There comes a point in life when people shift from saving for the future to drawing an income from those savings. Alternatively, you may already be retired but require additional income. It is really important your savings and investments are fit for this purpose.
How to generate a healthy level of current income from savings and investments?
Pensions and Annuities are likely to form a significant part of your plans, but I cover these separately in their own article. For now, I will offer some time-tested strategies to generate a healthy level of current income from liquid savings and investments, which also offers the ability to rise with inflation (there are few guarantees in the investment world, but inflation is an event that almost always occurs).
NS&I Income Bonds and Cash Bank Accounts:
These provide a level of interest income that is variable. It is usually possible to earn a higher interest rate by investing in Fixed Term Bank Cash Accounts and NS&I Guaranteed Income Bonds, although rates on bank accounts have fallen significantly since the base rate was reduced in March 2020. Consider laddering the maturities by placing some funds on instant access, then split money between 1,2, and 3-year maturities. You can usually earn more interest the longer the term, and when a bond matures you can reinvest for a further 3 years (usually at a higher rate) in the knowledge that another of your bonds will be maturing in 12 months. This is known as “laddering” maturities.
Corporate Bond and Gilt Funds:
Whilst it’s possible to purchase individual Corporate Bonds and Gilts, a fund offers more diversity. An income can be generated from a collection of holdings and the “yield” (the interest paid out) should exceed that generated by NS&I and Cash. Capital values of the underlying investments can fluctuate up and down, so it is important to select the right fund or combination of funds.
From a tax perspective, the Personal Savings Allowance allows basic rate taxpayers to receive tax free interest of £1000, reducing to £500 for Higher Rate taxpayers and zero if paying additional rate tax. Any interest earned within an ISA is tax free. This is in addition to the 2020/21 personal tax-free allowance of £12500. In certain circumstances, married couples and those in civil partnerships can transfer 10% of their personal allowance to their partner.
Equity Income Funds:
These can be UK focused or Global funds and whilst they can invest in any listed company, they tend to invest in large, well established companies which normally pay an above average dividend. However, please be aware that recently many companies have cut their dividend in order to maintain their cashflow during the coronavirus pandemic, so the income you expect from equity income funds will reduce in the short-term.
Whilst the underlying capital values of the funds can also fluctuate significantly with the stock market, the dividend income distributed by the funds in normal circumstances is generally higher than cash or bond accounts, and over the long-term can be an effective way to combat inflation.
Taxwise, everyone is entitled to a tax-free Dividend Allowance of £2000 per annum and dividend income within an ISA is tax free. Dividends in-excess of this are taxed at 7.5% for basic rate taxpayers, a favorable rate compared to earned income/interest tax of 20%.
In addition, “income” can be generated from long-term capital gains by utilizing an individual’s annual CGT exemption of £12,300 for 2020/21 which is often overlooked. If gains exceed the exemption, capital gains tax rates are currently either 10% or 20% depending on which tax band(s) the gain falls into when added on top of your income, which are still lower than tax on earned income/interest.
‘Everyone’s income requirements are different, and any investment solutions should be tailored to your individual needs. These should include your attitude to risk, investment timescale, other sources of income and most importantly your personal objectives during retirement. If you require income in retirement, we recommend you contact your local Lonsdale Wealth Management independent financial adviser for personalised financial advice. We are used to working with clients entering retirement and can offer effective income drawdown solutions so you can achieve your financial goals in retirement. For more information complete our booking consultation form or call your local adviser.’
Howard Goodship has written a number of articles in the Understanding Investments series.
The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. The contents of this article are for information purposes only and do not constitute individual advice. ‘The Financial Conduct Authority does not regulate tax advice.