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Generating sustainable retirement income

Since the advent of pension freedoms in 2015, income in retirement has become a larger focus for many investors, but with increased flexibility comes more choice and decisions to make about future income prospects. 

The changes to the pension landscape mean those nearing, or reaching retirement, or even in the midst of the process can adopt a much more phased approach to their later years. The increased flexibility of being able to stay invested yet withdraw an income, or switch to alternative investment solutions, all without the need to eventually purchase an annuity, has changed the game for many investors. 

Thinking long term

In spite of this, many investors are not thinking outside the box on the best ways to maximise and secure a sustainable income throughout their retirement. While many may continue working past the state retirement age of 65 (currently) and phase into retirement, others might take a more traditional approach and look to encash some, or all, of their pension pots to cover home improvements, take up new hobbies or go travelling. 

With the average life expectancy at age 65 currently measured at an additional 18.6 years for men and 20.9 years for women, it is clear that retirement incomes need to be able to maintain a required standard of living for decades after full-time work potentially ends. 

For many income-seeking investors the choice has traditionally been between relying on the ‘natural’ income generated by the underlying assets in their portfolio, such as dividends on company shares or interest payments on fixed-income instruments such as bonds, or creating cash by selling investment units. 

The issue with the latter approach of unit encashment is that when investors are looking to make their money last as long as possible, selling down the capital in their portfolio actively reduces the amount they have to live on. In periods when investment markets are steadily rising and performing well, this is less of an issue as the underlying units are worth more, requiring an investor to sell fewer units in order to achieve their desired level of income.

Although, even in these more positive circumstances investors still have to be aware of the need to balance their increasing life span and making sure their capital lasts as long as they need it to, with the desire and/or the necessity of withdrawing an income.  

For those considering a ‘cash is king’ approach to retirement income on the basis that less exposure to investment markets means less risk, the outlook is not that positive. Investments in cash may be considered safer, but with UK consumer price inflation (CPI) at 2.1% in July 2019, and low interest rates of 0.75%, investors get little more benefit from holding their money in a savings account than they would leaving it under their mattress. 

Taking a different approach

What other options are available to investors seeking an income? Another approach may be to look for a portfolio that offers a ‘natural’ income from its investments.