How to stop your pension turning into a horror story
Income SLASHED... Brexit fears on the rise... Don’t panic, here’s...
RETIREMENT is supposed to be a happy time, whether you are looking forward to filling it with a pipe-and-slippers or travel-the-world lifestyle.
But in recent years it has become more complex and stressful to ensure you choose the right way of financing it and for those on the cusp of retiring in 2019 it has got a lot, lot worse – a horror story, in the words of one expert.
Those desiring certainty of income in their twilight years by using their pension savings to purchase an annuity – an insurance plan that guarantees a fixed income for life – have seen rates plummet to 25-year lows. And once purchased, these contracts cannot be undone.
Last week, a 65-year-old with a £100,000 pension pot could have converted it into a fixed annual income of £4,692 – £721 less than if they had made the same arrangement at the start of the year.
Nathan Long, senior analyst at Hargreaves Lansdown, says: ‘Plummeting annuity rates are piling misery on soon-to-be retirees. It has been a horror story and risks pushing more and more people into the uncertainty of remaining invested in the stock market throughout retirement.’
Worries over Brexit, trade wars and a global economic slowdown have contributed to an increase in the cost of buying the secure investments such as bonds and gilts that insurers use to underpin annuity payments and in turn have reduced the yields paid.
Long says: ‘Anyone coming up to retirement needs to choose their options carefully. It’s unlikely to be best to buy an annuity when you’re still working, but when you finally retire permanently, a combination of secure income from an annuity to cover the essentials and drawdown – where you leave your savings invested and can make withdrawals any time for the nice-to-haves – is a solid approach.’
Those who simply cannot face locking into a record low annuity rate for life can take a side step by taking only the income produced by the investments held in their pension. This could be the dividends paid from shares, funds or investment trusts. But remember that share prices go up and down and dividends can be cut – or even scrapped. Though forecasts suggest dividends could be under threat as recession looms they are likely to remain an attractive option. The question is how do you do this safely in a way that mimics the steady regular income from an annuity?
SHARE PORTFOLIO WITH DIVIDENDS
BUILDING a portfolio of shares in companies seen as reliable dividend payers is one option – though risky if you keep too few companies in the pot and one or more get into financial trouble.
However, several firms have maintained their dividends for periods which, in some cases, run to decades, says Richard Hunter, head of markets at broker Interactive Investor. He says: ‘Companies such as Shell and Diageo are among this clan, along with engineering company Rotork.’
Such consistent dividend delivery can be the result of the company making lower payouts over time so it might be necessary to mix and match your shareholdings with higher paying shares to replicate the income from an annuity. At current rates, you need a yield of about 4.7 per cent a year to match the income from a typical annuity for a 65-year-old. Hunter says: ‘Diageo’s current yield is 2.1 per cent and Rotork 1.9 per cent. However, if a company has made the dividend policy core to its financial priorities, the figure can be higher, such as with Shell at an annuity-busting 6.4 per cent.’
Helen Bradshaw, portfolio manager at wealth firm Quilter Investors, says an advantage for those wanting some security is that stocks that deliver a regular dividend also tend to represent lower risk investments.
She says: ‘This is because they are largely high-quality companies that have a proven ability to derive sustainable profits and hand a share of them back to shareholders. Companies at the lower end of the dividend spectrum are more likely to be recycling their profits into expansion. That could deliver long-term growth.’ Investors may have to take the rough with the smooth – as companies that seem watertight dividend payers can be forced to change their strategy.
THE FUNDS THAT TRASH ANNUITIES
INVESTORS who prefer someone else to do the hard work choosing the appropriate dividend payers can consider equity income funds managed by experts in the sector. These funds aim to invest in a wide range of stocks in order to pay a regular income as well as grow your capital.
Myron Jobson, of broker Interactive Investor, says: ‘A well-balanced income portfolio could serve as a viable substitute to an annuity and can help see someone through retirement in comfort.’ There are
116 funds available currently that pay income levels in excess of typical annuity rates for a 65-year-old, according to broker Hargreaves Lansdown.
And as with shares, it is wise to mix and match rather than throw all your money into one fund. This is not only to spread investment risk but to smooth out when income is paid out so you can be sure you have enough swept into your bank account when the bills come in. Of the annuity-busting income funds, 32 pay income monthly, 48 quarterly and the rest paying only once or twice per year.
The aim is to take the ‘ natural income’ from the investments and preserve the capital. Long says: ‘Whilst dividends can fluctuate, by only taking the dividends you are never nibbling away at your capital when the stock market falls.’
UK Equity Income funds to consider include Marlborough Multi Cap (4.6 per cent yield) and JOHCM UK Equity Income (4.3 per cent yield). Brian Dennehy, at Fund Expert, says of the latter: ‘It has succeeded in growing the dividend paid to investors in nine of the last ten years.’
The hunting ground for income should also extend beyond British shores to include Europe, the US, Asia and the emerging markets.
Funds to consider with a worldwide reach include Newton Global Income ( 2.9 per cent yield) and EdenTree Higher Income (5.2 per cent yield).
INVESTMENT TRUSTS TO BOOST INCOME
ANOTHER great source of income for those prepared to take stock market risk is from investment trusts. These are funds that are listed on the stock market and can be traded like any share.
They differ from conventional funds as they are allowed to hold back profits in good times to ensure they still have enough to pay out in dividends when times are tough.
Many trusts generate reliable dividends – but payment dates vary. Canny i nvestors who want a monthly income can build a portfolio of investment trusts based not only on what dividend they pay but when they pay it.
The Mail on Sunday picked such a portfolio with help from the Association of Investment Companies’ ‘income finder’ tool at its website, theaic.co.uk.
We came up with ten big name equity-focused trusts that together produce a total annual income of about 4.3 per cent – and distribute this income regularly, although not the exact same sums each month.
These are City of London (4.5 per cent yield), Scottish American (2.8 per cent), Schroder Income Growth (4.2 per cent), Henderson Far East Income (5.97 per cent), Perpetual Income and Growth (4.9 per cent), Murray International (4.5 per cent), JPMorgan Global Growth & Income (3.9 per cent), BMO Managed Portfolio Income (4.4 per cent), JPMorgan Claverhouse (4 per cent) and Temple Bar (4.4 per cent).
They can all be bought through an online funds platform – run by firms such as AJ Bell, Halifax, Hargreaves Lansdown and Interactive Investor. About half of the funds derive their income from the UK stock market and the others from across the globe.
Annabel Brodie-Smith, at the AIC, says: ‘Investment companies have many i mportant benefits f or income-seeking investors. Their ability to squirrel away some of the income they receive in good years to boost their dividends when times are tough has enabled many investment companies to build up remarkable records of dividend growth.
‘Some have consistently increased their dividends for 20 years or more in a row, and four have increased dividends for more than half a century.’