By Martha M. Hamilton
Sunday, May 18, 2008

I admit, I have a mild hoarding instinct. No, I don't have stacks of decades-old newspapers around the house, but I do pick up and hold on to the odd doorknob or electrical cord or fabric remnant, thinking: This could be useful someday.

That makes me think I might end up hoarding the funds in my retirement savings. I know I'll have to start drawing down funds from my traditional Individual Retirement Account when I turn 70.5. But I'm not sure I'll touch any of it before then, unless it's to shift the money to a Roth account, which has no requirement for mandatory withdrawals.

As a hoarder of savings, I'm not alone. Research by the Investment Company Institute, the trade association for mutual funds, found that seven out of 10 owners of traditional IRAs say it is unlikely they will make withdrawals prior to age 70.5. "People do tend to hold on to their IRA and tap it late in retirement," said Sarah Holden, senior director of retirement and investor research for ICI.

Why this reluctance to withdraw savings? In my case, since I have a traditional pension and plan to continue working, I feel no pressure to spend the money I have accumulated over several decades. And beyond that, I have a healthy fear of future medical costs. Right now I have limited health insurance that goes away once I become Medicare-eligible at age 65. Since Medicare only covers about 51 percent of medical costs, I know I will need the money in the future.

But I think another reason those of us lucky enough to have accumulated retirement savings are reluctant to draw it down is fear of not doing it right. The looming concern for many who have only retirement savings and Social Security is outliving the savings. The prospect of a reduced standard of living toward the end of our lives is a real concern, given that many workers have amassed relatively small retirement funds.

For retirees without a traditional pension providing monthly payments for life, there are some other options. Some retirees use their savings to purchase single premium lifetime annuities as a way to guard against outliving their savings. Some turn to financial planners to guide their spending. And now mutual fund companies are beginning to offer funds designed to help retirees receive income in retirement for as long as they need it.

Fidelity Investments was the first out with its Fidelity Income Replacement Funds. Similar to target-date funds, they provide a mix of investments that starts out more focused on growth and then shifts to a more conservative allocation. Jonathan Shelon, portfolio manager of the Fidelity Income Replacement Funds, said the funds were created after several years of research that produced two major findings. "One, people didn't have a good idea as to how much they should be spending, nor did they have a good idea of how to select a strategy to make the money last," he said.

They also found retirees in their 80s who regretted they had not spent more in the early years of retirement. Fidelity's approach was to set up funds with what Shelon called "time certainty."

"If you want to plan to age 100, as a 65-year-old you can buy our 2042 fund," he said. That fund starts out with 4.75 percent of the amount invested as annual income paid in monthly increments. The payment rate gradually rises until 2042, when the remainder of the fund would be paid out in 12 monthly installments. Funds with shorter time horizons have larger payments and exhaust savings faster.

Fidelity had a total of $38.1 million in its income replacement funds as of April 30.

In April, Vanguard rolled out three managed payout funds with different goals: the Growth Focus Fund, the Growth and Distribution Fund, and the Distribution Focus Fund. All of them seek to provide monthly payments, but the amount they pay out per share varies depending on objectives. The payouts are greatest for the fund that emphasizes distribution. "The real need was for a relatively straightforward way to move into the distribution phase" from the saving phase of life, said John Ameriks of Vanguard's Investment Counseling and Research Group.

Ameriks said the funds "serve an audience for whom a custom-managed plan developed by a planner is not an option, either because it is too expensive or they don't feel comfortable working with an advisor."

Vanguard has a total of $189 million in its managed payout funds.

Both Fidelity's and Vanguard's funds have relatively modest costs. But it is also important to keep in mind that they are mutual funds and have no guarantees. Since they are mutual funds, investors can sell the funds, if need be. For instance, if your situation changed and you needed faster payouts, you could sell or exchange a longer-horizon fund for a shorter one. And both allow investors to suspend taking distributions. Payout funds appear to be a potentially useful product for some retirees, and other companies are likely soon to be offering similar products.

Additional thoughts on converting to a Roth IRA: I wrote about deciding to convert part of a traditional IRA to a Roth because the market was down and because I expect tax rates will go up. (Obviously if you expect your tax rates to go down, you would not want to convert.)

The IRA expert I consulted for my column said that both the bear market and the expectation of higher taxes were good reasons to convert, but what I didn't realize was that the source of the dollars used to pay taxes on my conversion would make a difference, especially if my tax rate stays the same. Calls and e-mails from readers and a subsequent discussion with experts at T. Rowe Price have convinced me that when the market is down, if you pay the taxes on the conversion from a taxable account, instead of from your traditional IRA, you may be able to save money on your taxes. That would leave you more money to invest long-term and more assets in your Roth IRA that you can withdraw in the future tax-free.

However, if you withdraw the money to pay the taxes from your traditional IRA, you may pay less in taxes in the short run, but this will not improve your final after-tax ending balance in the future. Conclusion: to take advantage of a down market, convert to a Roth using assets in your taxable account to pay the taxes.

My thanks to several readers for pointing this out.

Join Martha Hamilton and Jason Scott, retirement research director for Financial Engines, for an online chat at washingtonpost.com at noon on Tuesday.