David Lerner Associates: Distribution Funds - Putting Revenue on Autopilot

David Lerner Associates: Distribution Funds - Putting Revenue on Autopilot

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2015-01-26

A fund by some other name

Distribution funds also may be referred to as:

  • Managed income funds
  • Retirement income funds
  • Income replacement funds
  • Managed payout funds
  • Retirement distribution funds

Questions to ask about a distribution fund

  • How are monthly payments determined?
  • Does the fund make payments from earnings only, or from both earnings and principal?
  • What is the proposed withdrawal rate?
  • How much threat does the fund take in trying to achieve its targeted distribution rate?
  • What are the fund's underlying investments?
  • What is the fund's current asset allocation, and how may that allocation change in time?

Keep in mind: Past performance is no guarantee of future outcomes and asset allocation alone can't ensure a profit or prevent a loss.

Before investing in a distribution fund, carefully consider its investment objectives, risks, charges, and expenses, which can be found in the prospectus offered from the fund. Read the prospectus thoroughly before investing.

Distribution Funds: Putting Revenue on Autopilot

As baby boomers retire, they begin to focus less on accumulating assets and more on how those assets may be converted into an ongoing stream of income. Distribution funds are one way to simplify that method.

Distribution funds are actively managed mutual funds that focus not on maximizing asset growth but on making regularly scheduled payments to investors. Distribution funds were primarily developed to give retirees an easier way to receive income. For example, early retirees might use one to provide income until they reach full retirement age. They also may be used to complement a pension or other income sources.

How distribution funds work

A distribution fund basically functions much like a systematic withdrawal plan. Its annual payout (either a percentage of assets or a specific dollar amount) is divided into equal payments that are scheduled to be made at regular intervals (typically monthly or quarterly).

As with so-called lifestyle or lifecycle funds, distribution funds typically are offered as part of a group. All funds in the group use a similar investing methodology, but each fund has a different payout target or distribution rate. For example, one fund in the group might offer a 3 % annual payout. Another fund in the same group might target a 4 % payout, and a third might aim for 6 %.

One size doesn't fit all

Even though funds within a given series are consistent in their approach to income distribution, methods used by various families of distribution funds to generate returns and calculate payments vary widely. For instance, one series might distinguish its funds based on the annual percentage each one distributes. Another group of funds might determine annual income levels and asset allocation based on how long each fund's portfolio is intended to last. The shorter a fund's time horizon, the higher the targeted annual payout.

Some distribution funds are managed to ensure that all capital is exhausted by the end of a marked time period, typically getting more conservative as that end date gets closer. Others are designed to preserve capital and make payouts primarily from earnings; these generally have no time frame attached. Regardless of how the targeted payout rate is derived for a given fund series, it's based on what is considered a sustainable withdrawal rate given the fund's objectives, planned asset allocation, and time frame (if applicable). Also, in many cases, the amount of the payout is adjusted to keep pace with inflation.

A distribution fund's method of providing its targeted income is typically based on historical rates of return for various kinds of investments in both good and bad markets. Each fund's strategy is intended to minimize the impact of market fluctuations on its income payout. However, there is no guarantee a fund's payout will stay the same from year to year. Also, it's important to remember that all investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will succeed.

A distribution fund is typically structured as a fund of funds, implying that it is comprised of other mutual funds. Nevertheless, some also include other kinds of investments.

Distribution funds aren't annuities

Because of their focus on income, distribution funds are designed to fulfill a role in retirement that is somewhat just like that of payments from an immediate annuity. However, there are some key variations. Perhaps the most important is that distribution funds offer no guarantees of the payout levels they offer; immediate annuities generally do (subject to the claims-paying ability of the annuity's issuer). Also, a mutual fund is not an insurance contract, as an annuity is. And immediate annuities often are designed to guarantee an income that lasts throughout an individual's lifetime, and/or that of a spouse. Though an investor can attempt to provide that with an appropriate distribution fund, no fund can guarantee income for life.

Advantages of distribution funds

A distribution fund can help simplify and streamline the process of obtaining ongoing income. You don't need to stress over constructing that diversified portfolio on your own, shifting its asset allocation over time, or rebalancing it periodically. Also, the idea of a distribution fund may be easier to understand than an insurance contract that has many riders and variables. In addition, a targeted payout rate may make it easier to estimate how long your savings will last than if you were to try to manage your portfolio on your own.

Distribution funds also offer a great deal of flexibility. Even though you receive routinely scheduled payments, you can take out additional amounts from your principal at any moment. That implies you can change your annual retirement income from year to year, or make withdrawals to take care of unexpected costs. Investments that ensure a consistent income stream generally limit the use of your principal.

Because distribution funds were intended as low-cost alternatives to annuities, expense ratios tend to be comparatively low.

Tradeoffs with distribution funds

As discussed previously, a distribution fund may strive to provide a certain level of income, but there are no guarantees that it will do so. Depending on how a fund is structured and managed, a steep or prolonged market decline could affect the amount of the scheduled payments from year to year, or how long your investment will last. If you can not afford either possibility, a distribution fund may mean more uncertainty-- either long term or short term-- than you're comfortable with.

If you are willing and able to structure and administer a systematic withdrawal program independently, you may be able to replicate many of the advantages of a distribution fund with a well-diversified portfolio. That would give you greater ability to customize payouts to your individual situation. For example, you could shift investments based on what's happening in the financial markets or your own life, and manage your tax situation from year to year.

Distribution funds are designed for individuals who plan to stay invested in a given fund for an extended period of time. If you're an active trader or might withdraw your money relatively quickly, you may want to think twice; in-and-out investing will undercut the very reason for choosing a distribution fund. And be aware that even though you can withdraw amounts over and above your scheduled payments, those withdrawals will reduce future earnings that would have supported distributions in later years. That could leave you vulnerable to longevity risk-- the possibility of outlasting your savings.

You also may need to consider any projected distribution fund payouts in the context of other retirement income concerns, such as the tax consequences of those payouts, or required minimum distributions from a qualified retirement plan or IRA.

One of many choices

As with most investment options, a distribution fund may not fill all your retirement income needs. Don't hesitate to get expert advice on whether one might be useful for part of your portfolio, or for a specific purpose.

IMPORTANT DISCLOSURES

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.

David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable-- we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Some of this material has been provided by Broadridge Investor Communications Solutions, Inc.

Member FINRA & SIPC 

 

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About

Founded in 1976, David Lerner Associates is a privately-held broker/dealer with headquarters in Syosset, New York and branch offices in Westport, CT; Boca Raton, FL; Teaneck and Princeton, NJ; and White Plains, NY. For more information contact David Lerner Associates Call 516-921-4200 Visit our website: http://www.davidlerner.com

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Contact

Jake Mendlinger
Account Manager
Zimmerman/Edelson
516.829.8374 X 232
jmendlinger@zimmed.com

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