I turn 70 in 12 months’ time and I’m planning to start taking an income from my SIPP for the first time. I’ve calculated I’ll need about £12,000 a year (pre-tax), alongside my state pension, to fund my lifestyle. I have already taken my 25% tax-free cash and have a remaining pot worth just over £300,000. I’m keen to explore a ‘natural’ yield investment strategy, with the aim of leaving as much of my remaining fund as possible to my two children. Are there any pointers you’re able to give? Does this sound sensible?

Sheila

Tom Selby, AJ Bell Head of Retirement Policy, says:

A SIPP (self-invested personal pension) is a type of pension that allows you to choose from thousands of stocks, bonds and funds. This choice means you can use a SIPP to build a retirement investment strategy that suits your goals and appetite for investment risk. If you aren’t sure how you want to invest, lots of SIPP providers offer diversified multi-asset funds aimed at different risk preferences.

When it comes to turning your retirement pot into an income, SIPPs also offer plenty of flexibility. You can choose to take an income while keeping your money invested via ‘drawdown’, with no limits on how much or little you can withdraw. When taking an income in this way, it’s important to consider the sustainability of your withdrawal plan and the tax implications of taking large chunks out of your pension. As you note in your question, when you enter drawdown, you have the option of accessing up to 25% of your pension completely tax-free.

You can also take ad-hoc lump sums directly out of your SIPP, with a quarter of each lump sum tax-free and the rest taxed in the same way as income. However, as you have already accessed your 25% tax-free cash, I’m going to assume you’ve already opted to take an income via drawdown.

For completeness, the other main retirement income option is to buy an annuity from an insurance company. This gives you the security of a guaranteed income for the rest of your life, although you will lose the flexibility to adjust your income to suit your needs.

THE PROS AND CONS OF NATURAL YIELD

Let’s now turn to the specifics of your question. A ‘natural yield’ investment strategy involves attempting to live off the income your underlying assets deliver each year, while leaving your underlying capital untouched. This can be an ideal way to preserve capital for your beneficiaries after death. As you are living just off the income your investments produce, sustainability shouldn’t be an issue.

To do this, you will likely want to choose investments that aim to deliver dividends which, in turn, will provide your income in retirement. You can do this by choosing your own investments or paying a fund manager to choose investments on your behalf, in return for a fee. There are investment funds and trusts which aim to deliver income and are targeted squarely at retirees.

As always when you’re investing, make sure you only take risks you are comfortable with, aim for a diversified portfolio so you don’t have all your eggs in one basket, and keep your costs as low as possible.

The tax treatment of SIPPs on death is particularly attractive because they are usually free of inheritance tax (IHT). In fact, if you die before age 75, it is possible to pass on your fund completely tax-free, while if you die from age 75 onwards, inherited funds will be taxed in the same way as income when your nominated beneficiaries make a withdrawal. As you are planning to pass any leftover pension to your two children, make sure you have told your pension provider this is what you want to happen.

THE MAIN RISK

The main risk when opting for a natural yield strategy is your income may fluctuate if the companies you invest in – either directly or
through a fund manager – decide to reduce dividends. Should this happen, you would be left with the choice of either cutting your cloth accordingly or selling down your underlying capital to cover the gap.

In terms of the yield you might need, someone with a £300,000 pension would require annual dividends of 4% (after charges) to deliver a £12,000 income. That required dividend will shift depending on the performance of your underlying investments each year. If they increase in value then the required dividend will be lower, but if they fall in value then the dividend will need to be higher. You also need to consider whether a flat income of £12,000 is enough to fund your lifestyle, or whether you want that income to go
up with inflation.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

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.

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