Figuring out how much you can safely spend each year is an especially fraught question for retirees worried about outliving their savings.
Life span and health status are variables no one can plan for. Despite saving consistently and investing diligently over a lifetime, retiring into a market downturn or unexpectedly needing expensive medical treatment can throw a wrench in an otherwise well-devised retirement plan.
A new series of funds from Stone Ridge Asset Management, launched in January, tries to solve this problem by offering investors monthly payouts up until age 100. The series, called LifeX funds, pools the longevity risk of participants based on age and gender. The funds are similar to annuities in that they use actuarial longevity data the same way annuities do to pool longevity risk, but are bought and sold as regular mutual funds, not insurance products.
LifeX has 64 funds, each targeted to a specific age and gender cohort, with birth years currently ranging from 1948 to 1963. There are two versions of each fund: a standard one with flat payouts and an inflation-adjusted version with payouts adjusted annually based on the consumer price index.
Longevity risk
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The underlying holdings are simple portfolios consisting of Treasury bonds or Treasury inflation-protected securities. Compared with a portfolio of high-quality bonds, payout rates for LifeX funds are higher, a factor attributed to the power of pooling longevity risk: Those who die early subsidize those who live long.
Liquidity is another selling point. Investors can buy or sell the funds up until age 80, at which point the investments switch to a closed-end fund that can’t be sold. Shareholders continue to get monthly payouts until they reach 100 or pass away. At that point the funds are liquidated, and the proceeds get distributed to the living shareholders in the form of higher payout. There are no account proceeds made to beneficiaries after a shareholder’s death (if they die before 80, their beneficiaries may redeem them). As of now, LifeX funds are only available through registered investment advisors.
For those in retirement and actually ready to start generating income from their assets, “this is a really interesting opportunity, especially for people who want inflation protection,” says Wade Pfau, professor of retirement income at the American College of Financial Services.
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Looking at payouts
A tool on LifeX’s website lets users calculate what kind of distribution rate they can expect depending on their age and gender, and points to the corresponding fund with details on payouts.
For instance, a 70-year-old woman born in 1954 could make an investment in the inflation-protected LIAOX fund and get an initial payout rate of 4.7%. For a male the same age, the rate would be 5.1%.
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Compare that to a do-it-yourself 30-year TIPS ladder—which is similarly meant to provide predictable inflation-adjusted cash flow—where the payout rate would be 4.4%, according to tipsladder.com, an online tool.
How does that compare with a standard annuity? A quick check on ImmediateAnnuities.com finds that a $1 million premium might buy a 70-year-old woman an 8.47% payout rate for life. But it isn’t inflation-adjusted, nor can the 70-year-old get her money back after she buys it. The lack of inflation protection can be a big issue in periods of rapidly rising prices like the pandemic.
The longer you live, the more it pays
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If you want something that does better the longer you live, “that’s where LifeX really outperforms any kind of bond investment when it comes to providing longevity protection,” says Pfau, who is also founder of Retirement Researcher, an educational resource.
Before age 80 there’s no real difference between LifeX funds and regular income annuities (aside from varying payouts), says Pfau, as any remaining funds go to beneficiaries in both cases. If a LifeX shareholder dies soon after they reach 80, there would be value remaining in the fund but instead of beneficiaries getting it, the money goes to the surviving shareholders in that cohort. So the longer you live the higher your LifeX payouts.
A ‘fixed income solution’
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Although they have similar features, the folks at LifeX wouldn’t compare their funds to annuities. Rather, they say, these funds are built to replace bond income in retirement.
A basic income annuity doesn’t allow you to change your mind after the purchase is finalized and get your money back. “Irrevocable decisions are uncomfortable, and we wanted to make retirement easier,” says Nate Conrad, head of LifeX. With LifeX “you can change your mind and sell it until age 80, and invest in a familiar way because it’s a mutual fund.”
Cost trade-offs
LifeX funds come with a 1% annual expense ratio, which might seem high, particularly for a fund investing in basic Treasury bonds, says Amy Arnott, portfolio strategist at Morningstar.
“It’s a trade off,” says Arnott. “Some people might value the extra liquidity and potential estate benefits. If you’re just looking to maximize your payout rate, you might be better off going with a standard annuity. If you definitely want liquidity up to age 80, this could be an attractive product.”
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