DURING & POST
Generating an income
The liberalisation of the pension rules has meant that fewer people are likely to
buy an annuity, looking instead to investments to provide them with a stable
income over time, but – crucially – allowing them to retain their capital.
Investment income comes from three main sources:
dividends from shares, interest payments from
bonds and rental income from commercial property.
It is important that retirement income is not drawn
from just one source. For example, dividends from
shares tend to grow in line with inflation and are
therefore vital for preserving the long-term
purchasing power of retirement income, but they
can be more volatile, so balancing them with more
stable bond income makes sense.
This will give you a more consistent income
over time.
You should not neglect the importance of growth in
income. Assuming an inflation rate of 2 per cent,
you would need to see an income of £1,000 grow to
£1,700 to have the same purchasing power in 25
years’ time. For this reason, holding large swathes of
a retirement portfolio in cash and government
bonds may be more risky over a long period of time.
A final consideration for income investors is the
choice of share class. If you are seeking an income,
you should usually choose the income units of any
fund. If you do not need the income for a period of
time, you can choose to reinvest it and then switch
it back on when you need it again.
Key points
You will need a large investment portfolio
to live solely off the income (dividends)
Look out for funds and stocks that pay a
high income
It may be worth thinking about maintaining a
growth portfolio and selling down some of
your holdings as and when you need the cash
Even with the recent bull market in government
bonds, over 20 years, the equity market has
delivered an annualised real return (after taking
inflation into consideration) of 4.1 per cent, while
UK government bonds have delivered 3.5 per cent
(Source: Barclays Equity Gilt Study).
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