A new way to invest after you retire

Fund companies entice baby boomers with new 'payout funds' that promise to stretch retirees' money over set time periods.

For years, workers have been wooed by financial firms to open IRAs. And at work, many have been herded into seminars on 401(k) retirement plan investing.

But aging baby boomers are about to face the flip-side issue on retirement savings: How to safely spend those accrued assets once they retire.

And mutual funds companies are rushing in to help with a wave of new offerings geared toward retirees.

In October, Fidelity Investments unveiled a series of 11 funds called Income Replacement Funds. Each of these funds has an end date, ranging in two-year increments, currently from 2016 to 2036, and a payout strategy designed to allow participants to take regular monthly withdrawals until no money is left. In January, Fidelity expects to unveil three additional such funds, with end dates of 2038, 2040, and 2042.

Other mutual fund companies also plan to offer their own version of payout funds for retirees: In September, the Vanguard Group announced plans to roll out three new funds, called Managed Payout Funds, for investors in retirement. Moreover, sources say Charles Schwab, John Hancock Funds, Russell Investment Co., and DWS Scudder also plan to offer payout funds for retirees.

Apparently no one expects the list of new funds – as well as other options, including more annuity offerings – to end there. "This is the beginning of a whole new universe that we are going to see in attempts to meet people's cash flow needs in retirement," says Harold Evensky, a financial planner in Coral Gables, Fla.

Potentially, the new funds could be one way of addressing a growing need. Even as hordes of baby boomers approach retirement, financial planners and others cite a dearth of information and guidance about when and how much to spend in retirement. Boomers question how to make their retirement money last for the rest of their lives – especially when faced with rising healthcare costs, inflation, and the issue of providing for a surviving spouse after one's death.

"People don't know when to take their money out [of retirement vehicles], the tax issues involved, when to take Social Security, which one to take when," Mr. Evensky points out. "We've spent decades telling people to save for retirement, but [the financial community has said] very little about ... getting the money out."

The timing of the new funds seems opportune as more people approach retirement age. According to the US Census Bureau, there were 17.8 million Americans age 55 to 59 in 2006, and another 13.2 million age 60 to 64.

While the size of boomer retirement nest eggs – if they have one – varies, 2007 survey data of the Employee Benefit Research Institute show that 48 percent of workers age 55 and older have savings and investments (excluding their pension and the value of their primary home) of at least $100,000.

A big target audience for the new funds: 401(k) plan participants leaving these plans as well as holders of IRAs about to retire, some fund companies say.

To some observers, payout funds offer notable attractions, including pricing, at least in some cases. For instance, Fidelity cites expense ratios for its payout funds that range from 0.54 to 0.65 percent – "some of the industry's lowest expense ratios," the company says of this category of retail funds. Vanguard estimates its managed payout funds will have a 0.58 percent expense ratio.

Different payout methods offered

Because these payout products will be structured as mutual funds, they can be easily bought, redeemed, and exchanged. Investors will have distinct choices in payout structures, depending on which fund company they choose.

For example, Fidelity's offerings are designed to allow regular withdrawals that will grow to meet inflation over the specified length of a particular fund – after which time the funds will end.

But Vanguard's payout funds are expected to operate indefinitely. Each of its three funds will make payouts based on the funds' targeted annual distribution rate. The funds will offer conservative, moderate, and aggressive approaches with annual payout rates of 3 percent, 5 percent, and 7 percent, respectively. The funds are expected to debut in early 2008.

The DWS Scudder LifeCompass Income Fund for retirees, expected to be launched in January, will have a fixed dollar payout, sources say. Specifically, that offering will provide a fixed payout of 82.5 cents per share per year for 10 years. Sources add that the fund also will come with a financial warranty from Merrill Lynch Bank USA – meaning that if the fund lacks enough assets to make the distribution, it can tap Merrill Lynch Bank to make it. When the fund matures after 10 years, at least 17.5 percent of the fund's initial asset value will be returned to investors on a per share basis.

Given its array of payout funds, Fidelity – the only company with existing payout funds at this point – provides help with fund selection. Among its tools: a calculator on its website that can help find which payout fund best corresponds to a retiree's expected income needs.

Once in a fund, investors can bail out at any time; or they can switch into a different Fidelity fund without a penalty.

Words of caution from planners

But financial planners and others cite several concerns about these vehicles. Issues range from the fund's lack of a track record to their limited flexibility (and thus, ability to meet specific investors' needs) to payout risks with at least some of these funds.

"The limiting factor, at least as Fidelity and Vanguard describe in their planned or current offerings, is that once started, they don't adjust for what happens in real life," says Stephen Barnes, of Barnes Investment Advisory in Phoenix. "For instance, if there is a major change in either your income need or value of your portfolio ... you don't have the flexibility to make changes to the plan. [The fund] just continues at how it was originally structured."

And then, there's the issue of risk on payout amounts in some years.

"Unlike immediate, fixed-payment annuities, which pay steady, fixed payments according to the terms of a contract, these funds don't promise anything, including their targeted payments," Andrew Gunter, an analyst at Morningstar Inc., wrote in a recent report. "In Vanguard's funds, for example, if their holdings don't generate enough income from dividends – from either stocks or bonds – in a certain year, the funds may have to return investors' capital to meet [their] distribution target for that year, causing following years' payouts to be lower. Fidelity's have similar caveats."

Overall, it's too soon to make "hard conclusions" about the funds, Mr. Gunter says in a telephone interview. "We need to see how well they work in practice."

Of course, payout funds wouldn't have to be a lone way of getting income in retirement. And some fund mangers bill them as just one part of an overall income-producing plan.

Indeed, when Fidelity unveiled its Income Replacement Funds, it also launched a deferred variable annuity, called the Fidelity Growth and Guaranteed Income. These two products extend Fidelity's overall choices of payout arrangements, the company suggests. "The Fidelity Growth and Income annuity is a guaranteed product with a floor on its payment level," explains Christopher Sharpe, a Fidelity portfolio manager. "And to complement that, we wanted a mutual fund [series that also] provides an income stream."

And for Vanguard's payout funds, they "are just one of our options to help investors with their withdrawals," says spokesman John Woerth. Among other products and services, he says the company offers the Vanguard Lifetime Income Program, which is an immediate annuity.

"The managed payout funds for retirement offer an opportunity for investors to diversify their income streams – and to provide a complement to annuities, a pension, and Social Security payments," says Mr. Woerth. "If you already have income from a pension and Social Security, you might have the luxury of taking greater risk in products like these [payout] funds."

A simple way for retirees to calculate payouts

New mutual funds for retirees – that provide regular payouts – may be one way of getting an income stream after you stop working. But financial planner Bill Bengen, of El Cajon, Calif., says you don't have to go that route. Indeed, he believes many fund companies allow you to take steady automatic distributions from your existing fund accounts if you ask for them.

The wrinkle: You'd have to know how much payout to ask for.

And that's where Mr. Bengen's research comes in: Bengen, author of the book, "Conserving Client Portfolios During Retirement," published last year by the Financial Planning Association Press, has studied this issue since 1993. And based on his calculations, he believes 4.5 percent of total tax-deferred assets – stocks, bonds, and the like – is the correct payout amount in the first year of payouts. In following years, that payout rate would rise in line with inflation.

Bengen bases his withdrawal rate, back-tested over 80 years, on the effects of different withdrawal rates in different market conditions. He found that a 4.5 percent payout rate, annually adjusted for inflation, was the highest rate he could recommend to ensure that people's assets last for 30 years after retirement and sustain their lifestyle.

But is that typically enough for retirees to live on? "Clients may not like that percentage, but the numbers tell the story: You either live within your means or you'll be headed for trouble," he says. "This [4.5 percent] payout rate is designed to cover all your expenses, including income taxes, regardless of the size of your portfolio. Any higher rate could be hazardous to the health of that portfolio."

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