Investment trusts could help you capitalise on Budget pension freedoms

A view from David Prosser, former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine.

How will you capitalise on the private pension freedoms announced in the Budget earlier this year by the Chancellor? Many people are delighted the rules that currently require most savers with private pension funds to buy an annuity when they reach retirement age are soon to be dropped – instead people will have direct access to their savings and be able to use the money as they fit. But most of us will need to use those savings to generate a retirement income – if we’re not getting it from an annuity, we’ll have to look elsewhere.

Investment trusts could be the answer. Closed-ended funds are already very popular with income-seeking investors and they may become even more so as people look for investments that can provide them with reliable and growing payments in retirement.

Structural advantage

Investment trusts have certain advantages that leave them particularly well-placed to help investors confront the retirement income challenge. First, unlike other types of fund, they’re entitled to keep back up to 15 per cent of the income they earn each year for their reserves. This gives them a buffer from which income payments to investors can be made in years when the fund’s earnings disappoint.

That’s likely to appeal particularly to retired investors who need, above all, consistency– if they’re living off the income generated by their savings, they can’t afford to go through a period when that income plunges. Indeed, as inflation erodes the value of money, they need their income to rise each year in order to maintain their standard of living.

The second advantage that investment trusts hold is they are allowed to pay income out of their capital. This reduces the fund’s scope for future capital growth, but it means that funds investing in assets that don’t generate a predictable income, or even an income at all, can still make distributions to their investors.

Again, that’s potentially valuable to investors in retirement. Investment trusts offer access to some interesting asset classes that don’t always pay regular incomes – private equity is an obvious example – but which retired investors might otherwise like to consider.

For these reasons, investment trust managers expect their funds to attract the attention of people seeking to take advantage of their new-found investment flexibility in old age.

“We do think the changes in the Budget are very significant [for investment trusts],” says Simon White, the head of investment trusts at fund management firm BlackRock. “We have seen in areas such as the US and Australia, where you have very developed defined contribution pension regimes, significant growth in closed-ended funds.”

The dividend stars

The record of many investment trusts of paying rising dividends over extended periods underlines their potential attractiveness to investors looking for a growing retirement income. There are no fewer than 16 investment trusts that have increased their dividends in each of the last 25 years – many have a record of doing so that goes back even further.

In fact, City of London Investment Trust, Alliance Trust, Bankers Investment Trust and Caledonia Trust have all raised their dividends in each of the past 46 years; several others aren’t far behind.

For retired savers who prefer to raise income directly from their pension funds rather than via an annuity, that level of long-term consistency could be invaluable – and certainly impossible to match using other types of collective investment.