Investing for income in retirementJanuary 30th, 2013 by Dan Woodruff
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- The problems when investing for income in retirement
- Issues to consider
- How to invest for income in retirement
- 8 Products you can use
- Claim your free retirement checklist
The problems when investing for income in retirement
You have worked hard all your life and built up a pot of savings in various forms. Perhaps this might be in the bank, pension plans, or other investments. Now you want to learn about investing for income in retirement. The problem is that this can be daunting, and you probably want to ensure some form of security with your money.
The retirement income seekers
Here is an example of some typical clients. They have both had good jobs, and are now contemplating retirement. Of course, they came to us seeking advice about investing for income in retirement. Their problem was that they didn’t know where to start, since most of their savings were invested in simple bank accounts. This was not because they were completely averse to risk, but they didn’t want to make expensive mistakes with their money, since once they stopped work they would not have the chance to earn it over again.
The problem with this approach is that it does not make the most of your money, and they realised this too. One of their first comments was that their existing savings were effectively losing money versus inflation.
Investing for income in retirement – issues to consider
The usual rules of investing apply whether investing for income or growth in retirement (or both).
Set some investment goals
You should first think about what you want to achieve. Is it 5% income, is it 10%? Think about what you need, and this will give you a starting point when planning your retirement income. Do you need to achieve investment growth alongside income in retirement?
You should also think about how long you need your capital to last. You may be able to work a managed decline in your capital value over time, by taking a combination of income and withdrawals of capital. This does require careful management as you could find yourself short of capital, and therefore income, in later life.
Get some investment understanding
Most investment mistakes come from a lack of understanding. If you can’t get your head round it, either don’t do it, or employ an adviser who can explain it to you.
Think about how much security you need
Generally, investing for income in retirement requires that you take some investment risk. Work out how much you need to take to achieve your goals, and compare this to how much you are prepared to take. Sometimes your goals might be unrealistic. For example, if your goal is to achieve 10% income and growth, you might want to reconsider unless you expect to take significant risks and erode your capital. Of course, if you can work out a staged decline in your assets as part of your retirement income strategy, then this approach might be fine.
Diversify your assets
It is important to spread your assets into different types of investments. When investing for income in retirement diversification can be a little more difficult. You need to search for income-generating investments, and sometimes this means a narrower pool of investments that you would have chosen had you been investing for growth. Read about diversification and investments.
Don’t try to time your entry into the market
This is really difficult unless you are an experienced, professional investor. Studies show that amateur investors most commonly make this mistake, and that as a result they often miss key growth periods in the market. Decide on your strategy and stick with it. See our article on timing your entry to the stock market.
Rebalance from time to time
If your strategy calls for a certain allocation of assets, then from time to time you need to review and bring your investments back towards this ideal. You need to analyse the income or yield you are generating, as this is the primary reason for investing. Investing for income in retirement can be a juggling act between managing the growth and income sides of your investments.
As mentioned in our example, inflation is the biggest drag on your lifestyle when investing for income in retirement. At the moment, bank accounts return less income than inflation, so you will want to look for assets which help you to beat inflation over time. See below for some ideas. Of course, you have to balance this with the risks you are prepared to take. Examine your bank savings vs inflation.
How to generate an income in retirement
Here are some examples of types of assets you could consider when investing for income in retirement.
Bonds or fixed interest
Fixed interest securities are a kind of a loan to a Government or company. When issued, the investor pays the loan to the organisation, who then uses it for their purposes and pays a fixed interest for the term of the instrument. At the end of the term, the initial money is repaid. These types of investments often form an important part of an investment strategy when investing for income in retirement. As the name implies, they pay a fixed rate of interest each year until they come to an end. Therefore, the income is predictable. The underlying capital can shift in value, so they are not without risk, but they do tend to be less volatile than shares.
You can buy a range of fixed interest products ranging from the safer – Gilts or Government bonds, to corporate bonds, to high yield bonds. Generally, the higher the risk, the greater the income paid (otherwise what would be the point?). But this can be a volatile area, especially with an uncertain economy. If you invest in overseas bonds you can get a higher yield, but this does come with extra risks in terms of defaults and currency fluctuations.
These types of investments can be affected by inflation.
Fixed interest products are taxed as income, and basic rate income tax will be deducted at source.
Shares or equities
Historically, shares have proved to be the best way of beating inflation. The main reason for this is that alongside the growth in value of the assets, most shares also pay an income in the form of a dividend. This, when added to the growth of the asset is a powerful hedge against inflation.
Shares are issued by companies looking to generate cash. In return for this investment, they will pay an annual dividend to investors, although this is not guaranteed. Shares tend to be much more volatile than fixed interest, and so are generally riskier.
You can invest in the UK, or overseas. Historically, UK companies have tended to pay higher dividends than some other countries, but you can find shares or investment funds which invest for income in most geographical areas.
Share dividends are taxed at source as income, but there are some benefits to the way shares are taxed compared to other income sources, unless you are a higher rate tax payer.
Property can be used when investing for income in retirement. This can be via property investment funds or directly. The advantage of property if that it can produce a decent yield or income, but the sector is a difficult one at present. The major downside is that it can be difficult to sell property assets, and this can delay access to your capital.
Cash or Money market
Cash accounts or funds are a useful safer form of income. The downside is that inflation will likely eat into your capital, which means a gradually decreasing return. Unless you are completely risk averse, or need access to your money, we would not recommend putting too much into cash assets.
Products used when investing for income in retirement
These are the prime source of income for people who have built up pension funds (although don’t have to be bought with pension funds). Most people exchange their fund for a guaranteed income for life. There are various options which can be built into these products such as an increasing income, a spouse’s pension or a guaranteed payment period. The major benefit of annuities is security. However, income rates are particularly low at present. If you are investing for income in retirement, this product can appear to be poorer value than a few years ago.
There are alternatives to traditional guaranteed annuities. You can place your money into an annuity which is backed by an investment. however, this does mean that your income could be at risk in the future. You can also consider a shorter-term annuity, but these products are not for most people given that most people want to have an income for life.
Bank accounts are a mainstay of most people investing for income in retirement. While they will keep your capital safe, they do not currently pay high levels of income. What’s more is that this income is likely to be taxable, and behind inflation. This means that over time your buying power will be limited, and will reduce. For an accessible part of your income portfolio bank accounts can work well. Are you holding too much cash in your bank account?
Fixed rate bonds
A possible solution to lower returns on bank accounts is another bank product called a fixed rate bond. This ties your money up for a period – say 1 or 2 years – in return for a set rate of return. This can boost your bank savings rate. however, the downside is that you cannot access your capital in that period, which can cause problems. Also, the income paid is still taxable, and is generally not as good as you could obtain through products which take some risk with your capital. How to find out if your fixed rate bond is a dud.
There are some National Savings products which pay a decent, sometimes inflation backed income. Some of these are guaranteed and tax free. Some products do not pay an income, but the capital returned could act like an income.
If you are investing for income in retirement, you will probably want to beat inflation. Therefore, you could consider some form of investment product. There are different types of investments according to your tax situation. Broadly speaking, you could choose a wrapper to suit your tax situation, and within this you could buy a portfolio of investments to match your risk profile and income or growth requirements.
The great thing about these types of products is that they are generally flexible. You can usually get your hands on your money when you want, and you can choose from thousands of investments. These might include investment funds such as unit trusts, OEICs, investment trusts, shares, bonds, ETFs or offshore funds.
When investing for income in retirement you should not ignore your ISAs. These are simply tax-free wrappers around your other products. You can put most investment products into an ISA – bank accounts, investments, shares or fixed interest.
Many people consider property as an income source in retirement. This can be a good source of predictable income but does come with some downsides. You need to consider the hassles and costs associated with securing tenants. You should also think about your need for access to the capital since property can be difficult and costly to sell. Finally, there can be unexpected tax bills associated with property.
If you have pension funds, you can continue to keep the money invested, while taking a flexible income in retirement. These products allow more flexibility than annuities but do cost more and mean greater risk with your capital. You can now access all of your pension funds from age 55 using flexible pensions (called uncrystallised funds pension lump sum – UFPLS).
How we help people who are investing for income in retirement
We run an investment management service designed to help you to manage your investment assets. This means that you can hopefully avoid costly investment mistakes, but still achieve the income you require.You can sit back and live the retirement lifestyle you want, while we manage the investment side.
What to do if you are retiring soon
We have created a handy free resource if you are retiring soon – the retirement checklist. This gives you the top 10 tools you need to know to claim the maximum retirement income. Just complete the form below to claim your checklist.
Photo credit: Flickr>401(K) 2013