Having accumulated a big retirement portfolio but uncertain about how you should count on the portfolio to generate regular inflation-adjusted monthly payments? Our innovative financial service industry is not hesitate to help. Introducing the latest innovation in mutual fund industry … Fidelity Income Replacement Funds.
As marketed on the Fidelity web site:
Fidelity Income Replacement Funds are a new type of mutual fund designed to combine the power of professional asset management with professionally managed withdrawals to help turn part of your savings into regular monthly payments. The Funds are designed to be used in combination with other retirement income products and provide:
- Regular monthly payments that seek, but are not guaranteed, to keep pace with inflation
- Flexibility to change your mind at any time; you maintain 100% control of your investments with no additional fees or penalties
- Professional management of your assets and withdrawals
- Transferability of any remaining assets to your heirs, as with all mutual funds
In the hypothetical example included in the video demo, one can invest $100,000 today, and start getting inflation-adjusted monthly payout immediately, starting at $580 in Year 1 (to $680 in Year 6, $950 in Year 12 and $1,425 in Year 20). Expected total payout over the lifecycle of 20 years? Over $216,000.
I'm habitually very interested in analyzing new financial products, and this new product really amazed me, so I dedicated two hours to read the funds' prospectus and run the numbers. So what are my findings?
Similar to those "lifecycle" funds, Fidelity Income Replacement Funds automatically adjust the allocation of your portfolio toward a conservative mix over time, by investing in a number of underlying equity and fixed income funds.
In addition, Income Replacement Fund provides one more feature: it plans the right monthly withdrawal amount and send the money to you, so you don't have to worry the details of how much to withdrawal and whether your money can survive your lifespan. Fidelity accomplishes this by the Smart Payment Program, which will automatically sell mutual fund shares for you to make the monthly payment to you when necessary.
Let's say Income Replacement Fund is one step closer to a truly lazy man's solution. If you really don't want to work with money, you can set up the Income Replacement Fund, and just leave it to Fidelity to send you the monthly distribution check.
You can not blame Fidelity for only using its own funds to construct each Income Replacement Fund's portfolio. However, it is somehow discomforting to see Fidelity only uses actively managed funds as underlying funds. Shouldn't it consider lower-cost passive index funds?
Here is the list of underlying funds that are used in each Income Replacement Fund.
Domestic Equity Funds:
- Fidelity Broad Market Opportunities Fund
- Fidelity Large Cap Core Enhanced Index Fund
- Fidelity 100 Index Fund
- Fidelity Disciplined Equity Fund
- Fidelity Equity-Income
- Fidelity Advisor Mid Cap II
- Fidelity Small Cap Opportunities Fund
International Equity Funds:
- Fidelity International Discovery Fund
- Fixed-Income Funds
- Fidelity Total Bond Fund
- Fidelity Government Income Fund
- Fidelity Strategic Real Return Fund
High Yield Fixed-Income Funds:
- Fidelity Capital & Income Fund
- Fidelity Strategic Income Fund
- Fidelity Short-Term Bond Fund
- Fidelity Institutional Money Market: Money Market Portfolio
However, it is also worth noting Income Replacement Fund is not annuity, and there is no guarantee of whether your monthly payout will match inflation, or even whether you can get a monthly payout at all. Actually, your principal is also at risk since your money will be invested in a number of Fidelity-managed stock and bond funds.
Monthly Payout Prospect:
Here is how you can expect as monthly income in the first year if you invest $1,000,000 into one of the Income Replacement Funds.
Fidelity Income Replacement 2016 Fund (9 years' horizon): $9,290
Fidelity Income Replacement 2018 Fund (11 years' horizon): $7,982
Fidelity Income Replacement 2028 Fund (21 years' horizon): $5,082
Fidelity Income Replacement 2036 Fund (29 years' horizon): $4,240
* If things go smoothly as Fidelity planned, your monthly income will likely to increase every year to account for inflation.
Fidelity didn't discuss too much about its inflation assumption anywhere in the Funds' literature. The only hint it gave is in the demo video, which seems to suggest that Fidelity assumes about 3% inflation in the new five years, and 5% inflation thereafter. However, it is important to note that Fidelity will not peg year-over-year monthly income growth to CPI or any other price index; your 2nd year's monthly income is more a result of investment results in the first year.
Fidelity's series of Income Replacement Funds carries a reasonable fee structure. The only expense you will incur is those from the underlying funds. In other words, you don't pay a second-tier fee for the benefit of arranging
As stated in the prospectus, Income Replacement Funds carry an annual expense % between 0.54% (for 2016 Fund) to $0.65% (for 2036 Fund).
Handling the tax consequences for Income Replacement Funds can be hard, especially for the later years of every Fund's time horizon. That is because in later years, some of your monthly payout has to come from selling some mutual funds shares, and without proper reporting from Fidelity, it will be extremely difficult to tell which portion of your monthly income should be classified as dividend, capital gains, or just return of principal.
I do feel Income Replacement Fund is a nice invention that caters to those who already built their nest eggs, and want a no-hassle solution that will generate inflation-protected monthly income. Of course, potential investors need to know that by expecting better returns than annuity products, there is investment risk involved in the process, and Fidelity's actively managed funds may not the most cost-effective solution.