If you are banking on the state pension to fund your retirement, the ever-rising state pension age is cause for concern. Last year the government sped up the plan to increase the state pension age – it will rise to 68 by 2039, five years earlier than originally planned.
As the government struggles to come up with a solution to the problem of paying for an ageing population there is always a risk that it will increase the state pension age again, or even cut how much pensioners receive.
So, what can you do to supplement your state pension, or provide yourself with an income if you want to retire before you reach state pension age?
You have several options; which one is right for you will depend on how much risk you are prepared to take with your savings.
Risk averse people choose to keep their savings in cash and pay themselves a monthly income from the interest they earn.
“You can simply choose the best accounts that pay a regular income into your bank account – but you need to tread carefully as not all accounts offer this facility,” says Anna Bowes, director at independent savings website Savings Champion.
“The good news is that many of the best buy accounts on the market offer a monthly income facility, so savers do not need to miss out.”
RCI Bank tops the tables for easy access savings paying 1.29% monthly gross. On a balance of £20,000 that should provide an income of around £21.50 a month. If you don’t need instant access to the cash then Atom Bank has a one-year fixed rate bond paying 1.95%AER, that falls to 1.93% if you want the monthly income facility, but on a £20,000 balance that would give around £32 a month in gross interest.
Unfortunately, with interest rates so low you would need to have almost £400,000 invested in the Atom Bank bond to get a monthly income that matched the full state pension of £159.55 a week in the 2017/18 tax year.
For ideas on how to beat the banks and earn more interest on your savings, visit the Moneywise model savings portfolios.
However, if you want your money to earn more then you will have to take on some risk.
“Many investors have to make difficult decisions in terms of the level of income they want or need and the amount of risk they’re prepared to take to achieve it,” says Patrick Connolly, a certified financial planner at Chase de Vere.
Graham Wellesley founder of alternative property finance firm Wellesley & Co says: “Leaving your money in the bank with very low interest rates has risks of its own as inflation eats away at the capital values too.”
One option to supplement your basic statement pension is making contributions to an additional private pension plan with a pension provider. However, Mr Wellesley says: “For many people the issue is do you wish to lock up your savings to provide this income in retirement? In particular for those who wish to retire before the state pension age one would need to tie up a substantial amount of capital to produce sufficient income and that can only be accessed at 55.”
Nevertheless, investing in a private pension such as a self-invested personal pension is the most tax-efficient way of saving for retirement, as your contributions are topped up by tax relief. Plus, at retirement, you can withdraw 25% of the fund tax free.
Peer to peer (P2P) investments are an increasingly popular way to increase the amount of income. But they come with extra risks and shouldn’t be compared directly with savings.
P2P platforms allow investors to lend money directly to individuals and businesses. In return, they receive an attractive yield - provided the borrower does not default.
Investing in P2P loans is not the same as putting your money in a savings account. There is no guarantee that the cash will be repaid and it is not covered by the Financial Services Compensation Scheme.
Other investments that Moneywise readers have asked about because they often have eye-catching headline rates of interest are retail mini bonds. With these, you lend your money to a company and they pay you interest on that loan, which can be paid as a monthly income.
If you buy company debt via bonds like these, the money you make back depends on the firms issuing them not going bust. The risk here is that mini-bonds are not covered by the Financial Services Compensation Scheme, so you are dependent on the company not going bust before the bond matures so that you get your money back. Also, this type of bond isn’t traded on the stock market so you can’t sell your bond.
Alternatively, you could opt for a retail bond. These are traded on the stock market so you could sell your bond before it matures if you need to access your money.
Inexperienced investors who are unsure about how retail or mini-bonds bonds work or their potential tax liabilities should seek independent financial advice. We certainly wouldn’t recommend them unless you’re a sophisticated investor who understands the risks.
If you want to allocate some of your portfolio to bonds it would probably be better to invest in a bond fund, which offers you diversification by spreading your money between debt from lots of different companies and a professional manager to do all the hard work selecting which bonds are best. You could try Fidelity MoneyBuilder Income or Jupiter Strategic Bond funds which are both members of the Moneywise First 50 Funds list for beginner investors.
Another way to supplement your pension is to invest in a range of income-producing investments in the stock market.
The obvious choice in this scenario is to invest in equity income funds that focus on investing in companies that pay a healthy dividend.
Invest your money here and you can hope to get a better monthly income than you would from cash. For example, Mr Connolly recommends the Threadneedle UK Equity Income fund which has a historic yield of 3.92%, that would give you a monthly income of around £65 on a £20,000 investment, before fees. Just bear in mind that you would receive your money quarterly, from dividends rather than a monthly payment.
However, don’t assume by spreading your money across a few different UK equity income funds you are spreading your risk. “In the UK around 80% of all dividend income is produced by 15 companies and 50% by just five companies,” says Mr Connolly.
“This means that there can be a high crossover of stocks between one UK equity fund and another and so those who invest in a number of equity income funds may not be achieving the level of diversification they might expect.”
Mr Connolly recommends that income hunters spread their money across equity income funds, fixed interest investments and commercial property to build a truly diversified income portfolio. His tips include the Rathbone Income fund, Schroder’s Income Maximiser fund, the Henderson Strategic Bond fund, and Henderson’s UK property fund.
You can find more recommendations for equity income funds – both ones that invest in the UK and those that invest overseas, and commercial property funds in the Moneywise First 50 Funds.
If you do choose to supplement your pension income via the stock market using bond or equity income funds then you also need to consider the tax implications. Invest via a Stocks and Shares Isa and any capital growth or income you receive will be tax-free.