What Are Income Replacement Funds?
As the baby boom generation slowly enters into retirement, millions of investors are going to be faced with the difficult task of selling off investments in order to live comfortably during retirement. The task of liquidating retirement assets is especially difficult for those retirees that do not have a traditional pension from their employer, which makes monthly payments to them for life. The reason being these retirees will have to fund their entire retirement based off selling their investments, which is easier said than done for many reasons. Investors will be asking themselves many difficult questions like: what funds in my portfolio should be sold later in retirement? How much money should I be taking out of my retirement during down markets? How conservative should my investments be during the early stages of retirement? All of these questions are difficult to deal with and all do not have absolute correct answers, however, Fidelity and most recently Vanguard, offer mutual funds that can help you coast into retirement without having to make these difficult investing decisions.
How Do They Work?
These relatively new funds are called income replacement funds and are very similar to annuities, in that they offer payments throughout retirement, while actively investing the amount not being paid to the retiree. Basically, these funds work like this:
First, a person reaching retirement would purchase an income replacement fund for varying amounts, as an example, let’s say $100,000. Bought and sold just like any other mutual fund, this fund would make monthly payments to the purchaser starting off conservatively and gradually increasing the payout as the fund matures. The maturing date is determined when the fund is purchased, similar to target-date funds. You can buy an income replacement fund that fully matures or complexly liquidates in a pre-determined year, for example you can purchase a 2042 fund, which slowly deducts payments until the year 2042.
These funds start out more aggressively by investing in more long-term securities with higher returns, and as it reaches the target date, slowly reduce to more conservative investments. The idea is that the fund will maximize your retirement monies by making payments to you without dipping into your retirement principle. In other words, funding your retirement using only the interest your account earns for the longest period possible.
Advantages to Income Replacement Funds
A major perk of these funds is during bull markets your monthly payments are increased and during bear markets your monthly payments are reduced. Why is this good? Because during a bear market, obviously your fund will return less and if you continue to withdraw the same amount as you did during a bull market, you will be pulling more off of your principle, which would decrease the longevity of your retirement money. Another positive of these funds is their relatively low-cost, especially when compared to annuities, which generally are very expensive to own. Because these are traded like mutual funds, investors can sell them pending a change in retirement plans, another major advantage to annuities, which often lock up investors for years and charge expensive fees to get out. In addition, in-case you don’t need the money during certain months or years, the investor can opt to not receive the funds, if you choose this, the money would be invested back into the fund.
Conclusion
Although income replacement funds have a very short track record, I expect them to become more popular as baby boomers enter into retirement. They offer a great stress free way to withdrawal from your savings during retirement and attempts to maximize your money in the process. As these funds continue to gain in popularity, more companies will offer these products, which would most likely bring down the costs, and challenge the fund managers to out perform their counterparts – both positives for consumers. Keep these funds in mind as you contemplate your retirement years, although active investors could probably out perform these funds on their own and at cheaper cost, but with the increased pressure and stress – do you really want this during retirement? $
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Comments
Interesting. At first, I thought uh oh…annuity. I definitely like to see it operates for a few years and learn more about it, before even thinking about buying one.
Yea, it definitely sounds like it is similar to an annuity and if you’re not in the right place financially, it’s likely not geared towards the standard investor… But certainly an interesting option!