Mutual fund companies are increasing access to types of investments that provide guaranteed income for a lifetime.
Last week, Vanguard, a mutual fund company and pioneer in index investing, announced a new line of target-date mutual funds. This allows shareholders to use a portion of their retirement funds to purchase an annuity. Annuities are products sold by insurance companies that guarantee policyholders a certain amount of regular income over a certain period of time.
The mutual fund is expected to be available in 2026 and will only be available within defined contribution plans such as 401(k)s, the Wall Street Journal reports.
Vanguard, like other financial and insurance companies, including mutual fund and exchange-traded fund giant BlackRock, is working to offer funds that include pension options.
“Retirement is not one-size-fits-all, and for those looking for more predictability, a guaranteed income in addition to savings can provide added peace of mind,” Lauren Valente, managing director and principal at Vanguard Workplace Solutions, said in a statement.
As appealing as it may sound, it’s wise to do your homework before choosing an annuity investment, says David Rosenstrock, a certified financial planner at Wharton Wealth Planning in New York City.
“Pensions are a common way to guarantee a source of income,” he says. “However, before purchasing an annuity, it’s important to make sure it’s the right option.”
Whether a pension strategy makes sense for you depends on your personal financial situation. Please consult a trusted financial professional before making any important investment decisions.
In the meantime, here are answers to some basic questions about pensions.
What is a target date fund?
Target-date funds are mutual funds that hold a variety of assets, typically other stocks and bonds, and grow more conservatively (i.e., with a greater weighting in bonds) as you approach the year you plan to retire.
These are often the default selection for workplace retirement accounts. As of last year, more than 30% of 401(k) assets were invested in target-date funds, according to the American Council of Plan Sponsors.
These are intended to be all-in-one retirement portfolios that don’t require you to make asset allocation decisions on your own, said Jason Kephart, senior principal at Morningstar.
“These are designed with the idea that you put all your retirement savings into it,” he says.
What is a pension?
An annuity is a contract issued by an insurance company that guarantees the purchaser an income for a specified period of time or for the remainder of his or her life. Annuities can be purchased in a lump sum or in monthly installments.
Different types of annuities have different payout and fee structures, but in general, the amount of income you receive each month depends on how much you put in, how long you defer collecting payments, and your life expectancy.
How do target date funds with annuities work?
Target-date funds follow a so-called “glide path,” starting with an equity-heavy allocation and shifting the portfolio toward bonds over time. The annuity versions of these funds start moving a portion of your funds from a fixed income portfolio into insurance contracts at a certain age (age 55 for both the Vanguard and BlackRock funds).
Between then and your retirement date, money accumulates in the contract, eventually reaching a certain percentage of the assets in the fund (for example, 25% for Vanguard or 30% for BlackRock).
You can then choose to leave these funds in a bond portfolio or convert them into an annuity that provides a guaranteed income stream for life. That amount corresponds to the money you have in the fund.
What is the appeal of these funds?
Some forms of annuities, especially those that pay variable interest rates and hold underlying assets that fluctuate in value, can be difficult for the average investor to understand, Kephart says. However, he says the annuity model offered within target-date funds is relatively simple.
“You give us 25% or 30% of your portfolio as a lump sum, and this is the amount we give you every month for the rest of your life,” he says.
For some investors, having a guaranteed lifetime income stream alongside Social Security can provide security and flexibility, Kephart said.
“If you have a good idea of what your monthly expenses will be (in retirement) and can cover them between Social Security and your pension, it gives you flexibility in the rest of your portfolio,” he says.
Kephart says you can use the remaining assets to increase your retirement income, or leave them or donate them when you die.
And even if your retirement savings aren’t fully covered by pension payments, having at least a portion of your income guaranteed can alleviate the pressure of funding your lifestyle primarily through investment withdrawals, Rosenstrock says.
“Pensions may make sense for very conservative, risk-averse people nearing retirement who want a reliable source of income to cover their expenses in retirement,” he says.
What pension risks should I be aware of?
Experts say the prospect of reliable income comes with some tradeoffs.
Price is a big concern with any annuity, Kephart said, but it’s less of a concern when buying through a mutual fund because there are no commissions paid to salespeople.
Nevertheless, all annuities come with fees and risks, which insurance companies factor into the payouts offered, so it’s wise to consult a financial professional.
Another consideration for potential pension investors is liquidity. If you choose an annuity, the large amount of money you committed to the contract is no longer yours. If you die during the period you’re collecting income, whether it’s 6 months or 30 years, your heirs can’t continue collecting monthly payments on your behalf.
“You’re getting cash flow that will last a lifetime, but you’re giving up some of your portfolio,” says Kristin Benz, director of personal finance and retirement planning at Morningstar. “That’s not the case when you put your money in stocks and bonds.”
Relying on withdrawals from a portfolio of stocks and bonds to fund your retirement comes with unique challenges. If you earn less than expected or spend more than expected, you may find yourself short of money towards the end of your life.
But a portfolio of stocks and bonds can grow in value over time, providing returns that offset the price increases, Rosenstrock says. “Pensions offer no protection against inflation,” he says.
Rather than allocating a portion of your investments to a pension, you may be better off sticking to your investments entirely, Rosenstrock says. “The security offered by annuities can come at the cost of lower long-term returns than other investment options.”
Still, he and other experts say it may be worth the tradeoff if the level and consistency of pension payments makes sense for your retirement plan.
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