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How Important Is A Guarantee?


There’s a class of mutual funds called “retirement income funds.” They’re also called “income replacement funds” and “managed payout funds.” Since they sound like potential alternatives to payout annuities, I decided to look them over.

When you buy one of these funds, your money usually goes into other mutual funds, whose managers invest it in stocks, bonds or cash equivalents. Like a period certain annuity, the income funds pay a specific monthly income for a specific time.

To evaluate them, I used an online calculator at one fund company website. It allowed me to choose how many years I wanted to receive income and either how much money I wanted to invest or how much income I wanted to receive per month.

If I invested $100,000 and received payments for 15 years, the calculator told me, I’d receive about $700 a month. If I wanted $1,000 a month for 15 years, I’d need to invest $141,000. If all went according to forecasts, my account balance would be zero at the end of the 15-year term.

How does that compare with a 15-year “period certain” annuity? At current rates, an annuity paying $1,000 a month for 15 years would cost about $143,000. Alternately, an annuity costing $100,000 would pay about $700 a month.

Very similar numbers. So how can a person decide between the two? It all depends on whether you want a guarantee. Income replacement funds provide no guarantees. As far as I can tell, buying one isn’t significantly different from arranging to receive regular payments (a “systematic withdrawal plan”) from any mutual fund portfolio. Yes, the calculators that usually come with income replacement funds can help you identify a prudent drawdown rate. And sometimes the fund managers employ sophisticated techniques to smooth the volatility out of  their returns. But they promise nothing.

With the annuity, an insurance company guarantees the payments. If you were to die during the 15-year period, your spouse or children would receive death benefit annuity checks in the original amount until the period ended. Granted, you can’t dip into the principal at will. But if you could, there’d be no guarantee.

Written by Kerry Pechter


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