United States: The Role Of Managed Payout Funds In Retirement

Last Updated: November 6 2013
Article by Diana E. McCarthy and David L. Williams

Managed payout funds are mutual funds designed to provide a steady stream of retirement income while still allowing retirees access to their money during their lifetime. Managed payout funds are of relatively recent vintage (2008). The launch of these products coincided with the economic downturn, which adversely affected their popularity and growth for a time. As the economy has rallied, however, managed payout funds are gaining more assets. Managed payout funds make periodic distributions at a specified annual or monthly rate, but because they are mutual funds and not insurance products, they cannot offer a guarantee that payments will continue for a specified period or the life of the retiree.

Managed Payout Funds vs. Annuity-Like Products

Managed payout funds are often compared to annuity products or annuity-like products such as guaranteed minimum withdrawal benefits (GMWBs). There are key differences, however. In particular, annuity participants generally relinquish their retirement account (and access to its value during life) in return for guaranteed payments. A GMWB is an insurance product, owned by the investor, that provides guaranteed income for a retiree's life as long as the retiree does not withdraw more than a specified percentage from the fund each year; if the retiree opts for larger withdrawals, the lifetime income guarantee is forfeited. Managed payout funds allow investors to withdraw more than the payout (or their entire investment) at any time, but this liquidity benefit is offset by the loss of the anticipated payout. While managed payout funds seek to provide steady income to investors, such payouts will generally rise and fall depending on market conditions. It is possible for a managed payout fund to suffer substantial investment losses and simultaneously experience additional asset reductions as a result of distributions to shareholders. Thus, managed payout funds are a useful investment tool when combined with more certain sources of retirement income. For example, it may be prudent for a retiree to buy an annuity or GMWB to cover fixed costs and invest in a managed payout fund for discretionary spending that can be scaled back if the fund underperforms.

Types of Managed Payout Funds

Managed payout funds generally fall into two categories: those that pay out indefinitely and those that pay out for a set term and then liquidate (i.e., reverse target date funds). A principal difference between these types of funds is that the income for the indefinite payout funds will tend to vary more than the reverse target date type funds.

Indefinite Payout Funds. Indefinite payout funds function as you would expect. They are designed to pay out monthly income for an indefinite period of time. Schwab Funds and Vanguard Funds typify this type of funds.

Schwab offers three types of monthly payout funds: moderate payout, enhanced payout and maximum payout. Each fund type has the same investment objective: to seek to provide current income and, as a secondary investment objective, capital appreciation. Each fund is also a fund of funds, meaning that its principal investment strategy is to invest in other Schwab funds, which are a mixture of equity, fixed income and money market funds. The main difference among the three funds is the target asset allocation used to achieve the investment objective suggested by the name of each fund. The funds' principal risks are linked to those of the underlying funds and the adviser's ability to manage the fund to produce the monthly payout goal. The Schwab maximum payout fund aims to provide monthly income in the ranges of 1-5% in a low interest environment and 5-8% in a high interest rate environment. The other two funds aim for progressively lower percentages.

Vanguard also offers three different managed payout funds. Their investment objectives are to make monthly distributions of cash while seeking to provide inflation protection and capital appreciation. Vanguard's managed payout funds operate similarly to that of the three Schwab funds in that they have different asset allocation strategies geared to their distribution goals. They, too, are funds of funds, and their principal risks are similar to that of the Schwab managed payout funds. The monthly distribution goals range from 3-7% depending on the fund.

Reverse Target Date Funds. Fidelity's and PIMCO's fund offerings are examples of reverse target date funds. Essentially, these funds aim to pay out all of their principal and earnings by a date certain, thus the monthly income paid to investors is a combination of both principal and earnings. Fidelity has at least 14 of these funds with target liquidation dates ranging from 2016 to 2042. The allocations become more conservative over time. The Fidelity funds invest in all types of affiliated funds, in contrast to PIMCO's two managed income funds that liquidate in 2019 and 2029, respectively, and seek to invest at least 90% of their assets in "laddered" inflation-indexed Treasury bonds. PIMCO's investment objectives are to provide "consistent real (inflation-adjusted) distributions" through the maturity of the fund. The Fidelity managed payout funds' investment objectives seek total return through a combination of current income and capital growth, but their returns are not inflation adjusted like the PIMCO funds. Each of these reverse target date funds aims to make distributions that gradually increase over time to the date of maturity of the fund.

A main difference between the reverse target date funds and traditional target date funds is that the former seeks to provide monthly income for the investor through retirement, whereas traditional target date funds are designed to provide the investor with assets by the time of retirement.

Conclusions

Managed payout funds are relatively new and are only starting to gain traction in the market as investors and their advisers become more knowledgeable about how to use them. Generally, they are not necessarily intended to be an investor's sole source of income because their monthly income is not guaranteed. They are probably most useful for investors who have other sources of steady income, whether they be annuities, GMWBs, pensions or other sources.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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