Investing for retirement income explained

The easy investment rules that could make a real difference to your retirement income

As the recent Budget speculation has shown, there is often a lot of noise associated with the pension rules. The temptation can be to try and adjust your pension arrangements with each shift in policy. However, in reality, you are likely to be better off focusing on a few simple steps to build a secure retirement.

The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Retirement investment planning

It is easy to get caught up on how much you need to save to deliver a specific level of retirement income. While it is useful to have a plan, it can also be worrying if you feel you haven’t saved enough or have left it too late.

A better way to look at your retirement planning is that everything you manage to save today is likely to be worth far more to you in retirement. Every £1 you put in now will benefit from a combination of tax credits, compound growth and time. For example, every £800 invested sees the government add £200 as tax relief upfront. If you are a 40% tax payer, you could then claim another £200 through your tax return.

Compound growth could deliver another boost for your pension pot. Although stock markets are volatile, and there will be positive and negative years, the MSCI World index has delivered an average annual return of 8.9% since 31 December 1987.¹ Even a more modest return of 5% when compounded over time could see £1,000 more than double to £2,110 in 15 years or quadruple to £4,470 in 30 years.²

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The earlier you can start, the better. That said, it is never too late, you can still benefit from compound growth and tax credits in your 50s and beyond.

Investing well for retirement

To build a robust pension fund, you need the right investment strategy. When investing for retirement, you need to balance growth and resilience, creating a blend of assets appropriate to your age and risk tolerance.

Your pension pot needs to grow fast enough to outpace inflation. Leaving your money in cash may feel intuitively safe, but it may erode the purchasing power of your capital over time. There may also be an opportunity cost to leaving money in low risk, low return assets. The difference between an investment that grows at an average of 5% versus 3% can be significant, though investors need to make sure they are factoring in any costs associated with that investment. For a £1,000 investment, it is the difference between a return of £4,470 and just £2,456 over 30 years. This can make a meaningful difference to your retirement income.

It is also worth remembering that when investing for retirement, you will often have a longer time horizon, which gives you greater investment flexibility. You have time to recover from temporary set-backs in markets.

That said, you don’t want to go too far the other way. You need to ensure that you have a balanced portfolio that isn’t too focused on a single area of the market. Your portfolio should be appropriate for your age and risk tolerance. You need to be able to sleep at night without worrying about every bump in the road.

Investment trusts can be part of the solution for long-term growth and income. They can focus on higher growth areas such as smaller companies or emerging markets, or income generative assets such as dividend-paying shares. They can be a source of diversification, bringing in a broader range of investment opportunities. 

Tax free investing for retirement

Pensions come with some useful tax advantages. Any contributions you make are topped up by the government, and, potentially, by your employer as well. This can turbo-charge your savings. The government automatically adds tax relief of 20% to any pension contributions up to a certain level (£60,000 for the 2025/2026 tax year³). If you are a higher or additional rate tax payer, you can claim an additional 20% or 25% through your tax return. In addition to the tax relief, all income and capital gains generated on investments held within a pension are tax free.

Your contributions can also be given a boost by your employer. Under auto-enrolment, if you are over 22 and earn more than £10,000, your employer must offer a workplace savings scheme, or contribute to your personal pension scheme. An employee must contribute 5% of their salary, and the employer adds an additional 3%.⁴

ISAs may also have a role in retirement savings. There are no upfront tax advantages when saving into a standard stocks and shares ISA (though the Lifetime ISA – available to the under 40s – does have tax relief attached). However, all income and gains from investments held within an ISA are tax free. Also, any income taken out of an ISA is tax-free, so it can be a useful option to create a long-term tax free income stream.

Planning for retirement

Understanding the level of income you may need to support yourself is helpful in retirement planning. To do that, you will need to look at the kind of lifestyle you aspire to in retirement, and work out how much that might cost. This cash flow modelling will include your day to day expenses, plus areas such as travel and entertainment.

This may be very different to the level of income you need earlier in life. Your children may have flown the nest, you may have paid off your mortgage, which will reduce your expenses. On the other hand, you have the freedom to take more ambitious holidays and enjoy more leisure activities. It is also worth noting that your income needs might change over the course of your retirement. Financial advisers often talk of U-shaped income needs in retirement – high initially as you fulfil all those bucket list plans, lower as you slow down, then higher again as you need care fees.

This exercise can help you understand the level of income you are likely to need to retire at 50 or 70 and plan for retirement effectively. From there, you can build a robust understanding of whether you are on track, or need to adjust the amount you are saving, or the way you are investing.

Ignoring the noise

Pension rules are ‘noisy’. Successive governments have tinkered with the pensions’ regime and rumours swirl around every budget. However, it is often a bad idea to act ahead of any changes. In the most recent budget, around a quarter of people adjusted their financial plans based on worries over changes to pension and ISA rules.⁵ This included many investors who took their pension lump sum early in expectation of changes to the tax rules. The rules didn’t change and a fifth subsequently regretted the changes they made.

There are always rumours ahead of a Budget and tax breaks for retirement savings could be potential targets for a cash-strapped government. However, investors can be reassured that multiple governments have looked at areas such as tax relief and chosen not to change it. Equally, even where changes have been introduced, they haven’t been introduced overnight, giving retirees plenty of time to respond.

Sticking to retirement investment strategies and managing emotions

Emotional decision-making can be a quick way to destroy wealth. That might include selling out at the first sign of stock market volatility, or hunkering down in cash and neglecting the impact of inflation. Your pension strategy is long-term and any short-term volatility needs to be set in context.

There are strategies to help manage your responses to volatile markets. Keeping an eye on the long-term is important, allowing you to put any set-backs in context and showing that markets usually recover over time. It is worth remembering that investors are generally poor at market timing. The inclination to sell often comes at the worst possible moment, when markets are at a low point. Selling out means investors miss out on the recovery and compromise their long-term returns.

Investing regularly can help because it means you are putting capital to work at different points in the market cycle. This can help dampen market risk. Maintaining a balanced portfolio, with a spread of asset classes, geographic regions and sectors, can reduce overall volatility by leaving you less exposed to individual risks.

Generating income in retirement

Retirement is no longer a cliff edge. People are increasingly retaining paid work after retirement age, with over 1m people aged 66 and over still in work.⁶ People may launch side-hustles, full-blown businesses, or take on consultancy work. Retirement tends to be a journey rather than a point in time, with many people planning and preparing for retirement over several years.

That planning process is important and can make a material difference to your wealth in retirement. You need to be aware of some of the key risks in the years leading to and immediately after retirement. Sequencing risk, for example, is the risk that losses in early retirement permanently compromise your ability to generate an income. If you are withdrawing money at a low point in markets, the remainder of your pension pot won’t have the same capacity to recover. This makes it more difficult to maintain your lifestyle in future.

You also need to consider longevity and inflation. Retirement can last 25-30 years. With inflation running at 2%, the current Bank of England target, your £200,000 retirement pot could be worth just £121,000 after 25 years if it doesn’t keep pace with inflation.⁷ More recently, inflation has been running even higher.

Inflation is also important when investing for income in retirement. Cash and fixed income investments are useful for a steady and reliable income, but dividends have a good track record of outpacing inflation over time. Investment trusts may have a role to play as a source of income in retirement. Many have a mandate to grow the income they pay out to investors over time. All investment trusts can reserve income paid out from their investments during buoyant times to support the income stream to investors during weaker moments, thereby potentially delivering a steadier income for investors. They have a place as part of your retirement investment options. 

These strategies are more likely to deliver a healthy retirement than fretting about the minutiae of the pension rules from one budget to the next. Pensions can seem complicated, but the basic principles are straightforward – save as much as you can, for as long as you can, invest well and take advantage of the tax breaks available to you.