, “takes away from the ‘do-it-for-me’ potential benefit of these investments.”
Mike Piper, author of the Oblivious Investor blog, has a take on this fund, too.
Tomlinson said there are other negatives, which in the main, outweigh the positives associated with managed-payout funds. One is expenses, he said. Plus these products lack the benefit of longevity pooling and assured inflation-adjusted income that an inflation-adjusted single premium income annuity would provide.
Experts including Blanchett, Wade Pfau, a retirement-income professor at The American College and Michael Finke, a professor at Texas Tech University, have questioned the viability of taking withdrawals based on the 4 percent rule with current low interest rates and current high stock market valuations.
There is also the risk in using these funds to cover basic living expenses. If the payout goes down and the cost of your basic living expenses goes up or even stays the same, your standard of living will likely less than you planned for or desired. In short, it would be far better to use payout funds to cover discretionary expenses rather essential expenses. For basic living expenses, Tomlinson said he prefers to use single premium income annuities. “In my view the ‘cons’ outweigh the ‘pros,’” said Tomlinson.