Payout Funds Offer No Guarantees for Retirees

UP UNTIL RECENTLY, aging workers who've done a good job saving up for their golden years had just a few ho-hum planning options for funding retirement: Buy an annuity, gradually draw down assets, or try to live off of dividend and interest income.

Each approach had disadvantages. Annuities, while guaranteeing income for life, tend to be loaded with fees. Drawing down assets is risky since you may outlive them. That leaves nothing for the grandkids, and you may end up at the mercy of offspring or Uncle Sam for financial support. Setting up a dividend and interest portfolio is complicated, and usually requires the services — and service charges — of a financial planner.

Thanks to all the money that's to be made off of the boomer generation, more products are coming on the market. Among the latest are Vanguard's new "managed payout" mutual funds, which launched this spring.

The basic gist is to offer ordinary folks an endowment-like retirement account that will both produce monthly income and preserve or grow principal. The funds can always be accessed for unexpected costs and be bequeathed to heirs, unlike annuities, which lock up your money. Generally, you'd need to pay a financial planner to build such a portfolio. Now, Vanguard has conveniently packaged the strategy into a single-step purchase of a mutual fund. The catch? It's risky business for people who don't have cushioning elsewhere.

Vanguard designed the funds in a way that allows them to earn enough from their investments to generate monthly payouts without dipping into principal. That's the goal anyway, but there's no guarantee. "Worst-case scenario, it's a theoretical possibility that you could draw down the whole account," admits Vanguard's John Ameriks, of the firm's investment counseling and research group. "You need to be comfortable with the notion that from period to period, investments can lose money. They're still mutual funds."

Still interested? The three choices are Vanguard Growth Focus (VPGFX), Vanguard Growth & Distribution (VPGDX) and Vanguard Distribution Focus (VPDFX). There are different levels of investment risk. The more aggressive Growth Focus will have lower monthly payouts in the beginning but more growth potential. The more conservative Distribution Focus offers more upfront income but less growth potential. To date, more investors are favoring the middle path into the Growth & Distribution fund (see chart below).

Each fund invests in other Vanguard funds based on "quantitative and qualitative" analyses, Ameriks says. Currently, for instance, the Growth & Distribution fund holds Vanguard's Total Stock Market Index Fund (VTSMX), Total Bond Market Index Fund (VBMFX), Market Neutral Fund (VMNFX) and others.

While it's early on, the sentiment among financial planners we spoke with is mixed. "This may be good for a 'retail' client that is not working with an advisor and does not want to take the time to do further research or take on the challenge of rebalancing and deciding the proper asset allocation," says Bob Burger, a financial planner in Phoenix. But as an advisor, Burger says, he could see creating "a portfolio better suited to their individual goals/needs with potentially less operating expense." He points out, for instance, that some of the underlying funds in Vanguard's payout portfolios have lower expense ratios individually than when purchased in the one-stop-shop, which is still cheap with an annual fee of 0.58%.

Vanguard demurred when we sought help in comparing the cost of these payout funds to the cost of buying a Vanguard annuity, saying that with annuities the "cost isn't transparent." Ameriks instead suggested we look at monthly payouts to get a sense of the trade-offs.

So, the payout funds require a minimum investment of $25,000, which will initially pay out $69, $113 or $159 a month in the Growth, Growth & Distribution and Distribution funds, respectively. In comparison, if you're 65 years old and buy a fixed Vanguard annuity with inflation adjustments, you'll get $127 a month.

Ultimately, these payout funds make the most sense for people who will already have enough from Social Security and/or defined benefit plans to cover all their fixed retirement costs. The best way to view payout funds is as a way to manage your discretionary retirement income. While they're cheap and costs are transparent compared with annuities, and you don't give up access to your money, you do forfeit any guaranteed safety net. And when it comes to your retirement, that's not chump change.

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