Finding the money to save for retirement is hard enough. Then there's the whole rigmarole of picking the right investment so your savings make money instead of losing it.
But these two feats of financial acumen pale in comparison to the high-wire act of creating a steady income in retirement that is not too little, because you've worked hard and deserve to enjoy it, and not too much, because it might be worse to run out of money and live to regret it.
Even advisers find it difficult to help their clients unwind their investments -- be it RRSPs, TFSAs or non-registered money -- in a steady stream of income, says retirement-income expert Daryl Diamond, with Winnipeg-based Diamond Retirement Planning.
Many have gone with what's worked well in the past: setting up a systematic withdrawal plan.
Basically, this involves selling enough units of a mutual fund or exchange-traded fund (ETF) to provide a monthly income.
"Traditionally, this has been effective to some degree because we've largely seen a progressively rising market," says the certified financial planner and author of Your Retirement Income Blueprint. "If we're keeping the income value the same and the unit value is going up, over time you're selling progressively less units each month to create the income that you need," Diamond says.
Don't you love it when a plan comes together?
Unfortunately, it hasn't worked out that way for many retirees in the last five years.
"More often than not, markets have been sideways at best and volatile most of the time," Diamond says.
What can end up happening is you have fewer fund units over time to make up for the losses. It's dollar-cost-averaging in reverse, he says. This strategy can potentially munch through your savings far too quickly.
But Diamond says many investors and even advisers tend to overlook an option available on a good number of income funds and balanced funds: the fixed-payout option.
"This has been around for, like, forever. It's just that nobody is using it," he says. "It's one of those things where there are different strategies and tools during the income years versus the accumulation years, and this happens to be one of them."
The formula is pretty straightforward. The fund will pay out a monthly amount from income earned on the investments held within the fund instead of selling units of the fund to provide income.
The funds offering this option are balanced or income funds, and generally they have sold very well of late, says Derek Green, president of CI Investments, one of Canada's largest mutual-fund firms.
"Clearly, these products have been incredibly popular for really the last five years or so for a number of reasons," he says.
CI offers 16 different income funds, from bond funds to dividend, but its Signature High Income and Signature Diversified Yield funds are among its bestselling products.
One reason investors are drawn to these funds is the steady, diversified income they provide. Because these products offer a fixed payout from an assortment of securities, typically only the returns from the investments make up the monthly payment. In turn, these products are less affected by volatility, those ups and downs in markets that can affect systematic withdrawals that involve selling fund units. With the fixed-payout option, no units are sold.
Second, they're a better option for most people than GICs. While the funds offering a fixed-payout option are riskier than a GIC, they pay a sizable enough distribution -- generally four to six per cent -- to provide a decent monthly income for a retiree.
Third, they're conservative in nature.
CI's flagship, Signature High Income fund, provides a five per cent distribution, has been around for 15 years and has never cut its distribution, Green says. Overall, income-oriented funds are the most popular mutual-fund investment in Canada.
The net flow of all income funds sold in Canada in 2012 was $39.2 billion, Green says. That's 173 per cent of the total net flow of $22.7 billion for all funds. "This means everything else in aggregate was in redemption."
Their growth in popularity is also likely a result of an aging population retiring and looking for income. Not all these funds must pay income to investors. The earnings can be reinvested, making them suitable for conservative investors in the accumulation phase. But in particular, income funds are ideally designed for retirees because their diversified holdings -- dividend stocks, bonds, REITs and other income-producing securities -- virtually all offer a fixed-payout distribution.
Diamond says the fixed-payout option works most effectively for individuals with sizable non-registered portfolios, because a big pile of capital is required to generate a decent monthly payment to fund a retiree's needs. For example, $500,000 worth of retirement savings could be invested in three funds with this option. If they all yield five per cent payouts, the retiree receives about $2,083 of monthly income without touching the capital.
Still, funds with a fixed-payout option are not without risk, says Patrick Loranger, associate vice-president of mutual funds with Standard Life.
"I would say the biggest risk is capital erosion," he says. Investors need to remember these funds are primarily conservative investments, but some may involve more market risk than investors think. In other words, it's best to be cautious when considering high-yield funds offering distributions of eight per cent, because if market conditions go awry, investors could see a non-strategic return of capital.
Loranger says Standard Life's bestselling income funds offer a fixed-payout option, and market risk is always a top concern. Like many companies offering these strategies, its fund-management team meets annually to set the distribution with the aim of maintaining the same yield as the year before.
"We've got a good track record with conservative management, and clients are looking for that kind of product," he says, adding its Monthly Income fund cut its distribution only once (2004) in its 11-year history.
Diamond says advisers and individuals investing on their own need to research the funds thoroughly before they buy to be certain there will be no nasty surprises.
"How is this money being managed? Who is the manager? What is the historical track record, recognizing that past performance isn't necessarily an indication of future results?"
Yet even a cut in the monthly distribution to preserve your invested capital is better than the alternative -- continually selling more units in a down market to maintain an expected income stream.
"We've seen a few companies lower their distributions on some of their offerings, but that's not necessarily the worst thing in the world," Diamond says.
Generally, investors would see a reduction from a six per cent payout to a 5.5 per cent payout, he says. Most retirees can absorb that kind of cut.
"Heck, we've gone from seven per cent GICs in 2001 to two per cent, so adjustments happen."
What about the fees?: Fees on income funds tend to be lower than equity funds and a little higher than bond funds. The MER of CI's Signature High Income fund, which holds stocks, bonds, REITs and other income-producing investments, is 1.6 per cent. Dynamic's Equity Income fund, which invests mostly in stocks, charges a 2.17 per cent MER. But adviser Daryl Diamond says most funds provide a discounted MER for larger investments of capital, which is generally what investors commit to these funds when they're used to provide retirement income. "Fees can be reduced to 60 per cent of what they would otherwise be." In addition, the funds' fees are calculated into the net asset value (NAV) of the fund unit -- a percentage of the total worth of the securities held in the fund, expressed as a unit value. This means the fees are not reducing the cash flow to the investor, Diamond days.
Money mechanics: Here's a rough example of how a fixed payout works:
Capital to invest: $500,000
Unit value of fund (NAV): $10
Units purchased: 50,000
Cents per unit per month: 4.5
Monthly income: $2,250
Effective yield: 5.4 per cent
Where to hold the funds: Fixed-payout options are often best held outside an RRSP because they can provide a blend of tax-efficient income from dividends and capital gains, which are taxed much more favourably than interest income or RRSP withdrawals, both of which are fully taxable. These funds can also provide a return of capital, which, when done strategically, can help reduce the amount of taxes paid on monthly income because you can't be taxed on the original money you invested. These funds can also be held inside an RRSP or TFSA to provide a steady income, only just not with the same tax efficiency, Diamond says.
Other options: Besides the fixed-payout option on an income fund, two other fund structures can provide tax-efficient income outside the RRSP and TFSA. These are T-series funds and corporate-class funds. The T series are designed to provide a return of capital, which isn't taxable, instead of paying out earnings, which are taxable. Rather than being paid out as income, a fund's earnings are reinvested and sheltered within the T-series structure. Corporate-class funds also provide tax-efficient income, but instead of paying back capital, they pay a capital-gain distribution. Taxes on interest, dividends and capital-gains earnings from investments within the fund are managed within the corporate structure of the fund, and then investors are paid a capital-gain distribution, of which only 50 per cent is taxable, says Derek Green, with CI funds, which launched the first corporate-class fund in 1987.