What Is A Managed Payout Fund?

Managed payout funds are mutual funds that offer regular and predictable income to investors. Like annuities, these products provide a steady income stream, but unlike annuities, the income isn’t guaranteed and payments can fluctuate. Although these products gained steam after the financial crisis in 2008, they have struggled to get a foothold in the industry.

How Managed Payout Funds Work

Managed payout funds are designed to produce a predictable amount of monthly or quarterly cash distributions to investors. To that end, they invest in a diverse mix of assets that aim to achieve consistent returns rather than maximal gains.

Some managed payout funds act as decumulation vehicles. This means they pay out a steady stream of income based on investment performance along with a slow payout of the initial amount you invest. Other managed payout funds aim to protect the initial investment, but they may distribute it if necessary to make payments.

In some cases, managed payout funds operate like target date funds for your retirement—but instead of a focus on maximum growth, they home in on producing a target income stream over a retirement time horizon.

While that sounds ideal, it’s been an uphill climb for these products. “They were launched right around 2008, so already a pretty uncertain time for a lot of individuals, and not a time when people were looking to increase their exposure to the financial market,” says Madeline Hume, an analyst of multi-asset and alternative strategies for Morningstar. “And there’s a lot of competition outside the mutual fund industry for retirement income savings and translating that into a spend-down strategy, most acutely from annuities.”

Add to that the fact that retiree cash flow can be hard to nail down: Withdrawals typically are larger at the start of retirement and level out over time. This makes it hard for actuaries and fund managers to create fund payments that reflect many retirees’ complex financial needs. What’s more, low yields on steady fixed income investments have hampered managed payout funds’ ability to create a steady income stream without the benefit of insurance.

“It’s been kind of a minefield for them over the last 10 years in terms of picking a strategy,” Hume says. “They haven’t been able to deliver a yield in excess of the median of the broader allocation categories they’re a part of.”

And although managed payout funds offer a “target” or “anticipated” regular payout, the range may be as wide-ranging as 1% to 8%, which is a tricky foundation on which to build your retirement house. “It’s an interesting concept, but very hard to execute,” says George Gagliardi, a Certified Financial Planner (CFP) in Lexington, Mass. “If you’re looking at 1% to 4%, that’s no guarantee. What if I get 1%? I can’t live on that.”

The Many Names of Managed Payout Funds

Managed payout funds go by a variety of names, including retirement income fund, monthly income fund or income replacement fund. Regardless of the name, their goal is the same: to provide a steady and predictable stream of income in a mutual-fund-based packaging.

Managed Payout Funds vs. Annuities

Managed payout funds share several characteristics with annuities, in that they provide a stream of income over time based on a lump-sum investment. But they differ in a few key ways:

•  Guaranteed payments: While an annuity guarantees a certain payment over time, managed payout funds don’t offer payment guarantees. Though there is still risk you won’t get paid when you buy an annuity, annuities are backed by insurance policies that help preserve your income stream, even if an annuity company goes bankrupt.

•  Inflation: Managed payout funds have the potential to keep up with inflation over time whereas annuity payments generally will not, unless you add on a cost of living adjustment (COLA) rider. But COLA riders mean more fees, and they may decrease the amount of your early payments . “If there’s a hyper-inflationary environment, retirees would benefit from managed payout funds as opposed to a fixed payment like an annuity,” says Hume.

•  Liquidity: Investors can access and remove capital from their managed payout funds relatively easily. On the other hand, taking money from an annuity can result in penalties, particularly if you do so during the surrender period. Accessing funds during this period might result in forfeiting from 7% up to 20% of your annuity investment.

•  Taxes: Distributions from managed payout funds are made up of capital gains, interest, dividends and return of capital—so taxation will generally be a mix of advantaged and ordinary capital gains taxes. Annuity payments, on the other hand, contain interest, taxable at ordinary income tax rates, and principal, which wouldn’t be taxed if you purchased the annuity with after-tax money.

•  Inheritance: If you die, the savings in a managed payout fund can be transferred to heirs. “Some annuities do provide this, but often it comes at a premium,” Hume says.

Popular Managed Payout Funds

Few managed payout funds are on the market, and each of them operates a little differently. “It’s a small universe, and there are almost no two strategies that are exactly alike,” Hume says. With so many different structures, picking a managed payout fund can be difficult. But here are the major players:

Vanguard Managed Payout Fund

Vanguard’s Managed Payout Fund used to make monthly payouts to shareholders with an annual target distribution rate of 4%. But in February 2020, this fund was renamed the Vanguard Managed Allocation Fund, and monthly payouts were eliminated in favor of an annual distribution.

The company made this decision due to operational complexities associated with the reporting required when distributions included a return on capital. It also realized that many of the shareholders in the fund don’t use the monthly payout feature and instead choose to reinvest a large portion of their distribution.

“In recognition of how people were actually using [the fund], Vanguard decided to mediate that method a little bit more,” Hume says.

Gagliardi puts it slightly differently: “We’re in a world with 0% interest rates, so it’s hard to get income,” he says. “If you look at the products, Vanguard basically folded theirs.”

Fidelity Income Replacement Funds

Fidelity’s Income Replacement Funds work on a decumulation model, meaning the fund makes regular payments that gradually liquidate the amount you first invested by a “horizon date,” such as 20 years into the future. Fidelity notes that payments may not keep pace with inflation and will fluctuate year over year. This may make it hard for retirees to make financial plans.

John Hancock Retirement Living Funds

John Hancock has one managed payout fund, John Hancock Retirement Income 2040, with the objective of maintaining and growing regular cash distributions through December 2040. Cash distributions are composed of bond and equity returns as well as the return of what you invest, meaning like Fidelity’s model, it’s self-liquidating. The company targets a quarterly payment schedule and a minimum payout of $2.025 per share.

Schwab Monthly Income Funds

Charles Schwab has three Monthly Income Funds intended to serve differing retirement income needs. The company uses a fund-of-funds strategy, meaning each fund invests in a series of funds to achieve its goals. These funds aim to provide monthly income and the opportunity for investment growth. Investors pick the monthly income fund that best fits their asset allocation needs:

• Maximum Payout (0-25% equity, 60-100% fixed income, 0-15% cash and cash equivalents)
• Enhanced Payout (10-40% equity, 50-90% fixed income, 0-12% cash and cash equivalents)
• Moderate Payout (20-60% equity, 40-70% fixed income, 0-10% cash and cash equivalents)

Just like it sounds, the maximum payout fund aims to provide the highest possible payout by focusing more on fixed income and less on equity. The moderate payout, conversely, focuses more on equity and less on fixed income. Anticipated annual payouts range from 1% to 5% in a low interest rate environment and from 3% to 8% in a high interest rate environment, depending on the fund. Interestingly, the maximum payout fund aims to offer higher returns than its more equity-based counterparts. Though this might seem counterintuitive at face value, it’s by design.

“Although fixed income securities typically offer lower returns compared to equities, this predictability enables us to offer a higher anticipated payout,” says Mike Peterson, director of public relations for Schwab.

JPMorgan SmartSpending Funds

JPMorgan’s SmartSpending products also operate on a decumulation model, designed to help retirees spend down a portion of their retirement savings at a rate that will get their asset balance to zero (or near it) by year 35. At the beginning of each calendar year, the fund announces a “sample spend-down amount,” and it’s recommended that investors withdraw that amount that year. For instance, if you had $200,000 invested in a SmartSpending Fund and the annual sample spend-down amount for 2020 was 4.9% of the shareholder’s investment in the fund, the suggested spend-down for 2020 would be $9,800.

The Final Word on Managed Payout Funds

Overall, the field of managed payout funds is evolving and trying to adapt to market conditions, but it’s unclear what the future holds. “Retirees have not been served well by these products,” Hume says. “A lot of these products have been merged away, and the ones that remain are very small and suffering from changes in strategy. It hasn’t been a home run.”

If retirees are looking for a guaranteed source of lifetime income that starts now—which is what a managed payout fund aims to accomplish—a fixed lifetime annuity may be a better product to consider. With this type of annuity, you usually give an annuity company a lump sum in exchange for a guaranteed monthly payment for life.

“With interest rates so low, the payouts are low these days, but they are guaranteed and will last for your lifetime,” Gagliardi says. Though sometimes pricy, “lifetime annuities are ‘longevity insurance’ that lasts as long as you do.”