Generating sustainable retirement income

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.  

As mentioned, ‘natural’ income refers to the income generated by the underlying investments, such as company shares, and which is paid out as a dividend or the interest payments on fixed-income instruments. This means that no units or shares need to be sold to generate income and so the size of the original portfolio is not depleted.  

That said, the level of ‘natural’ income is not guaranteed, as it depends on the underlying investments and how well that company or asset class has performed. But if a dividend is cut, or even suspended, the portfolio still owns the actual shares in that business and providing they have a long-term outlook, investors will benefit once the dividends are increased or resumed.

In contrast, when taking a unit encashment route, an investor is unlikely to be able to choose when to sell the units, as income will be required at regular intervals. This means investors are left vulnerable to share price fluctuations and in times of market stress have to sell more units or shares than they would otherwise have done.  

Developing an income strategy

However, since the introduction of pension freedoms, investors at or near retirement do not have to pick just one option for their income requirements. This is particularly helpful for those investors who want an income during their retirement years, but also would like to take advantage of the flexibility of pension freedoms to leave some of their pot to future generations.  

Therefore, taking a holistic view of an investor’s entire portfolio to choose the right strategy to achieve their objectives is more important than ever. For those looking to leave an inheritance, this could include placing part of the pot in an annuity to ensure a guaranteed level of income, while unit encashment could be used for unexpected expenses, such as a broken boiler, and then ‘natural’ income can underpin the income strategy to generate a steady stream of income to supplement their retirement lifestyle and maintain a certain level of capital for their beneficiaries.

A multi-asset approach is an attractive option for combining the varied sources of income available into a portfolio that can sit alongside other investment options in the decumulation phase, helping to boost overall income. As more people look to spend more of their life in retirement than ever before, getting the right mix of investments and solutions to ensure their income lasts as long as they do, and even beyond, has never been more important. 

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