How I’ll pay myself a ‘salary’ from my SIPP at retirement

In the fifth chapter of our retirement series, in which financial journalists offer a personal perspective on their own pension portfolios,Faith Glasgow explains her approach to paying herself an income from her SIPP investments. 

Full retirement is some way down the line for me. With travel, entertainment and fun in general largely off limits in these drab homebody Covid-19 times, I am earning more than enough to live on as a freelance journalist; and given there’s not much else to do with my time, I would rather carry on working for the foreseeable future. 

This has two clear advantages, beyond keeping me out of the biscuit tin and off the streets. It means my full pension can remain invested and hopefully growing, and it also means my ability to make further SIPP contributions from any spare cash is not limited to just £4,000 a year, as it would be if I were to access any more than the tax-free element of the pension. 

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However, retirement at some level remains firmly on the agenda. It is likely to be a phased affair, if there is still work available, meaning that for a while at least I’ll be living off a combination of pension and earned income; and I also have a stocks and shares ISA from which I could generate additional income (with the advantage that it will be tax-free). So, I have a number of potential sources and will need to juggle these carefully. 

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It is more than likely that when I start to take an investment income, I will need to make some changes to the portfolios. At present, my investments in both SIPP and ISA are mainly focused on growth rather than income, although a number of the funds and investment trusts do nonetheless pay some regular income. Examples in the SIPP include TR Property (LSE:TRY) investment trust, Caledonia Investments (LSE:CLDN), Henderson Smaller Companies (LSE:HSL) investment trust and Mercantile (LSE:MRC) investment trust. 

Should I switch from growth investments to income investments? 

So one question to think about is whether to sell some or all of my current holdings and reallocate the cash to income-paying alternatives, possibly also increasing exposure to fixed interest, which is pretty minimal at the moment. 

First, then, should I switch out of growth-focused equity holdings and into equity income? There has certainly been little incentive to do so in recent times, particularly as Covid-19 has disrupted the UK economy to the extent that around 445 listed companies – including around half the FTSE 100 – have had to suspend, cut or cancel dividends this year. 

Well, although equity income funds have suffered in recent years, and through the pandemic especially, there are more resilient options, such as multi-cap income funds, which have a greater exposure to dividend growth rather than the traditional income sectors. 

LF Miton UK Multi-Cap Income and Octopus UK Multi Cap Income are examples of funds that delivered positive returns over the past six months and year to 22 October, beating the FTSE All-Share index and the UK equity income sector. However, I reckon the question of UK equity income will need to be revisited nearer the time, given the potential negative economic impact of the country’s departure from the European Union at the end of the year.

I’m definitely going to look at equity income funds focused on other parts of the world, especially Japan and Asia. Japan should prove quite interesting: the country has been relatively unscathed by Covid-19, companies were well-capitalised and, importantly, dividends have been a growing trend as companies have become more shareholder friendly in recent years. 

Asia, too, has recovered well from the coronavirus. Dividend growth has been a strong driver in that market as companies have increasingly recognised the benefits of keeping shareholders sweet through regular payouts - and a range of leading fund managers, including Fidelity, Guinness, Jupiter and Schroder, are successfully capitalising on that. 

Bond funds are a natural choice for income-seekers  

What about fixed interest holdings? A look at my SIPP through the instant x-ray tool on my interactive investor account reveals that 85% of the SIPP portfolio is in equities, and only about 2% is in bonds. In terms of diversification, bonds still play a role in a well-balanced portfolio, and they are a natural choice for income-seekers. However, flexibility makes a lot of sense to me, so a strategic bond fund, able to invest across a range of different bond types and risk profiles, would provide such flexibility.

I’m quite interested in Royal London Sterling Extra Yield and Royal London Global Bond Opportunities, and possibly also an emerging markets bond fund for a more global perspective. 

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There are also other income-generating diversifiers I could consider. Renewable energy and infrastructure investment trusts are two options, but both sectors are presently trading on premiums, meaning investors are paying more than the underlying investments in the trust are worth. Property is another diversifier; perhaps by the time I come to make changes there will be greater clarity as to the role of commercial property in our post-pandemic lives, but at the moment I am not minded to rush into it. 

Total return approach more prudent 

Looking ahead, my inclination at present is to tinker with the portfolios so as to reduce to some extent my high exposure to equity markets – certainly once I am no longer earning and am wholly reliant on my investments for a retirement income. 

But I prefer the idea of a ‘total return’ approach to income provision, drawing some natural income but retaining a goodly chunk of my pension in growth-focused holdings from which I can also take an element of capital.  

Against that approach, drawing too heavily on capital can impact on the long-term value of a portfolio, especially once you’ve retired and stopped paying into your pension. In the event of another serious market decline when both capital and income fall heavily, capital withdrawals from a pension are particularly dangerous: you’re actually cashing in investment units when you take money out, so there are fewer left to recover their value subsequently. 

If that scenario does arise, and it is more than likely to do so over coming decades, I am planning to keep a decent chunk of cash readily available - enough to live on for at least a year. I will then be able to draw on that, plus any natural income generated from my pension, and leave the capital alone. 

Of course, my cash pot will need to be topped up again when times pick up, using income or capital from the portfolio, and maybe also in due course some state pension. 

So that’s how I’m thinking at the moment as far as funding my retirement is concerned. But this is an area where I suspect I’d be well served by seeking holistic professional advice as to how to structure my pension and other assets (such as they are) to reduce risk and generate a tax-efficient income, and I may well do so nearer the time.