As any retiree can tell you, accumulating money for retirement is only half the battle. Figuring out how to convert those savings into a reliable income stream during retirement is what throws many for a loop.
Indeed, with pensions going the way of the electric typewriter, retirees are forced to fend for themselves, using a combination of dividends, interest paying bonds, annuities and systematic withdrawals from their equity portfolios to create cash flow.
A new category of products aimed at providing income payments during retirement, however, is making that job easier.
DB(k) retirement plan
The newest player in the lineup, which became available in 2010, is the DB(k) plan — a combination pension and 401(k).
Made possible by the Pension Protection Act of 2006, DB(k) plans allow businesses with 500 or fewer employees to offer workers a 401(k) savings option, while also providing a small, guaranteed lifetime monthly income during retirement. The pension part is equal to 1 percent of final average pay multiplied by the number of years of service, or 20 percent of the employee's average pay during the five consecutive highest earning years.
The defined benefit (pension) portion of the plan becomes fully vested after three years.
Under the defined contribution part of the plan — the 401(k) — employers who provide the DB(k) are required to automatically enroll workers at 4 percent of their salary, and offer a 50 percent, fully vested match.
The push is already on to make such plans available to larger employers as well.
Monthly income funds
Heeding the call to provide retirement income on a regular basis, several mutual fund concerns have introduced monthly income funds in the last three years, including Fidelity, Vanguard, Schwab, Baron, Russell, ING, John Hancock and Pimco.
Some return your capital and are intended to liquidate by a particular date while others attempt to maintain or grow your principal amount through retirement.
The funds, which go by many names, combine income-generating bond funds and varying degrees of equity exposure to help retirees generate a targeted — but not guaranteed — annual payout. They are designed to supplement other sources of retirement income, including annuities, pensions and Social Security.
Fidelity's Income Replacement funds, for example, rely on professionally managed withdrawals to create regular payments that seek to keep pace with inflation. It offers no-load as well as adviser versions of these funds.
The company notes its series of income replacement funds can be used to bridge an income gap or cover expenses until other income sources become available. For example, some retirees may wish to postpone receiving Social Security or pension payments so they can get larger payments from those sources in the future.
Because the funds are new, long-term performance information is not available. But because of their diversified holdings, it's a good bet that they won't fly as high as the S&P 500 in bull markets or sink as low as that benchmark in bear markets. The performance snapshots below bear this theory out.
For example, Fidelity Income Replacement 2024 (FIRNX), which uses a payment strategy designed to liquidate the fund by 2024, posted a 36 percent return over the one year through February, compared to a 54 percent gain for the S&P 500. Since the fund's inception in August 2007, the fund lost 1 percent while the S&P 500 fell 8 percent.
Vanguard's Managed Payout Growth & Distribution fund (VPGDX) gained nearly 40 percent in the year through February versus 54 percent for the S&P 500. Since its inception in May 2008, it fell 7 percent while the S&P 500 lost 10 percent.
Schwab's Monthly Income Moderate Payout fund (SWJRX) rose 27 percent over one year, and eked a 0.12 percent gain since its March 2008 inception, versus a 6 percent loss for the S&P 500.
Annuities are contracts between an individual and an insurance company that provide retirement income in exchange for payments (in the case of deferred annuities) or a lump sum (with immediate annuities). They are nothing new to retirees, but their appearance in 401(k) plans is relatively new.
Several insurance companies — including MetLife, Genworth Financial, The Hartford and Prudential — offer annuities that allow plan participants to contribute toward a guaranteed lifetime income product that kicks in after they retire.
The annuities available in 401(k) plans can work like deferred fixed-income annuities, where with each contribution you buy a certain amount of guaranteed income for life. Or they can work like deferred variable annuities, where with each contribution your account value increases. With the latter type, if the market does well, your portfolio does, too, but you get a minimum rate of return regardless of what the market does.
Of course, you pay for this protection, as the fees are generally higher than for mutual funds. But unlike regular annuities, no surrender charges apply. Employees can switch into other 401(k) plan investments if they change their minds.
As an example, Prudential's product offers employers a target-date fund with an annuity as the fixed-income component.
"There is an increased interest in putting annuities and other guaranteed products into 401(k)s, and that trend is going to pick up steam," says Christine Benz, director of personal finance for Chicago-based fund tracker Morningstar. "There is interest from the Obama administration in having retirees get handed this pool of assets upon retirement instead of having the employer say, 'You're on your own.'"
Guaranteed retirement accounts
In its annual report released in late February, the Obama administration's Middle Class Task Force explores various solutions to enhance retirement security for Americans. Among its recommendations was "further study" of Guaranteed Retirement Accounts, or GRAs, that would allow American workers to put a portion of their savings into an account that's "free of inflation and market risk" and that "would guarantee a specified real return above the rate of inflation."
GRAs would not replace Social Security, according to the report, and "most workers will want to continue to have a mix of assets with different risk and return profiles in their overall retirement portfolios."
As retirees look for ways to convert their savings into cash, employers and plan providers will continue rolling out new products that provide downside protection within retirement plans and meet the growing demand for consistent income during retirement.