Retirees who use a defined contribution pension plan to fund their day-to-day finances should focus on income…not volatility
Retirees who use a defined contribution pension plan to fund their day-to-day finances are urged to re-evaluate how they take money out of the plan – in the face of volatile stock markets and rising interest rates.
A ‘white paper’ has just been released by income planners Chancery Lane says income-hungry retirees should ensure investments in their retirement plan are ‘reliable enough to meet that unique personal need’.
He argues that too many retirees are holding investments in their retirement plans based on their ability to generate total return – a combination of capital growth and income – when the focus should be on ensuring life. a stable source of income.
Decision time: Many income-generating investment trusts listed on the London Stock Exchange can provide retirees with a stable income without selling assets held as part of a pension plan.
Doug Brodie, co-author of the report, says the two sources of return are “commonly confused” by investors, which he says is a mistake because “capital volatility [of an investment] may mask the stability of his income.
If pension investments are chosen on the basis of reliability of income, Brodie says, any short-term volatility in the share price can be tolerated. This is because investments do not need to be sold to generate income, so no capital loss needs to be crystallized.
He says that many income-generating investment trusts listed on the London Stock Exchange can offer retirees this stable income without selling the assets held as part of a pension.
The Chancery’s report is important because a growing number of people are retiring with a defined contribution pension – or a number of them accrued over their working lives – as their main source of income.
Unlike a defined benefit plan, where income is based on a formula based on salary and years worked, a defined contribution plan is more flexible.
Since 2015, retirees have much greater control over the money in such a plan. They can convert the fund into a lifetime income stream through the purchase of an annuity – an option made more attractive in recent months as annuity rates have risen in response to rising interest rates and gilt returns.
But many keep their pension fund intact, drawing “income” from it as needed. This income can come from the sale of assets – the conversion of capital into income – or from the dividends paid by the investments in the plan.
Brodie argues that income-friendly investment trusts “can help provide stable income for those who have said fond farewell to their old secure income – their monthly paycheck.”
He adds that such an approach “may not be sexy, but it’s definitely the most reliable boyfriend or girlfriend.” Basically, it keeps an investor’s pension fund intact. They don’t have to create revenue by selling assets.
Many investment trusts are ideal for people looking for income in retirement because of their ability to pay out regular income – usually quarterly – through thick and thin. In effect, they are able to dictate what they do with the stream of dividends they receive from the investments they hold (usually UK companies, overseas stocks or both).
They can pass it on to shareholders, retain a little to be paid later, or supplement the income with drawdowns from reserves.
Brodie says, “Income-friendly trust stocks tend to go up and down based on the underlying holdings. There is little or no correlation with the stable dividends they pay out to shareholders – stability resulting primarily from the use of income reserves.
The Association of Investment Companies says 46 investment trusts have increased their annual dividends every year for at least the past decade, and 17 for more than 20 years. Trusts such as City of London, Bankers, Alliance and F&C have over 50 years of dividend growth.
As an example, Chancery looked at how an investor would have succeeded if he invested £100,000 in the UK stock market in January 1999 and withdrew £4,000 of income from the portfolio at the end of each year.
Assuming the sum had been invested in a fund tracking the FTSE100 index, Chancery claim they would have ended last year with a sum of £69,552 – having benefited from a total income of £92,000. If they had placed the same £100,000 in “eight established trusts”, they would have been left with £214,792 at the end of 2021 and incomes totaling £161,543.
Brodie says, “Baby boomers, born between 1946 and 1964, are ignored by financial services. The view is that they have money, so it will be fine. But this is not true. It’s an income they need, and the industry needs to do more to help them secure it.