Investing for income: Rays of light in the gloom of low investment income

Introducing Income: Ten years ago, a pounds 100,000 pension pot would pay pounds 10,000 a year. Now, that's pounds 5,

INVESTORS RELYING on their savings for income are facing a testing time. Low interest rates may be good news for homeowners with large mortgages, but they are undeniably bad for income seekers. Despite recent small increases, interest rates are at their lowest since wearing flares and a Kaftan was considered cool. And payouts from bonds and stock market investments are also down.

Nick Fletcher, director of MGP Direct, says: "A few years ago you would be getting a 10 per cent return on a six-figure lump sum. Now you are looking at just 5 or 6 per cent."

Rates on annuities, the income for life you buy with the money in your pension fund, have also fallen. A double whammy of low interest rates and rising life expectancy means a smaller payout has to stretch that much further.

A decade ago, a 65-year-old man with a pounds 100,000 pension pot would be looking for an annual income of around pounds 10,000. Now he will be looking at little more than pounds 5,000.

Philippa Gee, an independent financial adviser in Shrewsbury, says: "The people hit hardest are those either coming up to retirement or who have recently retired. There are also the people switching from high-pressure, high-reward jobs to part-time or less stressful ones who need investment income to supplement the drop in their earnings."

But all is not doom and gloom. When bank base rates stood at 14 per cent in October 1990, the 11 per cent inflation took a huge chunk out of investment income. Last month, the underlying rate of inflation stood at just 2.2 per cent, which means it is no longer the great enemy for income seekers. Annual income of 8 or 9 per cent annually is available, but Ms Gee says that may be a gamble many may not wish to take. "You have to take a realistic view. If cash is paying just 6 per cent then something promising a much higher return must involve a risk somewhere."

Higher-return investments include high-income bonds, which are stock market investments that pay a guaranteed income for a set period then return your original capital, provided the stock market hasn't fallen over the term.

Some corporate bond funds also offer higher income. Corporate bonds are IOUs issued by companies to fund their expansion. Most funds that invest in these bonds pay around 6 per cent a year, and some pay up to 9 per cent.

The return can be notably higher than that from a bank or building society with only marginally more risk.

Figures from the Association of Unit Trusts and Investment Funds show pounds 1,000 invested in an average corporate bond fund 10 years ago would have increased to pounds 2,211. If you had put that money in an average building society deposit account the increase would be pounds 1,579.

Stocks and shares are the highest-risk investment but if you can stick with them over the longer term you should see the greatest returns. That pounds 1,000 invested in the UK equity income sector would have risen to pounds 2,914 over that 10 years.

Ms Gee says: "Before choosing an investment you must ask yourself what sort of guarantee you want. How long do you intend to invest? How much access do you want to your capital? Do you want monthly, quarterly or annual payments? Do you want your capital back at the end?"

If you have no dependants it will be less important to protect your capital, but remember that if you have no family to support you it is even more important to keep some money aside to meet any long-term care costs.

Another factor that will determine your approach is whether you need to take the highest possible income immediately, or can hold out for the promise of higher returns later, says Paul Penny, director of Financial Discounts Direct.

"It is better if you can afford to take the longer-term view and choose an investment that pays income of only around 3 per cent, but offers the prospect of capital growth. As your capital increases you will receive a rising income. Sadly, most people prefer to take the higher income immediately."

Before you do take out an income-bearing investment, you should first clear personal loans or credit card debts, which will charge a higher level of interest than can be earned from investing. Your mortgage is a relatively low-cost way of borrowing money and it is less essential to pay off, particularly if you will incur redemption penalties.

You should also try to reduce tax on your investment income. If you are being pushed you into a higher-rate band you should consider using tax-efficient investments such as an individual savings account (ISA).

People who have spent their lives putting money aside for retirement are understandably frustrated to see their lifestyle under threat from falling interest rates.

But plan your portfolio properly and those investments can still provide a decent income.