Dana Anspach, CFP, CEO of Sensible Money, LLC, which specializes in retirement-income planning, Scottsdale, Arizona. SensibleMoney.com
Bottom Line: Turn a nest egg into reliable monthly income
Many investors are surprised to learn that once they retire, investing becomes a lot trickier than when they were still saving for retirement. You have to transform the nest egg you’ve accumulated into a portfolio that generates a steady, reliable stream of income to live on and still make sure that you never run out of money. And you may need to strike this balance for decades. That’s a lot to ask from your portfolio!
Intriguing solution: Invest in a retirement income mutual fund. At least 10 major asset-management companies, including Charles Schwab and Vanguard, have introduced these funds as millions of baby boomers retire and the number of Americans over the age of 65 is expected to be 60% higher in 2025 than it was in 2010. The pitch for these funds is that you choose one that can provide the right amount of annual income for your needs, invest enough of your assets to generate that income, then sit back and collect a regular payment every month without worrying about what investments to buy and sell or how much cash to draw from your portfolio.
The funds’ promise: You won’t run out of money. But are these funds really as safe and easy as they sound?
Bottom Line Personal asked top retirement-planning expert Dana Anspach, CFP, to lay out the pros and cons of using these funds and how to choose a good one for your personal circumstances…
Before you decide whether a retirement income fund is right for you, take a basic inventory of your retirement finances. First, figure out what your monthly spending needs are likely to be. This includes essential spending (housing, utilities, groceries, insurance, etc.) as well as discretionary spending (restaurant meals, vacations, etc.). Next, subtract from that amount the total amount of relatively steady and reliable post-tax income you expect to receive each month from other sources. This includes income from Social Security, pensions, annuities, certificates of deposit (CDs) and US Treasuries.
The amount left over is what you’ll need to draw monthly from your investment portfolio. Important: If that amount is more than 4% of your portfolio, you may need to rethink your spending habits and lifestyle. A large body of research shows that 4% is the maximum sustainable annual drawdown from a diversified portfolio of stocks and bonds for a nest egg to have a high probability of lasting the next 30 years.
Most retirement income funds are designed to generate monthly income in similar ways. They all invest in a number of underlying mutual funds so that you wind up with a very broad array of asset classes. The income is generated from dividend-paying stocks…bonds…and/or capital appreciation when the manager sells investments in the portfolio. These funds aim to provide an annual payout rate of 4% of the value of the assets typically. Example: If you invest $500,000 in a typical retirement income fund, you can estimate an annual payout of $20,000 or a monthly payout of about $1,667. However, payout rates do differ from fund to fund and even can fluctuate within a particular fund over time.
There are two more aspects of retirement income funds that can make them more attractive and useful relative to other types of retirement investments…
You are able to sell your shares at any time if you need emergency cash and to pass on your shares and income payouts to your beneficiaries when you die. This is a significant advantage over long-term annuities, which typically can’t be liquidated without paying hefty surrender charges and whose guaranteed payments can cease altogether if you pass away.
Expenses are relatively low. The funds typically charge annual expense ratios as low as 0.34% and require initial minimum investments ranging from $100 to $25,000. In contrast, a financial adviser typically would charge you 1% of your managed assets each year to oversee your portfolio and set up an income flow—that’s a cost difference of $660 annually on a $100,000 investment. Annuities typically come with even higher costs.
While the simplicity of retirement income funds is appealing, they are a new type of offering that hasn’t been tested in a bear market. Keep the following in mind when deciding whether to use one of these funds for your retirement…
There are no guarantees of the size or longevity of monthly income payouts. Even though the fund managers strive to produce stable income, the funds can lose money in bear markets and/or reduce payouts at any time. That means these funds are best-suited for retirees who have the flexibility to cut back on their discretionary spending if necessary or who have other sources of occasional income such as part-time work. If you need absolute, guaranteed monthly income to cover essential spending, it may be worth the costs and restrictions of buying an annuity from a highly rated insurance company.
The funds are designed to hold the bulk of your investment money in retirement. Some investors may find it uncomfortable or inconvenient to cash in their preretirement portfolios and stash everything in one fund, no matter how widely diversified it is. But committing only a small portion of your investment portfolio to a retirement income fund defeats its purpose and forces you to have to manage multiple investments.
For details on retirement income funds from two fund companies, see below.
The following retirement income funds have different strategies, but they stand out as offering an impressive variety of solid underlying investments, very reasonable expenses and strong (if relatively short) track records. (Other retirement income funds have higher expenses, focus on a narrower range of investments and/or have even shorter track records. For instance, T. Rowe Price launched its retirement income fund in June 2017.)
Vanguard Managed Payout Fund (VPGDX). With $2.2 billion in assets, this is by far the largest retirement income fund and has the most aggressive asset allocation with about 65% of its assets in stocks recently. It uses 10 underlying Vanguard funds, aims for a 4% annual payout and requires a minimum initial investment of $25,000. Vanguard avoids sharp changes in monthly fund shareholder payouts by dipping into principal if the income generated by the portfolio falls. Every January, the fund recalculates the dollar amount of the planned monthly distributions for the coming year based on how well the fund has performed over the past three years. The fund is best for investors who are OK with the higher volatility of a stock-heavy fund. Annual expense ratio: 0.34%.
Schwab Monthly Income Funds. Schwab offers three different retirement income funds. Each one offers a different target payout rate, and even that rate will vary depending on the current interest rate environment. All three require minimum initial investments of just $100 and allocate their assets among five in-house Schwab funds.
Moderate Payout (SWJRX) strives for an annual payout of up to 3%, with 46% of the portfolio recently in stocks. Annual expense ratio: 0.58%.
Enhanced Payout (SWKRX) currently has a target annual payout rate of up to 4%. It recently had 32% of assets in stocks. Annual expense ratio: 0.46%.
Maximum Payout (SWLRX) currently has a target annual payout of up to 5% and recently had 18% of assets in stocks. Annual expense ratio: 0.34%.
These funds generate monthly payouts to shareholders through the interest and dividend income from their portfolios and do not expect to touch the principal. This means that the payout rates, which are recalculated each month, may fluctuate a lot. The funds work best for relatively conservative retirees who don’t mind fluctuating monthly income.