Major changes to pension rules have given people in retirement more freedom than ever in how they use their money in retirement – and some retirees may even consider trying to grow their savings pot.

Pension freedoms, introduced more than three years ago, mean today’s retirees are not forced to buy an annuity in order to produce a retirement income. Instead, a growing army of investors are choosing to keep their money in the stock market even after they stop working.

The traditional approach for older investors has been to find investments which will pay a reliable income, in the same way that an annuity would, to fund their overheads through retirement.

This has historically meant investing in UK Government bonds (known as gilts) and high-quality corporate bonds, which have reliable pay-outs and lower levels of risk.

But, with interest rates at rock-bottom for almost a decade, these traditional income payers no longer yield enough to even beat inflation.

NOW VERSUS THEN

Investors banking on gilts for their retirement income will instead find the value of their cash being eroded year after year. Research by Royal London (see accompanying chart) shows how much harder it is to find a decent yield compared to a decade ago.

As a result, investors are being forced into riskier income investments such as high-yield bonds – the debt of companies with a lower-credit rating – and even emerging market debt. These assets may produce the yield required but they come with a higher level of risk.

Trevor Greetham, head of multi-asset at Royal London Asset Management, says: ‘Savers need to realise that chasing after high-yielding investments today can involve investing in an unhealthily narrow range of assets that could suffer as interest rates rise.

‘Investment conditions today are a world apart from those before the financial crash and retirement strategies need to change accordingly.’

It’s therefore not surprising that more investors are considering a growth strategy in retirement. A nine-year bull run has given people the confidence to keep some money in the stock market even after they retire.

A growth strategy in retirement doesn’t mean upping your risk through extreme measures. Instead, investors consider how much they need as an annual income and try to build a portfolio which will grow by that amount. So, if you have a pension pot of £150,000 and need £7,500 a year, you would aim to produce growth of 5% a year.

HOW IT WORKS

Most investment platform providers will allow you enter a drawdown plan where you can withdraw the cash you need. So, if your £150,000 grew by 5% to £162,500, you simply withdraw your £7,500 and are back where you started ready to start making your money work for the next year.

Mike Deverell, partner at Equilibrium Asset Management, believes that’s a very sensible strategy. ‘If you just aim for as high a yield as possible then that actually increases your risk as it rules out certain asset classes and leads you to be highly concentrated in the few assets that provide enough yield.

‘We prefer a broad spread of asset classes including equities and bonds, but also alternatives like property, infrastructure and absolute return funds.’

DON’T FORGET THE IMPACT OF INFLATION

But this approach is not without risk. First and foremost, investors need to factor inflation into their calculations.

Andrew McCulloch, relationship manager at 7IM, says: ‘Not considering the future need to beat inflation can create problems down the line, which are exacerbated by the fact that people now live longer in retirement.’

He suggests a mixed approach, keeping enough money in liquid, low-risk choices to cover one or two years’ expenditure, with further tranches invested for the medium and longer-term with the aim of growing your pot.

He likes the Fidelity Money Builder Income (BBGBFM0) fund as a shorter-term option; it invests in fixed income assets and yields around 3.2%.

For the medium-term he likes Artemis High Income (BJT0KR0), which has around 40% of its assets in fixed income and the rest in equities, and yields 5.4%.

For the longer-term he suggests a growth- focused choice such as 7IM Moderately Adventurous (B2PB2K5) – it has exposure to UK value opportunities and equities across the globe.

WORDS OF CAUTION

Other advisers are more cautious around growth as a retirement strategy. Brian Dennehy, director at Dennehy, Weller & Co, warns that a few years of poor returns or a downturn in stock markets is enough to ‘obliterate’ your retirement plan.

McCulloch adds: ‘The problem with this approach is that if you have a year or more of flat or negative returns you start to eat into the capital. Like a snowball rolling down a hill, this can be hard to recover from.’

A final point to note, too, is the fees involved in drawing down capital from your pension pot.

For example, you might pay £25 per ad-hoc withdrawal or £100 a year for regular drawdown payments, as well as the usual trading charges of £1.50 for funds and £9.95 for investment trusts or shares. These should be factored into your calculations. (HB)

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