Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Could natural yield be a retirement income solution?
I’ve been inspired by the book ‘Your Retirement Salary’ by Richard Dyson and Richard Evans, and the method of accessing a pension via just its natural yield. WHowever, I’m not clear as to how this would actually work using either drawdown or UFPLS. Could you shed some light please?
Tom Selby, AJ Bell Senior Analyst says:
Before answering your question there are three bits of jargon which need explaining.
Firstly, ‘drawdown’ is simply a way of taking a retirement income while keeping your pension invested. When you enter drawdown, a quarter of your fund can be accessed as a tax-free lump sum, with the rest taxed in the same way as income.
Secondly, ‘UFPLS’ stands for ‘Uncrystallised Funds Pension Lump Sum’ (a catchy term coined by the Government). Going down this route means you take ad-hoc lump sums directly from your pension, with a quarter of each lump sum tax-free and the remaining 75% taxed in the same way as income.
Finally, ‘natural yield’ is a retirement withdrawal strategy designed to keep your underlying investments intact.
Rather than selling investments to generate a retirement income, someone who takes a natural yield approach would use income their investments pay out – via interest on bonds and dividends from stocks – to fund their lifestyle.
Where someone invests in income-producing funds rather than individual bonds and stocks, these will usually target a yield (say, for example, 4%).
Whether you’re taking an income in drawdown or via UFPLS, a true natural yield strategy would mean only ever taking withdrawals from the income your investments produce.
In the case of dividends, for example, these will usually be paid into a cash account which you can then access (provided you are over age 55). Remember that dividends are tax-free when paid within a SIPP, although withdrawals are taxable (after your 25% tax-free cash has been taken).
The main advantage of a natural yield strategy is that it preserves your underlying capital. This means that your pension can potentially continue growing over the long-term and eliminates the risk of selling investments during falling markets.
Natural yield can be particularly attractive for people who want to leave their retirement pot to loved ones after they die.
Pensions now benefit from generous tax treatment on death, with those who die before age 75 able to pass on their fund tax-free, while those who die after 75 can pass it on at their recipient’s marginal rate of income tax when they come to access it.
However, the big disadvantage of natural yield is that you’ll be reliant on your investments delivering sufficient income for you to live on.
In years where dividends are thin on the ground – something we saw in 2020 as lockdown forced companies to protect their balance sheets – you may need to reduce your spending. This level of uncertainty means a natural yield approach won’t be suitable for everyone.
Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.