This week, a firm called Retirement Advantage published a report on what retired people want from their money. It turns out that what most value above anything else is certainty. They want a guaranteed annual income every year forever.
That’s a bit awkward. The one thing chancellor George Osborne’s much-celebrated pension reforms has done so far is to remove the guaranteed bit from retirement income. If you don’t have a defined benefit pension (one of those lovely pensions that gives you a guaranteed inflation-linked income every year for life) and you haven’t bought an annuity, you are at the mercy of the markets – you get the income they offer.
I suspect that this is something many more savers are going to want once the dust clears on the carnage in the commodities sector. If you have been under the impression that dividend-producing equities are effectively “nature’s annuity”, the suspension of all payments from Anglo American this week (for at least 18 months) can’t have come as happy news. Even if you weren’t holding those shares, the reminder that dividends come at the market’s discretion can’t have been very nice.
The good news for Osborne is that even with the risks of using drawdown now nastily clear, his political bravery probably hasn’t been in vain. There will be no clamour for the return of the old annuity system for the simple reason that the second thing people want is flexibility, something that includes instant access to their savings.
Yup, they want someone else to take the risks involved in guaranteeing them an income, but they also want to be able to step out of that arrangement too. It’s a tall order. The ever-clever financial industry has started to cast around for some solutions to this oxymoronic problem – allowing investors to use some of their pension savings to buy an annuity while keeping the remainder in drawdown or a cash account, for example.
But it’s also worth noting that there are a few near ready-made answers to the problem out there already (I say near because it isn’t possible to have a guarantee of certain income and of flexibility from the same pot of cash simultaneously). Some of the biggest, most diversified investment trusts have recently taken advantage of regulation changes that allow them to pay their dividends out of capital – so the dividend payments from the funds can be higher than the total income paid out by the investments the fund holds.
If you are not holding the funds inside a pension and drawing down from that pension this isn’t something you should be particularly impressed by. Those still trying to build wealth clearly don’t want their capital cannibalised to pay dividends they don’t yet need. And the reasonably well-off holding the assets outside a pension are unlikely to want to have their capital converted into income for tax purposes. Why pay 40% on income when you could sell shares, take the cash as capital and pay 28%? Quite.
However, inside a pension it is all different. The key point is that most pensioners will have to spend their capital at some point in their retirement whether they want to or not (this is what the experts call “decumulation”) and this is a very easy way to do it when yields across the board are very low (that won’t last for ever – I hope).
But the other reason this makes sense for those in pension drawdown is that every single penny inside a pension – whether it is the tax-free income you contributed in the first place or the capital gains and dividends from investing that income – is treated as income when you withdraw it. So while it might irritate other people to get their own capital back as income, it makes not a jot of difference to the pensioner in drawdown.
On to the funds to look at. This is a subject we’ll come back to time and again, but when I asked Mark Dampier, head of research at Hargreaves Lansdown, for his thoughts on the best one-stop fund for the retired this week, his answer was one of my own favourites – RIT Capital Partners. This holds a pretty diversified portfolio of some listed and some unlisted equity investments alongside government bonds and currencies. It hasn’t set a level of dividend it guarantees to pay but it has changed its articles to allow it to pay income out of capital. That rather suggests that the dividend will be more or less certain to stay at least its current level (the yield is just under 2% – so solid, rather than spectacular).
Lord Rothschild, the major shareholder in the trust and its chairman, is no spring chicken, so perhaps he has the interests of other over-70s at heart when he lets his board know the level of dividends he’d like to see.
The other fund to look at is Personal Assets Trust. Again, it is diversified and unconstrained (the managers buy whatever they like). It has had a run of bad performance, but given its usually competent management that is unlikely to last much longer. The latest quarterly letter from the trust reminded shareholders that the fund is “taking advantage of the ability to distribute capital profit as dividend by undertaking to pay a regular total of £5.60 [per share] per annum”.
An undertaking isn’t a guarantee – and the payout on the trust is still less than 2%. But for those looking for some income certainty from their investments in a nasty environment for income, it is at least a start.
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- This article was first published in the Financial Times