This article was taken from the Spring 2024 issue of The 1875. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications
How to take an income in retirement is a question nearly everyone has to consider. While the pensions landscape has changed dramatically over the years, retirement income can be a more complex business than ever before. It’s been ten years since the 2014 Spring Budget when then Chancellor George Osborne announced a raft of significant changes in how retirement income could be taken. Prior to this, retirees had been compelled to buy an annuity, guaranteeing an income for life.
While this income is regular and reliable, annuities are inflexible, once bought they cannot be reversed, and cannot be inherited by family. Annuities are closely linked to 15-year gilt yields and, in an era of low rates and yields, annuity rates were correspondingly low. A no-frills annuity bought for £100,000 for a 65-year-old at the time of the 2014 Budget would have produced an income of just over £6,000 per annum.
Dubbed ‘Pension Freedoms’, when the legislation was introduced in the following April, retirees were free to do nearly anything they wanted with their retirement funds, with 25% of withdrawals being tax free, a significant departure from the previous system. Pension funds could now be accessed flexibly by lump sum or via regular income.
Retirees had many more investment options and could elect beneficiaries to inherit their pensions after death. Then Pensions Minister Steve Webb courted headlines with his comments that the Government was not overly concerned “if people do get a Lamborghini and end up on the State Pension.” On reflection, one can see his point, a diligent saver is probably unlikely to break the habits of a lifetime on turning 55. Retirees have indeed been sensible and Pension Freedoms have proved to be extremely popular, with over £72bn being flexibly withdrawn since they were introduced. Data from the Financial Conduct Authority shows that more than 205,000 drawdown policies were entered into in 2021/22.
One substantial change was that pensions could now remain invested and reap the benefits of stock market growth and dividends. The FTSE 100 has often been considered fertile ground for income-seekers in retirement, with giant and well-established blue chip companies in oil and gas, insurance and banking paying regular dividends. Increasing government and corporate bond yields have also recently made a welcome return to retirement income portfolios. Reliability is naturally a large concern for retirees, as regular and sustainable dividends are needed to ensure a stable income. A variety of income strategies can be employed. Natural income, whereby capital remains untouched, and dividends are taken as they occur, perhaps with a target in mind. Total return, where a set figure in cash or percentage terms is paid out, and where income alone is insufficient, an element of capital is used.
Investors could also invest in growth stocks and draw down on capital on the assumption that the portfolio will grow at a faster rate than the drawdown and enjoy an income while maintaining or growing their capital. Investment funds are also a popular vehicle for income in retirement. While individual shares may pause or reduce dividends, a fund of income generating stocks may provide smoother returns due to the benefit of diversification. Retirement income specialists Chancery Lane looked at the income returned from 32 funds from 1974 and found that income had been returned each year 100% of the time. Additionally, as inflation is a major concern for retirees, they examined the dividend growth of six London listed investment funds against inflation on a five-year rolling basis from 1986 – 2002 and found that dividend growth consistently outpaced inflation over the period.
With retirees no longer obligated to rely on annuities for income, the market unsurprisingly declined. 420,000 policies had been sold in 2012. Ten years later, this figure was down to 68,500. The period of ultra-low interest rates from the 2008 global financial crisis to the resurgence of inflation on the tails of the COVID-19 pandemic, saw depressed yields on government bonds which made annuities less attractive.
This trend has recently seen something of a sudden reversal, as interest rates have risen and government bonds offer more tempting yields. The fallout from Liz Truss’ short-lived ‘mini budget’ in particular saw a large spike in gilt yields, which corresponded to a 12% increase in annuity yields. This recent resurgence meant that 2023 was the best year for annuity sales since the Pension Freedoms reforms were introduced.
Pensions never seem to be out of the news for very long. The run-up to every Budget prompts speculation in the media as to how the Chancellor might tinker with them. The lifetime allowance has been raised, lowered, and then done away with altogether. The minimum pension age seems to be going only one way; ever upwards. Questions are being raised as to the sustainability of the ‘triple lock’ guarantee on the State Pension. While there is much uncertainty, retirees also have more income options than ever before and can save, invest or spend their lifetime’s savings to shape their own unique retirement.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of publication but may have changed at point of reading.