Retired Money: How Vanguard’s 4% targeted payout on VRIF makes it easier for retirees to draw income

My latest MoneySense Retired Money column looks at Vanguard Canada’s new targeted 4% annual payout vehicle for retirees and near-retirees, provided by its new VRIF ETF. You can find the full article by clicking on the highlighted headline: The lowdown on Vanguard’s Retirement Income ETF: can you rely on its 4% payout target?

The Vanguard Retirement Income ETF Portfolio [VRIF/TSX] started trading Sept. 16^th and offers retirees and near-retirees a 4% targeted — as opposed to guaranteed — payout. See also the Hub’s republication of Robb Engen’s preview on VRIF that appeared first on his BoomerandEcho site.

Positioned as a “Decumulation” product for retirees and near-retirees, it’s probably no coincidence that the 4% target is nicely in line with the long-established 4% Rule discussed on the Hub and MoneySense earlier this summer.

While a targeted return is NOT a guarantee – unlike the guaranteed but puny rates paid by GICs these days – Vanguard expects it will attract a fair amount of money from income-oriented investors suffering sticker shock when their GICs mature. Currently, many 1-year GICs pay around 0.5%, ranging from as little as 0.3% to no more than 1.1%. Even going out to 5-year terms, they’re typically paying only 1.4%, ranging from under 1% to 2% in the best case.

Technically, those GIC returns are “guaranteed”  but a cynic might say they’re guaranteed to lose money on an after-tax, inflation-adjusted “real return” basis. Based on recent statements by the Bank of Canada and US federal reserve, this is not likely to improve before 2023. In the UK there are even renewed whispers of negative rates.

Of course, to achieve the 4% targeted payout, investors still have to bear some stock-market risk. VRIF consists of eight existing Vanguard stock and bond ETFs with an asset mix of roughly 50% stocks and 50% bonds.

VRIF has much lower fees than comparable income mutual funds and income ETFs

Monthly income mutual funds and ETFs have been around for years but as is typical, Vanguard aims to be the low-cost leader in the category. With such tiny returns from the fixed-income component, those costs are an important determinant of how much money is left for investors. The full MoneySense article recaps the fees relative to existing income mutual funds and income ETFs.

As a fund of funds, VRIF is the latest addition to Vanguard Canada’s five popular Asset Allocation ETFs. Incidentally, the Vanguard Asset Allocation ETFs were the first one-ticket asset allocation solutions chosen in the annual MoneySense ETF All-Stars feature that I spearhead. Based on a discussion with panelists Robb Engen and Dale Roberts, VRIF is likely to join them as All-Stars.

The AA ETFs pay out quarterly rather than monthly income but that’s not targeted and they’re aimed at those still saving and building wealth;  VRIF is for those wanting regular income more than growth. Engen says one-ticket portfolios like the AA ETFs have introduced more investors to simple, low-cost, index investing in their accumulation years. “But a tougher nut to crack has been when it comes to decumulation in retirement. How does one derive an income from an ETF portfolio that may only distribute 2% per year, paid quarterly?”

The answer is to sell ETF units rather than rely on distributions, but that doesn’t seem palatable for many income-hungry retirees. VRIF solves this with a steady monthly income stream targeted at 4%, Engen said. “I think it will be good for retirees who can’t get past the psychological barrier of having to sell shares to generate their retirement income. In this case, VRIF becomes the retirement equivalent of VBAL.”