Pensions freedoms - why consider investment trusts?

We are nearly there now. It has been a year since the Chancellor dropped his Budget bombshell, unveiling pension reforms that give people much greater freedom about how they use their savings once they reach age 55. But with just weeks to go until April 6, when the reforms come into effect, people are still arguing about what their impact will be.

On the one hand, once you can make withdrawals from your pension savings much more easily, there will be less reason to lock into a poor value annuity – instead, you can move your money into income-generating assets within the pension fund, or move the money elsewhere with the same goal. On the other, the great thing about annuity income is it’s guaranteed for life – there is no danger of making a mess of retirement investment and running out of money.

Is there a middle ground to be found? If so, it lies in steering clear of annuities only if you are confident of your ability to find assets that can be relied upon to provide consistent income that keeps pace with inflation while also preserving your capital for the long term.

Investment companies’ moment to shine

Step forward the investment company, for it could play exactly that role for millions of savers in the years ahead.

Take the question of inflation-busting income. This week, the Association of Investment Companies published its regular report of funds with a strong track record of raising their dividends. It was able to find no fewer than 17 investment companies that have raised their pay-outs to investors in each and every year for at least the past 27 years. Topping the table are City of London Investment Trust, Bankers Investment Trust and Alliance Trust, on 48 years and counting.

In part, this is good management, but the investment company sector has an advantage. Uniquely, these funds are entitled to keep back some of the dividend income they earn from their underlying holdings each year in order to finance dividends to their own investors in disappointing years: it’s a smoothing effect that other funds can’t replicate.

As for capital preservation, no fund investing in tradable securities such as equities and bonds can guarantee its investors that there will be no down periods. But over the vast majority of longer-term periods, investment companies’ track record shows them outperforming other types of fund (and very often the underlying sector benchmark too).

Time to make the shift?

Does that mean investors over the age of 55 who are anxious to avoid an annuity should move their money into investment companies? Well, possibly, but not without doing some due diligence first. For example, if the only way you can access the investment company sector is by making withdrawals from your pension pot, be careful not to fall foul of the tax rules that require income tax payments on withdrawals of all but the first 25 per cent of saving – and be particularly careful about withdrawals that tip you over into a higher tax rate.

Equally, think hard about whether you’re really ready to turn your back on an annuity – rates may be low, but these products offer a guarantee of income for life – you won’t find that guarantee anywhere else.

Still, if you’re sure that annuity purchase is not the right route for you – at least not straight away - it will be important to think about how your savings are invested over the course of your retirement years. And on the issue of income and capital growth, investment companies can be very worthy contenders in the battle for your money.