First quarter 2012 retirement income scorecard: Managed payouts


This post continues my retirement income scorecard for the first quarter of 2012, showing how much retirement income you can generate with $100,000 of retirement savings at the beginning of 2012. This post examines managed payouts, which are one of three ways to generate retirement income from your retirement savings. For background on these methods, you may want to review my recent post, "My four favorite ways to generate retirement income."

Retirement income scorecard first quarter 2012: Interest and dividends
IRAs and 401k: 3 ways to generate retirement income

Method #2: Managed payouts

You'll often hear statements from financial planners and writers that go something like this: Invest in a portfolio balanced between stocks and bonds, withdraw four percent each year for retirement income, give yourself a raise for inflation each year, and you'll have a 90% chance that your money will last for 30 years. Hence the justification for the so-called "four percent rule."

The four percent rule is actually a good starting point for considering an appropriate withdrawal rate, but you might want to consider withdrawal amounts lower than four percent in these circumstances:

-- If your retirement investments are actively managed and charged more than 50 basis points (0.50 percent) for investment expenses, over the long run, you may fall short of the net rates of return that justify the four percent rule.

-- If you're married, both of you are healthy, and you retire in your early to mid sixties, there's a good chance that one of you will live for more than 30 years.

If either of these statements is true, you may want to consider payout rates of three or three and a half percent. Here's the simple chart for the purpose of comparing these annual retirement income amounts and payout rates to other methods of generating retirement income.

Now let's look at managed payout funds offered by mutual fund companies. Vanguard offers its Managed Payout funds, and Fidelity offers its Income Replacement funds. These funds invest in portfolios balanced between stocks and bonds, and pay a monthly retirement income that includes interest, dividends, and principal payments. Here's a comparison of the annual retirement income produced by these funds and their payout rates.

The payouts from these funds are generally higher than the payouts from the simple managed payout rules shown previously. Why? There are a few reasons:

-- With the simple managed payout rule, your monthly income is intended never to decrease, even with unfavorable investment returns. You start with a low payout rate to be able to withstand possible future unfavorable investment returns. With the Vanguard and Fidelity managed payout funds, your monthly income can decrease in the future if there are unfavorable returns.

-- The Fidelity funds are intended to be exhausted at their target date (hence the snarky name "target death funds"). The Vanguard funds are intended to last throughout your life, but that's not guaranteed.

Note also that the Vanguard and Fidelity funds each have different asset allocations, depending on their growth goals, which are the reasons for the different payout rates.

Clearly there are differences in the way managed payouts can work, and you'll need to spend some time learning about the different strategies and features that are possible. Don't simply pick the method or fund that generates the highest retirement income. This demonstrates that managed payouts require the most ongoing attention of the three different ways to generate retirement income.

Please note that the amounts shown above are pre-tax income amounts. Federal and state income taxes will have a significant effect on your after-tax income and should be taken into account. The income taxes you pay will vary depending on whether your retirement savings have been invested before taxes in traditional IRA or 401(k) accounts or have been invested after taxes, such as in a Roth IRA, or are eligible for special tax treatment on capital gains, ordinary dividends, or municipal bonds.

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Stay tuned for my next post that shows the retirement income scorecard for Method #3, immediate annuities, and wraps up this series.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.