New Ways to Tap Savings

Mutual Funds

New Ways to Tap Savings

Retirement-income funds let you convert your kitty into steady income.

That nest egg you built steadily through your working years is ready to hatch. And just in time, investment companies are introducing funds to help you make the money last through your retirement years. Will these retirement-income funds deliver? That depends on your expectations.

If you want the benefits of a broad portfolio and modest but steady payouts, then the answer is probably yes. If you want surefire income, the answer is no. Says Luis Fleites, director of retirement research for consulting firm Financial Research: "People will see a target return of 5% and take it as a guarantee, when it isn't."


Other Retirement-Income Funds

An Income to Last a Lifetime

Investments That Pay You Every Month

But here's what you can count on: Fidelity's Income Replacement funds, for example, are broadly diversified, and each offers monthly payments until the fund expires. Fidelity Income Replacement 2024 (symbol FIRNX) seeks to make annual payments at a rate of 7.31% of your original investment until the horizon date, at which point the fund should be exhausted. So if you invest $100,000 at the beginning of a year, you'll collect $7,310 in income that year.

The word seeks is key. While the amount of each monthly payment remains the same during a calendar year, the payout is reset at the beginning of each year, depending on the previous year's performance. And because a fund's price (net asset value) varies day to day, the payment percentage won't reflect the most recent closing NAV.


Jonathan Shelon, co-manager of the Fidelity Income Replacement funds, says that to ensure the funds don't run out before they terminate, disbursements "must ebb and flow with market performance." He adds that there is a "reasonable probability" the funds will succeed in making all expected payments, with the probability being higher the sooner a fund's termination date. The further out the termination date, the lower the expected payout. For example, the 2042 fund has an annual payout rate of 4.75%.

What's in these fund portfolios? In the 2024 fund, half your money goes into Fidelity stock funds, divided among funds that cover small-, midsize- and large-company domestic stocks, and foreign stocks. The rest is in bond and money-market funds.

The Fidelity funds that make up the company's Income Replacement funds have varying records of success, and that's the case with most income-replacement funds: The fund families that devise them pick their own kids for the team, and not all of them are special. For example, Fidelity Short-Term Bond, a poor performer, is a holding in all of the Fidelity retirement-income funds.

But why shouldn't all your kids be special? That's the argument of Adam Bold, chief investment officer of the Mutual Fund Store, an investment adviser. He says investors can accomplish the same thing that retirement-income funds do -- but with better returns -- by assembling a portfolio of the best mutual funds and then making steady withdrawals.


But he also sees the flip side. Practically speaking, many investors aren't "intellectually and emotionally prepared" to manage a well-diversified portfolio and make prudent withdrawals. So having a fund company take on those chores -- even if the portfolio isn't loaded with all-star funds -- can be a smart decision.

Principal preservation. Vanguard takes a different approach to retirement income. Its funds seek to preserve your initial investment -- and perhaps generate some growth -- while they make payouts, and they aren't programmed to evaporate at a set date. So while the Fidelity funds are meant for a specific period -- say, to bridge income between a job and receiving full Social Security benefits -- Vanguard's are meant to last indefinitely. Managed Payout Growth Focus (VPGFX) aims to distribute 3% annually; Managed Payout Growth & Distribution (VPGDX), 5%; and Managed Payout Distribution Focus (VPDFX), 7%. The higher the payout, the less the fund's principal is expected to grow.

Instead of just a pool of stock and bond funds, Vanguard may use other investments for the Managed funds to try to further dampen volatility. For example, it can invest in Vanguard's new Market Neutral fund, which sells stocks short and may use options and futures to try to reduce risk. Actual payouts will be based on an average of the funds' previous three years of performance and will be refigured each January 1. As with other retirement-income funds, Vanguard warns that distri-bu-tions could rise and fall substantially from year to year.

Because retirement-income funds were introduced in the past year, when stocks have sagged, "they're being pressure-tested right away," says Fleites. If market losses continue and more principal gets eaten up, "that could turn off people pretty quickly," he says.


A long-term bear market would be the worst-case scenario for these funds, resulting in far lower payouts than were predicted. The bear is one reason experts recommend only a portion of your nest egg be invested in any of them.

If you want a guaranteed return, you can buy an immediate annuity (see An Income Stream to Last a Lifetime ). But an annuity's dependable return isn't usually indexed to inflation, and there's nothing left to bequeath to heirs upon the death of the annuity holder. Vanguard's John Ameriks, an analyst in the investment-counseling and research group, says investors want flexibility and are reluctant to lock up money in an annuity for life. "People think, I want to hold on to these resources. What if something bad happens to one of my kids, or one wants to start a business?"

No retirement-income fund is time-tested. But we prefer the Vanguard and Fidelity offerings for two reasons: Both have successfully managed broad portfolios in their target-date funds, and both charge reasonable expenses. The Vanguard funds charge 0.57% or 0.58% annually. Expense ratios for the Fidelity funds range from 0.54% to 0.67% a year. Both firms require a minimum investment of $25,000.

If you like the idea of retirement-income funds but don't like the current offerings, bide your time. Plenty more funds will be hitting the market soon.