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Retirement Gimmicks Gone Wild

You can tell that the baby boom generation is nearing retirement. Everywhere you turn, fund companies are coming up with new ways to help retirees manage their finances more easily. From target retirement funds to immediate annuities, the industry has been gearing up to capture more and more of the growing pool of retirement assets.

Fidelity recently launched some new mutual funds to help retirees take income from their savings. Its Income Replacement Funds are designed to make monthly payments to shareholders over a given time frame that investors choose, ranging from 10 to 30 years. Fidelity's goal is for the monthly payment amounts to rise with inflation over time and to leave investors with a zero balance at the end of the specified period.

How they work
The idea behind these funds is fairly simple. Each of the funds uses a simple asset-allocation model to invest fund assets, buying shares of other Fidelity funds. Like target maturity funds, Income Replacement Funds with longer time periods invest more aggressively than those with shorter time frames. For example, the 2016 fund has a mix of about 36% stocks, 40% bonds, and 24% cash and short-term investments. The 2036 fund, on the other hand, has a 62%/32%/6% mix. These allocations are intended to provide the returns necessary to support the fund's payouts.

Each fund then uses a formula to determine how much of its assets it will pay out each year, based on your time horizon. For instance, if you choose a 30-year payout, it pays out 5% the first year and then increases the percentage paid over time. After 10 years, you'll get about 6.5% annually. After 20 years, you'll receive about 11%.

No guarantees
According to the fund prospectus, the combination of investment allocation and payout schedule is intended to support growing monthly payments over time. However, there's no assurance that they will be able to do so. There's nothing unique about their investment methods -- although they don't say exactly which Fidelity funds they'll use, it's likely you'll end up with positions in large-cap stalwarts like Nokia (NYSE: NOK  ) , AIG (NYSE: AIG  ) , ExxonMobil (NYSE: XOM  ) , and Hewlett-Packard (NYSE: HPQ  ) among your top indirect holdings.

Unlike annuities, there's no insurance company providing guarantees of fixed payouts or minimum values. And the high withdrawal rates -- well above the 4% rate that the Fool's Rule Your Retirement newsletter and other experts generally recommend -- may jeopardize your ability to make your money last as long as you need it.

Yet the biggest risk these funds leave for investors is the potential for misunderstanding what they do and don't do. It's tempting to think you can use them to put your investing plan on autopilot, but they don't eliminate the risk of outliving your savings. If you live past the time period you choose, there won't be any money left in these funds. And they won't help you smooth out your income stream over changing market conditions. If the markets do well in a given year, you could get a huge raise the following year. If they do poorly, however, you might get saddled with a large pay cut -- at a time when you're least able to handle it.

Convenience
The main benefit of these funds is that they save you the work of setting up regular withdrawals. The funds will automatically pay you each month, handling any sales of shares that may be necessary to come up with enough cash. That saves you the trouble of deciding what to sell. And the funds don't charge anything extra for the service -- they just pass through the expenses of the other mutual funds they hold as investments.

But for the most part, funds like this are just repackaging existing investment choices into a catchy new package. That's fine for a gimmick -- as long as it doesn't lull you into a false sense of security.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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