Once you retire, your financial strategy switches from the accumulation phase to the withdrawal phase. This is when all your years of disciplined saving and investing pay off, and your retirement accounts begin to provide income to sustain your retirement lifestyle.
But how can you ensure you generate the income you need, without drawing down your savings so fast that you risk running out? The idea is to find just the right mix of stocks and bonds to have your savings producing the payouts you need, and growing fast enough that they can continue to pay out in the future. This can be tricky even for experienced investors.
This is where retirement income funds come in. Retirement income funds are professionally managed funds that are designed to provide a predictable stream of income from a fixed amount of savings, similar to an annuity but with more flexibility and control. There are two main types of retirement income funds, nonperpetuity and perpetuity.
Nonperpetuity funds are designed to provide a stream of income for a set period of time. Over that time, which lasts five to ten years or more, the fund returns your principal plus capital gains, interest, and dividends accrued from the investments.
One of the largest of such funds is Vanguard’s Target Retirement Income fund, which has $11.5 billion in assets. This fund holds a combination of Vanguard mutual funds – about 20 percent in U.S. and international stocks and 65 percent in bonds. Like typical Vanguard funds, its expense ratio is extremely low, just 0.16%. Another large fund is Fidelity’s Freedom Income fund, which also has a very low expense ratio.
Retirement income funds are designed to maintain a stable value. For example, Vanguard’s Target Retirement Income fund fell 15% from February 2008 to February 2009, compared with a 43.3% loss in the S&P index over the same period.
Perpetuity funds are designed to provide a stream of income in perpetuity, not for a finite period. These funds are designed to keep your savings growing, while distributing income from interest and capital gains. Because perpetuity funds must preserve principal, their return rates are lower than for nonperpetuity funds.
Different funds have different investment strategies and combinations of stocks and bonds. When evaluating a fund, ensure the strategy and combination of investments suits your style and risk tolerance. If the percentage in equities is too high, find another fund with more fixed income investments. When comparing different funds, ensure the funds you’re comparing are the same type, for example two nonperpetuity funds with the same payout period.
You will also want to pay attention to the expense ratio and sales commissions, not only of the fund itself but also the mutual funds that it invests in. High expenses can eat into your profits and reduce your returns.
Retirement income funds are a convenient tool for those don’t have the time or inclination to manage their own investments. If you are comfortable with managing your retirement assets, you could always find a retirement income fund you like and duplicate it by purchasing the underlying mutual funds yourself. Typically, retirement income funds invest in large and publicly traded index funds. For example, the Vanguard Target Retirement Income fund invests in the Vanguard Total Stock Market Index fund and the Vanguard Total International Stock Index fund, as well and Vanguard’s bond funds.
For more information
See a description of the largest retirement income fund groups from Vanguard, Fidelity, and Schwab here.
See a longer list of retirement income funds here.
Use Vanguard’s retirement income calculator to determine how much you’d need to invest to generate a specified income, or vice versa, from the Vanguard Managed Payout Fund.