DIY pensions: the six alternatives to an annuity-Richard Evans

Pensioners are now looking for alernatives to annuities, with many opting to generate their own retirement income through bonds and shares. Below we look at six ways to take on your own 'DIY' pension

With the Government's decision to scrap the effective compulsion to buy an annuity from next year, more and more people are taking the DIY route to ensure a useful and reliable retirement income Photo: Howard Mcwilliam

On last week’s front page we reported that American annuities paid about 7pc, compared with the 6pc available to British pensioners, and looked at the alternative of retaining your capital while investing it to obtain a comparable income.

This week we’ll look in more detail at how to generate a useful and reliable income from your retirement savings, assuming that you decide against an annuity. More and more people are taking this route in response to the Government’s decision in March to scrap the effective compulsion to buy an annuity, a change that will take effect in April next year.

One of the advantages of buying an annuity is that once you have done so there is no further effort involved – you will receive a steady income for the rest of your life without lifting a finger. But managing your own investments to produce an annuity-like income needn’t involve a huge amount of time and effort.

Below we look at six approaches to the problem, starting with the most “low-maintenance” – a fund that does everything for you – through to what amounts to acting as your own fund manager, buying and selling the most appropriate shares and bonds. We then look at some alternatives that avoid the financial markets altogether, such as peer-to-peer lending.

First though a word on practicalities. If you want to generate an income by owning shares, bonds or funds, you’ll need the services of an “investment shop”. These online platforms, also called fund supermarkets or fund shops, provide an easy way to buy, hold and sell investments in one place. They handle all the administration, including the tax side of Isas and Sipps – self-invested personal pensions.

The investments described on the right can be held in either of these tax-efficient schemes, or indeed outside them in ordinary “trading” accounts. Remember that tax is due on any income you take from your pension beyond the 25pc tax‑free lump sum.
Choosing the best investment shop for your needs is not always straightforward. For example, the cheapest option for an investor with, say £50,000, who chooses the first of our options – an all-in-one fund – may not be the cheapest if you choose to pick your own shares instead. Another investor with a larger sum to invest might be better off at a third fund shop. Our easy-to-use table here will help.
The income leveller
An all-in-one fund designed to pay a steady 4pc or 6pc income
For a steady income from a diverse range of investments, a “multi-asset” fund is ideal. Such funds come in two flavours: one that simply owns a mix of shares, bonds and other income-producing assets directly, and another that buys stakes in other funds.
This second is called a “multi-manager” fund or “fund of funds”. Here, the manager of the “parent” fund chooses the best equity fund managers, the best bond fund managers and so on, and splits his money among them.
A further refinement is to “smooth” the income produced by a multi-manager fund. This is what Old Mutual’s Generation range, which is aimed specifically at retired people, does.
The range consists of four multi-manager funds: two have a target income of 6pc, while two aim for 4pc. In each case there are variants that aim for a total return (capital growth plus income) of 3pc plus inflation and 4pc plus inflation The underlying assets are mostly shares, bonds and property, but with returns smoothed by the use of sophisticated financial products called “derivatives”. In effect, the use of derivatives tops up income when the assets fail to produce it naturally, but at the cost of sacrificing some returns when the investments outperform.
Use of derivatives would normally sound alarm bells with many investors, but the manager of Generation, John Ventre, said the funds were not at risk if the other parties to the derivative contracts defaulted because they paid Old Mutual upfront for the right to any excess returns.
Total costs are 2.04pc-2.15pc.
• Current expected yield: 4pc/6pc
• Who is it suitable for? Those who want income stability and a high degree of diversification from a single fund
• Pros: Greater certainty of income than from most funds
• Cons: Income certainty comes at the cost of potential capital gains; relatively high total charge from two-tier structure
• High or low maintenance: Very low
Your own panel of experts
'Multi-manager’ funds that see your money split among a group of professional investors
There are plenty of other multi-manager income funds in addition to the Old Mutual range, although without the income stabiliser. Among them are the F&C MM Navigator Distribution fund, managed by the respected team of Robert Burdett and Gary Potter. The fund yields 4.8pc and the total annual cost, including both layers of charges, is 1.53pc.
Other options include Jupiter Merlin Income (yield 2.8pc, total annual cost 2.36pc), managed by another experienced investor, John Chatfeild-Roberts, and Premier Multi Asset Monthly Income (yield 4.9pc, total cost 1.53pc), managed by David Hambidge.

The multi-manager approach provides huge diversification of your sources of income: for example, the F&C fund contains a total of about 2,400 underlying assets within its constituent funds.
One disadvantage of multi-manager funds is that you have to pay both the overall manager and those of the underlying funds, so the total cost is often higher.
• Who is it suitable for? Those who want the simplicity of owning a single fund with the advantages of a team of expert managers and good diversification
• Pros: Low risk to income thanks to very wide range of sources
• Cons: Two layers of cost
• High or low maintenance: Very low
Simple diversified funds
A wide range of assets from a single low-cost fund
This is the other type of “multi-asset” fund, the kind that avoids the two-tier structure of a fund of funds and simply owns its assets directly.
Many such funds are managed by a team, with specialists for shares and bonds, for example. A well run multi-asset fund will be less volatile than a single-asset fund because different markets do not normally rise and fall at the same time.
Philippa Gee of Philippa Gee Wealth Management tipped the JP Morgan Multi-Asset Income fund, which yields 3.6pc and has a total cost of 0.83pc, and the Aviva Investors Distribution fund (yield 3.6pc, total cost 0.74pc).
A similar mix of assets is also available through investment trusts. These are funds structured as companies whose shares you can buy on the stock market.
Multi-asset investment trusts include Scottish American (yield 4pc, total cost 0.9pc), which has a “silver” rating from Morningstar, the fund analyst.
A complication with investment trusts that ordinary funds avoid is that the shares can trade at a “premium” to the value of the underlying assets.
This is currently common among income-producing trusts.
Building your portfolio by choosing your own funds requires slightly more monitoring as you are relying on the decisions made by a single manager or team rather than the diverse range of expertise that you get from a “multi-manager” fund.
• Who is it suitable for? Those who want income stability and a high degree of diversification from a single fund
• Pros: Simplicity and low cost, good diversification
• Cons: Reliance on a single manager or single team
• High or low maintenance: Low
Your own basket of funds
A spread of different income-producing funds that you select yourself
The three approaches we’ve looked at so far have all involved investors buying a single fund and leaving it to the manager of that fund to choose a well diversified spread of assets.
But you can also do the job yourself. The easiest way is to pick a basket of funds of different types – in effect, you are replicating what the manager of a fund of funds does.

For a diverse range of income sources you will want some shares, probably with an international spread, plus some bonds and perhaps a little property.
“Equity income” funds aim to pick shares that pay good and growing dividends. Well regarded funds include the following: for British shares, Woodford Equity Income (which aims to yield 4pc and costs 0.75pc), River & Mercantile UK Equity Income (3.3pc, 0.89pc) and Threadneedle UK Equity Income (3.9pc, 0.82pc); for the US you could use the SPDR S&P US Dividend Aristocrats exchange-traded fund (1.8pc, 0.35pc), which focuses on dividend growth; in Europe, Standard Life Investments European Equity Income (3.9pc, 0.9pc); for Asia the Newton Asian Income fund (4.7pc, 0.69pc); and for global exposure Aberdeen World Equity Income (3.9pc, 1.14pc).
Among bond funds, FundCalibre, the fund rating service, tips Jupiter Strategic Bond (6pc, 0.74pc) and Invesco Perpetual Monthly Income Plus (4.7pc, 0.67pc). For property it gives the thumbs up to Henderson UK Property (3.8pc, 0.85pc).
• Who is it suitable for? Investors happy to pick their own funds but not to research the stock market
• Pros: Good diversification, ease of changing portfolio
• Cons: Fund management charges, need to monitor fund performance
• High or low maintenance: Medium
Your own basket of shares and bonds
A diversified spread of high-yielding individual investments
Investors who are comfortable making their own decisions could go a step further from picking funds and choose their own shares and bonds. The advantage of this approach is that you avoid the cost of a fund manager.
As an income investor you’ll want shares that offer a decent dividend but, just as importantly, a reliable and ideally a rising dividend. Identifying high yielders is easy enough but checking that a dividend is sustainable or likely to rise is harder. For the first task, compare the dividend per share to the earning per share figure, or, even better, the cash flow per share figure (found in the accounts). Ideally earnings or cash flow should be at least double the dividend payment.
To pay a rising dividend, companies need to be increasing sales or raising profit margins by increasing prices or cutting costs. You’ll need to keep up with the business news and ideally read plenty of research, but your own observations and common sense are also great allies.
As a starting point Jeremy le Sueur of 4 Shires, the financial adviser, said BAE Systems, Chesnara and Sainsbury would all qualify as reliable income-paying shares. They yield 5.4pc, 5.4pc and 5.8pc respectively.
As for bonds, many are not available to ordinary investors, so look for those listed on the recently established “Orb” market. Be as careful choosing your bonds as your shares, looking at the strength of each company’s balance sheet and the sustainability of its profits.
Mr Le Sueur said retail bonds issued by Primary Health Care Properties, Workspace and Premier Oil were good prospects. The yields are 4.7pc, 4.8pc and 4.5pc respectively.
Kevin Doran of Brown Shipley, the wealth manager, said: "With attractive looking yields in a low interest rate environment, retail bonds most certainly have a role to play for income seeking investors, but it is important to realise that lending money to companies comes with its risks and, unlike more normal corporate bonds, retail bonds can be tricky to dispose of once the initial purchase has been made. For that reason, we would recommend performing a full credit check on the organisation and being in a position to hold the bond until maturity should the need arise."
• Who is it suitable for? Investment enthusiasts
• Pros: Low cost
• Cons: Relative lack of diversification, complete reliance on your own skill and judgment
• High or low maintenance: High
The stock-market-free zone
The other options for people who don’t trust shares
Shares, funds and bonds are not the only ways to generate an income. Here are some of the other options.
Peer to peer lending
If you put money in a bank savings account, the bank uses it to make loans to borrowers. With peer to peer lending, the bank is eliminated and you lend directly to individuals or businesses that want to borrow. P2P websites allow you to split your loans among a large number of borrowers, so you won’t lose all your money if one defaults. The largest P2P company, Zopa, pays 5.2pc interest. Zopa, which is nine years old and has lent a total of £610m, says no customer has ever lost money.
Buy to let
Some people are more comfortable with assets they can see and understand, especially residential property. Yields of 6pc are available on buy to let, although by no means everywhere. A lot of work is also involved, with many incidental costs. If you take out a mortgage, remember this effectively magnifies any capital gains or losses.
Pensioner bonds
A new savings product from next year. The bonds, to be sold by NS&I, are likely to pay better interest than current cash deposits – the Government has mentioned 4pc on a three-year bond and 2.8pc for a one-year term. The limited issue of £10bn is likely to sell out quickly. You need to be a pensioner to buy them.

Culled from the Telegraph