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Do Income Replacement Funds Make More Sense
Than Annuities?
It's getting to be the case that virtually any standalone
investment product sold to individuals can be repackaged into a
mutual fund. It makes a lot of sense — everyone already knows
what a mutual fund is, and all that's left to explain is the
objective, availability of capital, specific risks and fees.
Such is the case with income replacement funds that aim to
replace annuities as a way for retirees to manage their
spendable assets during the years they expect to be in
retirement.
Aimed at the Baby Boomer Market, mutual fund leaders Fidelity
and Vanguard are among others getting into this product, which
are a bit like target-date retirement funds in that they start
with a pile of stocks, bonds and cash that grows more
conservative based on the dates you'll need to draw those
assets. Essentially, that means if you're retiring in 2020 and
you want money available through 2040, you pick a fund that's
labeled for that withdrawal window, and you accept that such
funds are invested properly for that timeframe.
Generally, after taking an expense fee, the fund pays the
investor a rising percentage of their account value each year
until the balance runs out in the termination year. The idea is
that you'll get a relatively stable income stream that may keep
up with inflation.
Unlike many annuities, however, you can cash out whenever you
want.
It all sounds good, right? Beware of the following, and seek
some advice from a financial expert like a Certified Financial
Planner™ professional:
- There's no exact
guarantee on how big the payments will be, unlike most
guaranteed annuities that set fixed payments. That means
that if the market slides, so will your payments;
- It is possible to
outlive your money, so be very careful in planning how and
for how long these payments will be made.
There's nothing wrong with investigating these mutual funds,
and depending how much retirement savings you have and what your
needs will be, they may be one of a series of options you use as
interlocking parts of your overall portfolio to arrange a flow
of income in your non-working (or partially working) years. But
like all mutual fund choices, they are not one-size-fits all
solutions, and it's good to get some advice that fits your
situation.
Keep in mind that a qualified financial planner should go
beyond telling you whether to put your money in an income
replacement fund, an annuity or other investment choice. One of
the big benefits of seeking qualified financial help is
assessing how much income may be required in view of your
various goals in retirement — whether you plan to work
part-time, whether health issues might affect your income needs,
or any one of a host of issues unique to an individual's
retirement.
Back to income replacement funds. Keep in mind that
investment products are a lot like new car models — sometimes it
makes sense to wait a year or two to see that the kinks are out.
Products attempting to address various financial concerns are
being designed daily. By all means study the advantages of such
products, but keep in mind that these products might be
reconfigured to make later versions more attractive and always
note that there are product costs to having "concerns or
risks" addressed in product design which should be weighed
against costs, and perhaps flexibility, of "active"
oversight.
January 2008 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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