What it means
When people retire, they need to turn a lump sum into something that behaves like a salary. A retirement income fund does this by paying out part of its income and sometimes part of its capital at regular intervals.
The investor receives a monthly or quarterly payment instead of having to sell investments personally. The fund's mix of assets determines both the level and the stability of the income.
Bonds provide steady interest, shares add growth and dividends, and some funds include property or infrastructure for extra yield. A higher payout usually means taking more risk or running down the capital faster.
Different countries use the name for different things. In Canada, a registered retirement income fund is an account into which retirement savings are moved and from which minimum annual withdrawals are required.
In other places the term is used for managed funds aimed at retirees, so it is vital to read the fund documents and not rely on the name. The key risk is that the payout may be too high for the fund to sustain.
If the fund pays 7% a year but earns only 4%, it must eat into capital, and the income will fall as the pot shrinks. Inflation is a second risk, because a fixed payout buys less each year.
Investors should compare the payout with the fund's long-run return, check the fees and understand what happens to the income in a market fall. Some funds target a stable payout, some target a stable capital value and some try to balance the two.
The right choice depends on how much flexibility the retiree has with spending. Costs deserve a close look because they come out of the income.
A fund charging 1.5% a year takes $3,000 annually from a $200,000 balance, which is a large bite when the payout itself may be only 4% or 5%.
In practice
Real-world examples.
Example
A retired nurse moves $250,000 from her workplace pension into an income fund that pays a monthly amount. The payments top up her state pension and she does not have to decide when to sell investments.
Example
A couple holds a retirement income fund inside a tax-sheltered account. Each year they take the required minimum withdrawal and spend it on household costs, leaving the rest invested for future years.
Example
A former factory owner sells his business for $1,200,000 and puts part of the proceeds in a multi-asset income fund. He compares the fund's 4.5% payout with the 3.5% he could get from a deposit and checks how much risk he is taking to earn the difference.
Formula
Calculation
Annual income = Fund balance x Payout rate
Balance after one year = (Fund balance - Annual income) x (1 + Investment return)
Suppose a retiree holds $400,000 in a fund with a 5% payout rate. The annual income is $400,000 x 0.05 = $20,000, which is about $1,667 a month. If the fund earns 4% over the year, the balance becomes ($400,000 - $20,000) x 1.04 = $380,000 x 1.04 = $395,200. Because the return is below the payout rate, the capital is falling slowly.Case study
Seen in the real world.
Fernhill Savings is an illustrative, fictional provider that launched a retirement income fund aimed at people leaving work. The first version paid a high fixed monthly amount, which attracted many investors in the first year.
When bond yields fell, the fund struggled to earn enough to cover the payout and began returning capital. The board changed the design so that the payout is set each year as a percentage of the fund's value, which makes income vary but protects the capital.
In this fictional case some investors disliked the variable income, but the fund survived a market fall without running out of money. The illustrative lesson is that a retirement income fund must balance the comfort of a steady payout against the maths of what its assets can earn. The provider also began publishing a simple chart showing how the payout would change in a weak market, so investors knew what to expect.
Watch out
Common mistakes.
- Choosing a fund because it advertises the highest payout, without checking whether that payout can be sustained.
- Assuming the income is guaranteed, when most funds can reduce payments if markets or yields fall.
- Ignoring inflation, so that an income which looks comfortable today buys much less in fifteen years.
Questions
People also ask.
What is the difference between a retirement income fund and an annuity?
A fund keeps your money invested and pays income that can vary, while an annuity is a contract with an insurer that usually pays a guaranteed income for life.
Can I lose money in a retirement income fund?
Yes, the value of the underlying investments can fall, and payouts can drop if the fund earns less than expected.
How should I decide how much to take from the fund?
Compare the payout rate with the fund's expected long-run return, keep a margin for inflation and review the figures every year.
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