New funds can provide payments in retirement | Dallas Morning News | News for Dallas, Texas | Personal Finance | Dallas Business News

By PAMELA YIP / The Dallas Morning News
pyip@dallasnews.com

If you've saved enough money to retire, congratulations. You're far ahead of many others.

Now your challenge is to make that money last.

Some consumers use annuities, which are contracts sold by insurance companies, and create an income stream at a later point in time, typically at retirement, to provide steady cash flow.

But there's a new kid in town called a managed-payout mutual fund, which is similar to annuities but definitely not the same.

These funds aim to provide regular income payments through a professionally managed, diversified portfolio.

Annuities can pay an income that can be guaranteed to last as long as you live. If you choose a "joint and survivor" feature, the annuity pays income as long as either you or your beneficiary lives.

"Payout funds are not guaranteed," said Steve Utkus, principal of the Vanguard Center for Retirement Research. "They're designed to help people who don't want to annuitize to come up with some type of financial structure to spend their money."

Payout funds also don't have the tax advantages that annuities do. In an annuity, your money grows tax-deferred as long as you leave it there.

But payout funds are taxed like any other mutual fund. That is, each time you take money from a mutual fund account, you're selling shares, so you have to report a gain or loss from that sale on your income tax return.

Because of how they're treated tax wise, managed payout funds are best used in an Individual Retirement Account or something similar.

As with mutual funds in general, you should pick a payout fund with a low expense ratio, which is a fund's cost of doing business, expressed as a percent of its assets.

"Some are considerably over 1 percent, which I would consider expensive," said Dan Culloton, senior analyst at Morningstar, a fund research firm. "I would treat them like a regular mutual fund and get more suspicious the further they go over 1 percent."

Read the fund's prospectus and understand how it invests.

For example, Fidelity Investments' Income Replacement Funds are similar to target-date retirement funds.

They have preprogrammed asset allocations that gradually shift from stock funds to bond funds as their target dates approach.

At the beginning of each year, the payment rate increases based on a predetermined schedule and is designed so that the payments, while not guaranteed, can keep pace with inflation.

When the fund reaches its target year, all of your remaining principal, including any investment gains, will be returned to you, and the fund will close.

Unlike Fidelity's, the Vanguard Group's managed payout funds don't eventually liquidate.

Vanguard's managers hope to earn enough on the funds' asset allocations to ensure that they meet their payments without dipping into shareholders' principal.

Since payout funds are still relatively new, you should do more homework on them.

"This is an area where investors have to walk and not run," said Mr. Culloton of Morningstar. "Take your time, understand what the fund is doing, figure out how to use it to your advantage and make sure you're going to be in this for the long haul.

"These things really need to prove themselves before anyone can endorse them as a must-have solution for a retirement plan."

Still, if you have an annuity, you could use a payout fund to complement the annuity.

"There is nothing that says that these products can't co-exist in a retirement income plan," said Viktor Szucs, a certified financial planner at Quest Capital Management in Dallas. "Retirees may combine these strategies and use their managed income funds to cover discretionary expenses, while using Social Security, pensions, and annuities to cover fixed ones."

But it's going to take a lot more tools to ensure that you don't outlive your money.

"Managed payout funds can be a good alternative for do-it-yourself investors," said Michael Busch, a certified financial planner and president of Vogel Financial Advisors LLC in Dallas. "They can help you avoid investing too aggressively or too conservatively relative to your cash flow needs in retirement, but it is important to remember that they are a blunt tool, not a precision instrument."

Although payout funds give you monthly income, the payments will fluctuate up and down because you're subject to the volatility of the stock market. In today's investment climate, that's especially important to remember.

It will take you and a financial adviser to figure out many other details, including at what rate you should withdraw money each year from your retirement income portfolio so you don't deplete your assets. The recommended withdrawal rate typically is no more than 4 or 5 percent a year when planning for a 30-year retirement.

Inflation also is a huge factor.

"The two questions the baby boomers must all eventually answer are how much income can they get from their portfolio in retirement, and how large of a nest egg they will they need to get the income they