The search for the Holy Grail: an income in retirement

AFTER spending a working lifetime saving for retirement, it’s vital to get the most out of your money.

Having a reliable source of income is crucial and until now the only way to secure that for those who didn’t have a huge pension pot was to buy an annuity.

But for anyone who wants to keep their money invested and take an income, there is a range of alternatives that have begun to hit the market. The key is to choose a route that can provide for the entire length of your retirement, which could be 30 years or more.

Research from insurance company Zurich has found that up to three- quarters of people fear they will run out of money in retirement. That figure rises to 84 pc among those aged 35 to 44. So, for those who don’t want an annuity, here are the various choices available.

You might not want to buy a Lamborghini with your nest egg, as Pensions Minister Steve Webb suggested, but you may still want to take your pension pot in cash, especially if it is small.

For anyone with around £10,000, this could be the most sensible route, as it means you can combine it with other savings and you don’t get stuck with a paltry annuity.

HOW THE TAX CAN QUICKLY ADD UP

WHEN you take a lump sum it will be taxable at your normal rate. And depending on the size of the lump sum you take, it could push you into a higher tax band, say from 20pc to 40pc. We will reveal more about the tax implications of taking a lump sum tomorrow.

But assuming you are a 20pc tax payer, if you take £10,000 from your pension then £2,500 would be tax-free and you would pay 20 pc tax on the remaining £7,500, which adds up to £1,500.

The more you take, though, the more complicated it gets.

If you took £100,000, £25,000 would be tax-free. Assuming you had no other income that year, you would then have £10,000 tax-free under your personal allowance, so would pay 20 pc tax on the next £31,865 and 40 pc on the remaining £32,135. The total tax bill would be £12,800, leaving you with £87,200 from your £100,000 pot.

Of course, losing £12,800 to the taxman is not ideal but there are times you might want to take a sum this big and are willing to pay the higher rate of tax. For example, it could be worth it if you wish to purchase a buy-to-let property to provide your retirement income.

The lump sum of £87,200 you took in our case above would be a deposit of more than 40 pc on a £200,000 property, opening up some of the best mortgage rates on the market. The average rental yield is around 6 pc — which would be £5,323 (the returns on buy to let vary greatly depending on the location and type of property.)

HOW TO KEEP YOUR POT INTACT

THE 25 pc tax-free lump sum you take from your pension can prove very useful, particularly if you need to spend money on home improvements or a holiday of a lifetime.

But experts advise considering whether you really need to have all the money or if it might pay to leave it invested and take chunks as and when you need to.

One of the most prominent changes to come out of the pension reforms is that people will be trusted to be in charge of their own savings pot.

Previously, you had to prove that you had a secure retirement income of at least £12,000 a year elsewhere before you were allowed to move your pot into so- called flexible drawdown, where you can make withdrawals every year while keeping your pot invested.

Now, however, anyone will be allowed to use their pension savings a bit like a bank account. And you can still get that lump sum to spend.

With a £100,000 pot, you could take 25 pc tax-free. You could live off this £25,000 for five years while the remainder of your fund stays invested.

If the remaining £75,000 grew at 5 pc a year, by the time you came back to it after five years you would have almost £96,000, putting you back almost to where you started. With some careful planning and investing you can make sure your pot replenishes itself, so it doesn't run out too early.

The trick is not to take so much each year as income that it depletes your savings too quickly. Taking £10,000 a year as income would see that cash run out in less than 13 years, even if it continued to grow at 5 pc a year.

However, if you took just £5,000 a year, you would still have almost £67,000 left after 25 years. And don’t forget you have your

state pension — a flat rate of £155 from 2016 — to supplement this income, too. This strategy won’t work especially well for smaller pots. It will help you eke out your savings a little further, but they’re unlikely to last for a full 30year retirement.

Remember, you can’t go into drawdown with all providers at the moment and it’s important to check out fees, too, because many will charge you each time that you withdraw cash. Fund supermarkets are ahead of the curve and have their offerings ready, and are generally some of the cheapest.

BEWARE THE UNTRIED FUNDS

IF YOU want to enter drawdown when you reach retirement, you need to fill in a transfer form instructing the drawdown provider of your pension scheme details to move over your money. Usually this takes four to eight weeks.

Costs will vary, but with Hargreaves Lansdown, for example, the actual drawdown product is free of charge, but you pay the same annual fees you would to hold investments in an Isa, typically 0.45 pc. One of the major dilem- mas for retirees, of course, is where do they invest their money in retirement.

Savers need a fund safe enough to protect their capital, but one which is also able to keep it growing, so it doesn’t run out.

Many of the major fund groups, including BlackRock, Threadneedle and Schroders, have recently launched dedicated funds to fit this new gap in the market.

They aim to pay incomes of between 4 pc and 6 pc a year while keeping your money safe.

But experts are concerned that because these products are brand new with no track record, there is no way of knowing whether such promises can be kept. Rob Pemberton, head of investment at HFM Columbus, is concerned about the avalanche of new funds.

He says: ‘The new pension freedoms are like a red rag to a bull for the investment industry, who sense a whole new market opportunity in one-stop shop retirement products.

‘We are seeing a real bandwagon effect with a confusing range of fund launches and a dusting down, rebranding and re-launching of funds that had been gathering dust.

‘Without having to take the risk of investing in a wholly new fund, there are plenty of multi- asset income funds around with a decent yield and performance track records, and all will pay out a monthly distribution.’

He recommends looking for a fund that yields around 4 pc — pointing out that in a world where interest rates are stuck at record lows, managers promising yields that are much higher are likely to be taking more risk with your money.

He likes Premier Multi-Asset Monthly Income, which is a type of one- stop shop fund that invests in other funds to spread its investments across bond, company shares and property. It has returned 41 pc over the past three years and currently yields 4.6 pc.

He also likes Invesco Perpetual Distribution, which invests directly in company shares and bonds.

It has around 57 pc of its assets in company shares and bonds, and around 7 pc in cash, so should be a steady ride for retirees. The fund yields 4.2 pc and has returned 33 pc over the past three years.

DON’T GET STUNG BY HIGH FEES

WHILE one- stop shop funds can keep all your money in a single place, the downside is they will tend to charge a little more in their annual management fees, especially if they are investing into other funds rather than directly themselves.

For example, the charges on the Premier fund rack up to 2.28 pc a year, compared with around 1.54 pc for the Invesco fund.

The Premier fund has a higher return and yield, but savers need to work out the option that best suits their needs over the long term.

Investors keen to avoid paying any more than they absolutely have to will need to put in a little more effort and pick a few different funds that complement each other.

The good news is that because once you are in retirement your financial needs are likely to change very little, so once you have chosen the investments to put in your portfolio you shouldn’t have to review them more often than every few years.

This mix could include a strategic bond fund, which invests in government and company debt — Jupiter Strategic Bond and Fidelity Strategic Bond are Mr Pemberton’s favoured choices — as well as an equity fund, such as Threadneedle UK Equity Income or Schroder Income Maximiser, and even a property fund, such as Aberdeen Property Trust for an extra bit of income.

Ben Yearsley, head of investment at Charles Stanley, says: ‘ It is difficult generating a decent income and at the same time making sure your capital has the opportunity to grow, but isn’t too volatile.