Make your money last a lifetime, take 2

A handful of new funds try again to solve the problem of retirees running short of cash

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By Walter Updegrave, Money Magazine senior editor

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Follow the bouncing payment
With one of Fidelity's new Income Replacement funds, your monthly check could drop sharply if the market hits a rough patch like 2000 through 2002.
Monthly payments if you had invested $500,000 in the Fidelity Income Replacement 2036 fund
Jan 2000 $2,121
Jan 2003 $1,607
Jan 2007 $2,267
Source:Morningstar; fund prospectus.

Notes: Hypothetical example based on the payment percentages, asset allocations and performance of the funds owned by the Fidelity Income Replacement 2036 Fund; if a fund was not in existence during a certain period, Morningstar used returns for the category average.

NEW YORK (Money Magazine) -- Making sure your savings last as long as you do is one of the toughest tasks you face in retirement. So far the only way to guarantee income for life is with annuities. But as I've often pointed out, annuities can have many drawbacks, including high fees.

The issue that stops most people, however, is that once you "annuitize," or convert your assets to income, you can't access your money for emergencies.

Now mutual fund companies are taking a stab at the retirement income problem with a new breed of mutual funds that aims to turn money in IRAs and other retirement accounts into spending cash for retirees.

Several companies, including DWS Scudder, Russell and Vanguard, have such funds in the works, but to date only Fidelity is actually selling them.

Not surprisingly, these new funds won't be a perfect solution either. But by taking a close look at the one version that's available today, Fidelity's Income Replacement funds, you can learn about the advantages mutual funds might bring to the table, as well as their drawbacks.

How they work

Fidelity's Income Replacement funds are a bit like target-date retirement funds in that they have a diversified portfolio of stocks, bonds and cash that grows more conservative over time.

But instead of picking a fund with a date that corresponds to your planned retirement, you choose a fund with a date ranging from 2016 to 2036, based on the number of years you want to receive income.

After deducting annual expenses of 0.65% or less, the fund then pays you a rising percentage of your account value each year until the balance runs out in the target year.

So if you're 65 and want to be assured of income until you're in your nineties, you'd pick the 2036 fund. Your payment would start at 5.2% of account value in 2008, rise to 7.3% in 2010, then to 26% in 2033, and in 2036 the fund pays out whatever is left in your account.

The drawbacks

The theory behind these funds is that by simultaneously paying an increasing share of your account value and shifting more of the fund's assets into bonds and cash each year, they will be able to provide a relatively stable stream of income that can also keep pace with inflation.

Crucially, as with any mutual fund, you always have access to your money and you can cash out at any time.

It's important to understand these funds' limitations, though. While they can ensure that you'll receive income through the target year, they can't guarantee the size of the payments. That depends on the funds' investment performance. And as the table below shows, your income can drop if the markets hit a rough patch.

There's another risk: The funds send you a portion of your balance each year so that eventually all your money, both your original investment and your earnings, is returned to you. In short, they're designed to be tapped out in the target year. So you'd better be careful about which fund you choose.

If you're 65 and buy a 2028 fund, your balance will run dry in 21 years. Thus, if you live beyond 86, which you have roughly a 50% chance of doing, you'd better have other assets to fall back on.

I'll be surprised if we're not awash in dozens more retirement income funds within the next year, with all sorts of twists. But however many you may have to choose from, the most important thing to remember is that they're not "the answer" any more than annuities or any other particular investments are.

The real key is finding a way to combine different options so you have access to your savings, protection against inflation and assurance that you won't outlive your income. Because as important as it is to have retirement income choices, it's even more important to make them work together.  To top of page

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