Pension freedoms have given us more control over our finances – but how can you ensure a regular income? We share ways to arrange your investments to generate a steady monthly payout.
The retirement landscape has changed dramatically since the pension freedoms were introduced four years ago (April 2015), handing retirees the ability to take control of their retirement savings.
Retirees have been taking advantage of this, and demand for income drawdown has soared while annuity sales have slumped. Although annuities still have their place despite rates being close to historic lows, the flexibility of the freedoms is for many too attractive to pass up. It means, for instance, that they have instant access to pension savings that should grow over time and can be passed on to loved ones when they die.
Therefore, it has become increasingly commonplace for individuals to use their pension pots to pay themselves an income at retirement, whether they are self-directed investors or are paying for professional help through a financial adviser or wealth manager. For those who arrange their investments carefully, a monthly income can be achieved; there are several ways to go about this.
Doing the maths
First things first: some groundwork needs to be done. Calculate the amount of income you would like to achieve – in other words arrive at an annual figure you would like to pay yourself as a ‘salary’ at retirement, factoring in both essential and discretionary spending.
In financial adviser circles, working out how far the amount of income an individual would like matches up with reality is achieved through cash-flow modelling. This involves calculating a yearly percentage growth rate from the chosen investments in their portfolio in order to achieve their desired goal.
Michael Martin, a private client manager at Seven Investment Management, notes: “I have a lot of clients who want to retire at 60 on £10,000 a month, who ask me how they achieve that. My answer is that we need to get the structure of their investments correct first and then we can move on to calculating what return they need to achieve on their investments.”
For some individuals, the growth rate needed for their goal will be too high to achieve without in all likelihood exhausting their pension ahead of their life expectancy; others will find the investment mix required is too high-octane for their risk appetite. Either way, they may opt to lower their income goals. Some, though, may take the opposite approach and increase investment risk to achieve the amount of income they want.
Other bits of general housekeeping include adding the state pension into the income calculation (if you are at an age where you can claim it), as well as any other assets that can be drawn on in retirement, such as Isas. Those who do have substantial sums in Isas should look to use them first and leave the pension untouched as long as possible, because the tax rules on leaving a legacy are now more favourable for pensions.
Pension money passed on by those who die before age 75 is tax-free, while for those who die above that age, the beneficiaries will pay income tax on any pension withdrawals they make. No inheritance tax is payable in either case. In contrast, Isas form part of a person’s taxable estate (though they are free of tax when passed on to the Isa holder’s spouse on death).
Rated Fund monthly payers for a year-round income
|Fund||Mainly invests in||Allocation (%)||Yield (%)|
|AXA Framlington Monthly Income||UK Equities||20||5|
|Threadneedle Monthly Extra Income||UK Equities||20||4|
|Artemis Monthly Distribution||Global equities and bonds||10||4.3|
|MI Miton Cautious Monthly Income||Global equities and bonds||10||4.5|
|Liontrust Monthly Income Bond||Bonds||10||5.3|
|TwentyFour Select Monthly Income||Bonds||10||7.1|
|Artemis High Income||Bonds||10||6|
|F&C Commercial Property||Property||10||4.2|
|Overall portfolio yield:||4.9|
Source: compiled from FE Analytics, as at 7 March 2019
Generate the natural income
There are various ways to arrange investments to pay an income at retirement, with perhaps the most obvious being to focus primarily on income-generating assets. To reduce risk, which is particularly important in retirement, a prudent approach is to draw only the income produced by the pension investments (the ‘natural yield’) rather than eating into capital growth.
In terms of putting together a DIY monthly income portfolio, the hassle-free route is to focus solely on funds paying a monthly income. The downside is that the choice is narrow, as it is far more common for funds to pay quarterly or bi-annually.
However, out of our Rated Fund selections for 2019 we have assembled a hypothetical portfolio of eight funds that all make monthly distributions, with around 50% held in equities, 40% in bonds and 10% in property (see table above for fund choices). The overall yield is 4.9%, but it is worth bearing in mind that this should not be viewed as a ‘buy and forget’ option, as the overall asset mix is adventurous.
That’s the case for the bond funds in particular, as they tend to focus on the riskier areas of the fixed income universe, including high-yield bonds. Moreover, a 40% weighting to UK dividend-paying shares is high, especially at this juncture where Brexit uncertainty continues to cloud the outlook.
This yield can be boosted further by adding in a couple of specialist income funds, which have much higher yields as a result of sacrificing capital growth to buy derivatives. Again, there is not a huge amount of choice, but out of our Rated Funds we can use Schroder Income Maximiser (yielding 7.3%) and Fidelity Global Enhanced Income (5%), in exchange for the two lowest equity-based yielders (Threadneedle Monthly Extra Income and Artemis Monthly Distribution), to bring the overall hypothetical portfolio yield up to 5.7%.
Out of our 201 actively managed Rated Funds, only 10 pay income monthly, so we were constrained in terms of choice. If we widen the net to include funds or investment trusts that pay dividends every quarter, there is a much bigger pool to fish in. It would then be a case of looking at when the dividends are paid and ensuring enough income is being generated each month.
But rather than being fixated on dividend dates, Kay Ingram, director of Public Policy at LEBC, the retirement adviser, suggests another tactic is to simply divide the expected annual income into monthly payments. She adds: “By focusing on distribution dates there’s the risk that you could end up with a portfolio that is biased towards an investment style, country or asset class,” she says.
There’s another downside to this income-focused approach, points out Hannah Goldsmith, founder of Goldsmith Financial Solutions. She advises against putting all your eggs in the income basket, pointing out that this approach comes at a cost: your capital will likely not grow much. She adds: “While the income booster funds may offer an extra 2% to 3% in terms of yield, the big thing that’s missing is growth, so it is a riskier approach than some investors may realise.”
Investment trust dividend heroes for monthly income
|Investment trust||Yield (%)||Distribution dates*|
|City of London||4.6||February, May, August, November|
|Bankers||2.3||February, May, August, November|
|Alliance Trust||1.7||April, June, September, December|
|Caledonia Investments||1.7||January, August|
|BMO Global Smaller Companies||1.1||January, August|
|F&C Investment Trust||1.6||February, May, August, November|
|Brunner||2.2||April, July, September, December|
|JP Morgan Claverhouse||3.9||March, May, September, November|
|Murray Income||5.1||January, March, June, November|
|Witan||2.9||March, June, September, December|
|Schroder Income Growth||4.4||January, April, July, October|
Source: dividendmax *Data shows expected distribution dates in 2019; bear in mind dividend dates can change in future years.
2 funds missed out are richard curling jupiter monthly alternnative - & TB wise multi-asset income. Both now pay monthly divs. Als Kames diversified.
Of your list Famlington is the star under George Luckraft.
the AIC now have an income tool to plan for income payments - its very good , unfortunately wont work with open ended or ETF - although those with programming ability could knock one up or even use spreadsheets.
I would caution against using Caledonia as has a lot of unlisted investments. Not ideal for income IMO.
I would also think about selective REIT - but need to be savy about discounts and problems with retail.
Also infrastructure but best done via a fund - however these usually generate income quarterly - rather than monthly
you can use a number of free services to setup you portfolio (Trustnet) & monitor performance.
Another approach is a 'barbell' whereby you mix income generating funds (high yielding bonds,fixed interest,REIT, ptoperty) with higher growth funds such as smaller cos, healthcare, technology,FAANG etc. The growh comes from the latter over time & can be slowly sold off or recycled into income stocks.
There are a myriad of different ways to play different tunes.
Another strategy is to keep 50% in cash - and keep a look out for dips in the market & buy then. Slightly more tricky & timing the market is not easy but prevents heavy losses if there is a sevre market sell-off
I have a lot of clients who want to retire at 60 on £10,000 a month!!
You have to wonder what planet these people are living on. £120K gross per year would require a pension pot in millions! (exceed lifetime pension allowance for starters!)
Regarding pension income - there is nothing wrong with relying on natural yield - provided you monitor your portfolio. It works well with other pots (ISas) and cash deposits.
Other 'tunes' that you can play are (for the lazy) use lifestyle trackers such as those from Vanguard (20%-100% equity) only trouble is that these dont generate much income so you might have to sell units to make up shortfall.
Multi asset funds are good - but again need to watch out for charges. For more sophisticated investors combining bond/loan funds, infrastructure and property funds to 'spit out' income with growth funds (smaller companies tech, healthcare, far east) in a 'BARBELL approach' is worth noting.
Mr Brumwells Investment trust portfolo is always worth looking at if not copying - also John baron of Investors chronicle.
For most non savy pension (SIPP holders) its best to contract this task out to a wealth manager or IFA who - at a cost - will undertake this task. Otherwise you will haveto roll up your sleeves, fire up a spread sheet & do the task yourself with help from Trustnet or other sources (Morningstar).
It helps keep grey matter ticking!
The art comes in blending different funds (asset classes) to achieve a desired objective. If you do the task yourself & then become infirm or pass away need to think how your partner or wife will manage.
In my experience 90% of people will prefer to study their local football team history, or roam the web looking for holiday bargains than spend a few hours a week getting on top of this monetary task.
Correspondingly they have to pay for somebody else to do this job, and may in certain cases get shafted by costs or obtain an inadequate income.