Popular income investments to put in your Isa
Pensions are not the only fruit when it comes to retirement saving. Isas also play an increasingly important role in helping us reach income goals when we give up work.
Although there is no tax relief applied to contributions to Isas (unlike with pensions), the big attraction is that savers not only see their pot grow in a tax- friendly way but they can draw an income from it totally tax free. These plans are also more flexible than pensions as they can be cashed in at any age.
Rebecca O’Keefe, head of investment at Interactive Investor, says that large numbers of savers are already maximising their chance of future tax free rewards as the end of the tax year looms on April 5. Many are piling their Isa allowances – up to £20,000 each year – into income-generating funds, investment trusts and shares.
They are doing this not only to draw an income now but to build a fund for the future.
Laith Khalaf, of broker Hargreaves Lansdown, says: ‘Had you invested £10,000 in the UK stock market 20 years ago, you would now have £13,666 and have received £6,930 in dividends along the way. But if you had reinvested them, thanks to compounding, it would have grown to £26,640 – £6,044 more.’
And shares that produce a healthy stream of income, in the form of dividends paid to shareholders, are not hard to find. O’Keefe says: ‘A quarter of our 20 most popular funds and trusts have an income focus and the most widely held shares are FTSE?100 stocks, most of which could easily have been selected with income in mind.’
Helal Miah, investment expert at broker The Share Centre, says income-focused companies – that distribute part of their profits as dividends – are also liked by risk-averse investors because they tend to be mature and have weathered many downturns.
He says: ‘They have solid balance sheets and some, such as the utilities and pharmaceuticals, can ride out the economic swings.’
The key magnet for investors is the generous yields paid – on average 4.3 per cent – nearly three times the best returns available on cash deposits. Laith Khalaf says: ‘Yields were slightly higher earlier this year but before that you have to go back to 2009 to see them as high.’
Trusts and funds generating income – whether taken now or reinvested for the future – carry different risks, depending on the levels of return you are seeking. Laura Suter, of broker AJ Bell, says: ‘A good place to start is a cheap FTSE?100 tracker fund to earn 4 per cent – but there are plenty of other options.’
She likes City of London Investment Trust – dubbed a ‘dividend hero’ of the sector because its payouts (currently 4.5 per cent) have risen every year for the past 52 years.
Juliet Schooling Latter, of Fund Calibre, an investment research firm, says: ‘Those who want to see their income grow and keep pace with inflation could consider Invesco Global Equity Income which invests all around the world. The manager of the fund – paying a yield of 3.55 per cent – likes to generate a rising stream of income rather than investing in high-yielding companies.’
Those prepared to take more risk can generate an even higher income – with 5.9 per cent currently available from M&G Emerging Markets Bond. Bonds are a form of loan made to companies that pay interest to investors and can be traded on the stock market.
For savers who prefer to avoid the volatility of the stock market but are fed up with poor returns on cash, there is the option to invest in peer-to-peer loans. These are purchased for Isas on specialist platforms such as RateSetter and Funding Circle and pay ‘lenders’ rates sometimes 5 per cent or more.
For those building a fund to produce income in the future, the key question is what size of pot do you need – and how long will it take? AJ Bell has crunched the numbers, based on a saver investing their full £20,000 annual Isa allowance each year (see the table above). Assuming 5 per cent for growth (after charges) the broker calculates it would take ten years to build a big enough fund – £250,000 – to generate £10,000 a year of income (assuming 4 per cent yield). An income of £20,000 requires a £500,000 pot, which would take 16 years to nurture.
Savers keen to reach their target sum sooner rather than later need to act quickly to invest this year’s allowance. Miss the deadline of April 5 and it is a case of ‘use it or lose it’ as the allowance cannot be carried over. If too busy, and uncertain about where to invest, Khalaf suggests ‘cash and dash’. He says: ‘Park your money in a stocks and shares Isa and invest it later when you have more time.’
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