Choosing the right income options in retirement

Even before these reforms, an increasing number of investors have been opting for pension drawdown, and this trend looks set to continue as flexibility and sustainability become key watchwords for those prioritising income.

Once retirees have understood the importance of achieving a sustainable income in retirement, the question is about how much risk they are willing to take to do so.

Annuities, for example, offer a guaranteed income for life but tend to be inflexible, which can expose pensioners to a range of other risks later on, such as inflation. On the other hand, drawing down an income from invested savings offers scope for growth and flexibility, but incurs varying degrees of risk.

Of course, the choice between investment and annuitisation need not be black and white. Many savers will opt for a ‘bit of both’ strategy, dividing their pension pot to create a combined retirement solution.

For instance, a pensioner might choose to cover regular, essential expenses – such as groceries or household bills – with an annuity, while using an invested pot to give flexibility and the potential for income growth that keeps pace with inflation.

An invested pension portfolio should reflect a client’s specific risk profile, and the asset classes it holds will be central to this. For example, different asset classes, equities, bonds or commodities pose different levels of risk and offer varying levels of potential income. They behave differently throughout economic cycles, and so diversifying between them can mean a smoother set of returns for investors over time.

Indeed, the benefits of diversification are as powerful in the search for income as they are when investing for growth.

Looking at markets today, it is clear investors are more likely to find attractive levels of income in alternative areas such as infrastructure or loans, rather than in more traditional income assets such as bonds.

Infrastructure is an attractive asset class for several reasons, while bank loans, which are also known as floating-rate secured loans or leveraged loans, can provide investors with an alternative source of income.

One thing is certain: changes are afoot in the UK pensions landscape. Over the next few years, increasing numbers of investors are likely to opt for drawdown strategies in retirement, and the need for a consistent and sustainable stream of income will be of central importance.

In this environment, the effective use of a combination of asset classes actively managed by professional investors can deliver consistent returns with a lower level of volatility, providing greater certainty for investors planning their retirements.

Eugene Philalithis is portfolio manager of the Fidelity Multi Asset Income fund

ALTERNATIVE INCOME FOR RETIREES

Eugene Philalithis from Fidelity highlights some alternative asset classes for retirement income:

Infrastructure

“Infrastructure is an attractive asset class for several reasons. As infrastructure assets tend to be backed by contracts, they offer a predictable and stable dividend yield – as well as having low correlations to traditional assets – which gives greater scope to generate more consistent returns with lower volatility.

“There are a number of different infrastructure sub-categories, but its key characteristics are stable dividend yields, inflation protection, low correlation to equities and low exposure to the economic cycle. Government-backed infrastructure projects provide a more certain and stable income stream. While infrastructure is a global industry, the UK has become a centre of excellence and the London Stock Exchange is one of the preferred listing routes.”

Bank loans

“Bank loans, which are also known as floating-rate secured loans or leveraged loans, can provide investors with an alternative source of income.

“Such loans pay a floating rate, earning a base rate – typically Libor [London inter-bank offered rate] – plus a spread, which means that if interest rates rise the income from these securities will rise in tandem. The spread they pay over the base rate also means they offer a relatively attractive level of income in what remains a low global yield environment.”