Generating an income at retirement: how this writer is doing it

In the fourth chapter of our retirement series, in which financial journalists offer a personal perspective on their own pension portfolios, Helen Pridham explains why it is not prudent to purely focus on income-producing investments at retirement. 

Not putting all your eggs in one basket has been very much my investment mantra from the time that I first started putting money aside for the future, both within pensions and outside of them. It was one of the reasons that I did not stick to one pension provider or put money just into pensions when saving for retirement. It is also the reason that I will not be relying on dividends alone to provide my retirement income, but instead look at the total returns from my investments so that I can also withdraw capital when needed.  

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One of my first steps, as I started to prepare for the time when I would need to take a retirement income, was to consolidate my past pensions within a self-invested personal pension (SIPP). Like many people, I had accumulated a number of pension pots during my working career, including within two employer pension schemes. They were both investment-based defined contribution schemes. 

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Had they been final salary schemes especially bearing in mind their modest size, I would have let them run – the security they would have provided would have been very welcome. Final salary schemes were rolled out by employers during the 1960s, 1970s and 1980s, offering workers a guaranteed income for life when they retired. 

SIPPs allow you to diversify investments all in one place

But for most of my working life, I have been self-employed and, during that time, I have set up a number of pension policies with a variety of providers. In the early years, you had to set up different pensions if you wanted to spread your investments around. Nowadays, of course, SIPPs are the norm, enabling you to diversify your investments within one plan.

Having consolidated my various pensions within a SIPP - with the exception of my Scottish Widows ‘with profits’ pension, which offered a guaranteed annuity rate too good to refuse for a small portion of my overall pension - I have spread my investments across a number of funds and investment trusts.

Since pension freedoms were introduced in 2015, not only has it no longer been compulsory to buy an annuity with your pension pot but - if you want to - you can take it all out in cash, subject to tax on the amount you withdraw over and above the 25% tax-free allowance. 

It has been reported that some people have used this option to purchase buy-to-let property, which is often seen as a failsafe way of generating a retirement income. But this approach does not appeal to me. Not only have you got the hassle of dealing with tenants, but it is a classic ‘all your eggs in one basket’ scenario for many people who already have a significant amount of their assets tied up in the home they live in. Property is also illiquid, and you can’t make partial withdrawals if you need cash. During lockdown, some landlords have seen their rental incomes affected as tenants have lost jobs.

I invest in a variety of funds and trusts to spread risk 

I prefer the thought of having a diversified portfolio within a SIPP and outside. The prospect of market fluctuations does not bother me too much. I have seen plenty of market volatility in my career and I am thinking of the long term as I expect my retirement to be a lengthy one. Investing in a variety of funds and trusts helps spread your risk.  

It is true that the income which these investments generate cannot be guaranteed, especially given the challenging backdrop for company dividends at the moment. This is a reason I am an advocate of holding some solid, long established investment trusts in a portfolio if you are looking for income. Thanks to their ability to hold income reserves as a cushion to maintain their future dividends (they can retain up to 15% of the income they receive each year), there are a good number of trusts which have managed to ride out previous dividend droughts without having to cut their own.

Not all of my retirement savings are held within a pension, as I have also built up a stocks and shares ISA. In addition, I hold Index Linked National Savings Certificates and some cash. If you are setting up your portfolio from scratch when you retire, say with money transferred from an employer’s pension scheme, it is important to hold a cash sum equivalent to around two to three years of the retirement income you think you will require over and above your state pension and any other fixed pension. This will give your investments time to grow and a reserve to dip into if you need extra cash when market conditions are unfavourable, so you don’t need to sell investments during a market dip.

As I have held some of the investments within my SIPP and ISAs for some time, I have been fortunate enough to have seen them grow significantly in value. My intention is to gradually withdraw some of this growth to supplement my income. It means that I can continue to hold a wide spread of investment trusts and funds in my portfolio, without having to focus on higher-yielding, income generating funds and trusts, which are tend to be biased towards the UK.

Not everyone is in favour of withdrawing capital to boost their income. They prefer to rely on the natural yield (the amount of income generated by the fund or trust’s underlying investments). It can, of course, be risky to erode your capital, but if excessive withdrawals are avoided, I think this is valid approach.

It means I can continue holding Scottish Mortgage (LSE:SMT), which has been one of my best performing investments in capital terms, and currently has a yield of only 0.3%, as well as specialist trusts such as private equity fund of funds Pantheon International (LSE:PIN), which does not pay an income. It means that if I wish, I can also include defensive trusts such as Personal Assets (LSE:PNL), which has a modest 1.2% yield.

I will also be considering investment trusts that pay all or part of their income out of capital.  JPMorgan, for example, has at least four trusts which pay regular quarterly dividends funded partly from capital set at 4% of net assets at the beginning of each financial year. European Assets is another trust which adopts this strategy. Far from eroding capital, this approach can potentially produce more growth because managers are not tied to high-yielding shares in their universe.

I have some investments that are not held within a SIPP or ISAs, and making capital withdrawals from these funds is more tax efficient than taking income, because I can use my annual capital gains tax allowance (£12,300 for the 2020-21 tax year) to take them free of tax.

All in all, I am optimistic that my state pension, combined with income and capital withdrawals from my SIPP and ISAs, plus the odd bit of freelance work will provide me with a relatively comfy retirement.