From the September 2009 issue of Boomer Market Advisor • Subscribe!

A hard look at retirement income funds

The mutual fund industry is waking up to the boomer tsunami. New products offering targeted income and principal protection have emerged in the last few years, attempting to capitalize on the growing need for retirement income flows. Some of these funds are specifically designed to provide scheduled payments for those entering retirement, a feature which appeals to many boomer investors.

As with any new product offering, there are special features that need to be examined in detail. You don't want to assume that if the new product resembles products that were effective for clients in the past, they will work exactly the same.

Specifically, these relatively new mutual fund offerings aim to provide a stream of predictable income for an investor similar to annuities. In fact, they have been offered as direct competition to annuities. You may find that your investors feel more confident utilizing the mutual fund product and avoiding the traditional complexities of annuities, as well as layers of fees, long surrender periods and high commissions. But the mutual funds are less complex products and charge a single management fee for the professional management of client funds and the structuring of the income payments.

On the flip side, the mutual fund products offer no guarantees that the payments will keep pace with inflation throughout retirement, and poor investment performance can actually create variation in the client's income stream. In 2008, a major mutual fund company offering income replacement funds actually cut its participants' paychecks by 25 percent because of the volatile markets. How can that be? Did you read the fine print? Scheduled payments are appealing, especially to retirees who do not have any form of pension payments upon which to rely. Social Security, which might be a boomer's only source of pension-like income, will certainly not be sufficient to live on. Therefore the onus falls on the advisor to be vigilant about understanding the potential pitfalls of each income replacement fund offering.

Since this wave of boomer retirees is only in the beginning stages, we will continue to see countless new products emerging within the industry in an attempt to capitalize on the need for income replacement. Whether these products have been properly designed, researched and tested through various market conditions are questions advisors need to ask.

Before investing client funds in any unfamiliar product, I make it a point to ask the questions that I would ask if I were investing my mother's retirement savings: What is the scenario in which this product fails? Can the income payment vary? What if the client lives to age 100? What type of asset allocation model will provide the needed income for the client? What are the potential tax consequences of this stream of income? If your wholesaler can't answer these questions, then move up the ladder until you are satisfied that you have a full understanding of the useful features as well as the caveats.

Also an important, but often overlooked step in this process of folding a new product offering into your firm's mix of investment options is the education of your staff. Be sure to include your licensed admins and other support personnel in the due diligence process to ensure your clients receive accurate information from anyone who is representing your firm.

I have previously written on this issue of creating systematic streams of income for boomers in retirement as traditional pension plans become less common. These new products may be useful solutions, but may not provide the entire solution on their own. I recommend that the use of these mutual fund income replacement products be part of a well-balanced diet of investments.

Mark A. Cortazzo, CFP is senior partner with MACRO Consulting Group in Parsippany, N.J.

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