Figuring out how much you can safely spend during retirement has often been described as the most difficult problem in financial planning. If you take out too much from a portfolio to support retirement spending, you run the risk of running out of assets later in life, especially if you’re fortunate enough to enjoy a long life span. If you take out too little, you might miss out on some of the fruits of a lifetime of savings, such as travel, dining out, gifting money to charity or family members, or spending more on leisure activities.
LifeX, a brand-new series of funds from Stone Ridge Asset Management, promises to solve this problem by offering steady monthly payouts up until an individual reaches age 100—about 10 to 12 years beyond the average life expectancy for a person currently aged 65. These funds are interesting and novel in some respects but probably too pricey to truly revolutionize the retirement-income industry.
The LifeX funds are similar to annuities in some ways but are structured as open-end mutual funds. Each fund is targeted to a specific age and gender cohort, with birth years currently ranging from 1948 to 1963. Each age and gender cohort is available in two versions: a standard one with flat payouts and an inflation-adjusted version with payouts adjusted annually based on the Consumer Price Index.
Investors can buy and sell each fund at net asset value up until age 80, at which point each fund will convert to a closed-end format with no liquidity. Shareholders continue to receive monthly payments up until the age cohort reaches 100, at which point the funds are liquidated, with proceeds distributed to any shareholders still alive at that point. There are no payments or account proceeds made after a shareholder’s death.
The structure of these new funds is clever in that it provides a new way of pooling longevity risk. In contrast to an annuity, which transfers longevity risk to the insurance company, the funds are structured to mutualize longevity risk across each group of shareholders in the same age and gender cohort. This structure is similar to a tontine, an investment vehicle that was popular in Europe in the 1700s and 1800s but has fallen out of favor partly because of its unsavory reputation. (Essentially, tontines allow surviving shareholders to benefit from the death of other shareholders in the same pool.)
Offering risk pooling in a mutual fund format has other advantages, as well. Shareholders (working with an advisor) can simply purchase the funds in a regular brokerage account instead of filling out confusing and time-consuming applications for annuities offered by insurance companies. And in contrast to annuities, which typically offer no liquidity after purchase, shareholders purchasing the funds can redeem shares at NAV up until age 80. It’s also difficult to find fixed annuities with inflation protection; those that do offer it typically come with a flat inflation adjustment rather than one indexed to the CPI. The inflation-indexed LifeX funds therefore do a decent job approximating how payments work for Social Security, where each year’s payments are adjusted for inflation.
The LifeX funds have one obvious drawback: a 1% expense ratio. Given that their underlying holdings are simple portfolios made up of Treasury bonds or Treasury Inflation-Protected Securities, it’s tough to justify a fee that high, in my opinion. Granted, the funds aren’t simply index funds as there are embedded actuarial estimates (provided by New York Life) for each fund in the lineup. Even so, 1% is still a steep price tag, especially because it’s structured as a unified management fee that doesn’t change in percentage terms over time.
Partly as a result, the payout levels don’t look all that compelling. As of early February 2024, a 62-year-old male could purchase shares of LifeX Income Fund 1962M LFBHX for $19.55 per share, which translates into an annual payout rate of 5.1%. A single-life fixed annuity for a person of the same age and gender currently offers an annual payout rate of 7.0%. Fixed annuities not only offer higher payouts but are also guaranteed by the issuing insurance company (with additional guarantees typically offered by state insurance associations). Stone Ridge contends that the expense ratio is not the primary driver behind the LifeX funds’ lower payout rates. Instead, it attributes the lower payout rates mainly to different actuarial assumptions, potential estate benefits for shareholders who pass away before age 80, and the value of liquidity for other shareholders before age 80.
There are some quirks that make the LifeX funds more tax-efficient than a standard fixed annuity. Whereas annuity payouts (above the original basis) are taxed at ordinary income rates, a portion of the distributions from LifeX (essentially the portion of NAV that reflects additional assets from shareholders who passed away) will be taxed at lower capital gains rates. These tax advantages probably aren’t big enough to offset the lower payout rates, though.
Finally, the LifeX funds are only sold through financial advisors, which means that most shareholders will pay an additional layer of asset-based fees. A LifeX spokesperson confirmed that the financial advisors the firm has met with are generally planning to include these funds in their asset totals when calculating asset-based fees.
There is a clear need for better retirement-income solutions. More than 4 million Americans will turn 65 this year and each year through 2027, which means that more people than ever will be transitioning into retirement. The existing options for retirement income are often complex and difficult to understand, making them less widely used than they could be. The LifeX funds are a partial solution to this problem, but further work is still needed.
Clarification: This article was updated to include Stone Ridge's statement that the LifeX series’ expense ratio is not the primary driver behind the funds’ lower payout rates and a summary of the other factors to which it attributes the lower payout rates.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.