The rise in the cost of living means that many are likely to need more income to maintain a comfortable standard of living in retirement. You could try to stretch your existing resources to provide more income (see Key ways to stretch your retirement income, IC 19 August 2022). However, if doing this still doesn’t provide enough retirement income and you don’t want to make cutbacks, you need to find new sources.

You could go back to work – at least part-time. As well as more income, you might get employer contributions to a pension, boosting your retirement pot for when you fully retire. If you are “an employee over state pension age you will generally not pay National Insurance, [keeping] more of your hard-earned income”, adds Bruce Davison, senior wealth planner at Atomos. “You might also be entitled to further employer-paid-for benefits.”

But going back to work has its costs, the most obvious being that you would have to give up the freedom and leisure that comes with being fully retired. Physical preparedness and the possibility that work would need to fit in with other responsibilities, such as caring for relatives, should also be taken into account.

Self-employment might be better, especially if it’s something that you did before you retired and are familiar with. You can dictate your own hours and working patterns and, depending on the nature of what you do, might be able to work from home. You would not be auto-enrolled into a pension but could make pension contributions at a level you choose – or not make them.

However, you would not have the certainty of income that paid employment provides, and with economic conditions deteriorating, attracting regular custom may prove harder and you might not get as much income as you desire.

Whatever choice you make, more income from employment could push you into a higher tax bracket when considered alongside your pension income. “Income tax needs to be considered, especially if you are close to any tax thresholds, as does the impact on any state benefits,” says Davison. So consider if it is financially worth you doing this extra work.

If you have already accessed a defined-contribution pension, in many cases you will have triggered the money purchase annual allowance (MPAA), which means you can only contribute £4,000 a year before your tax reliefs disappear. If you breach this limit, you will have to pay a charge, likely to be worth about the value of tax relief you would have received on contributions over £4,000.

But there are exemptions for those taking their 25 per cent tax-free sum, withdrawing money to buy a lifetime annuity that provides a guaranteed income for life that stays level or increases, or cashing in pension pots worth less than £10,000. Those contributing to defined-benefit pensions are also exempt from the MPAA.

Using property

As an alternative, you could downsize your home. By this stage in life you are likely to have paid off your mortgage so will receive most of the sale proceeds. If you have owned your home for a long time you are likely to have benefited from a long period of rising house prices, meaning that the difference between the price of your existing property and new home could be large – even with the recent moderation in price growth.

Living in a smaller home could also mean lower bills and maintenance costs, helping your income go further.

However, downsizing when house prices are falling, as may be the case this year, is in theory not a good idea. If, for example, your £400,000 home has shed 10 per cent of its value and you buy a home that was worth £250,000 but had also fallen 10 per cent, it would only achieve a saving of £25,000. But this doesn’t factor in gains made over the course of ownership of your existing property, which could be substantial if you have owned it for decades.

The costs of buying and selling include stamp duty, and estate agents’ and solicitors’ fees, which can eat into any profit you make from downsizing. If you are used to a home of a certain size, also consider how comfortably you could live in a smaller property.

You then need to decide what you do with the capital you realise. High inflation makes it particularly important to invest it appropriately. But you should also be prepared for its value to fall if equity markets prove volatile.

A second property could generate a regular monthly income. Although the rent from buy-to-let property contributes towards your income and could push you into a higher tax band, you can deduct certain expenses from your rental income, including maintenance, insurance and letting agents’ fees when working out your taxable profit. You also get 20 per cent tax relief on mortgage interest payments. And if you have a spouse or civil partner with lower or no income you could transfer the property and income to them, reducing the amount lost to tax – or hold it jointly and use both your allowances.

With house prices now falling, you might be able to purchase a suitable property for less than you would have paid for it a few months ago. However, when you purchase buy-to-let property, you pay an additional 3 per cent stamp duty compared with primary homes, and costs such as insurance, ongoing maintenance, mortgage repayments and utility bills will eat into your rental profit.

Tenants can default on rent, and legal action to remove a tenant who refuses to leave can be costly. If the tenant moves out and you cannot immediately find someone else, you might have void periods when no income is received.

It also takes time and effort to manage a buy-to-let property, which might not be possible or preferable as you get older, so you may have to pay an agent to manage it. And, unlike pensions, the property would fall into your estate for inheritance tax purposes.

If you sell a buy-to-let or second property, you are liable for capital gains tax (CGT) on the proceeds. The annual CGT allowance falls from £12,300 to £6,000 from 6 April, then further to £3,000 in April 2024. Selling can also involve costs such as estate agents’ and solicitors’ fees. It could take some time to sell and, especially in the current housing market, you might not get as much for it as you want.

Ian Cook, financial planner at Quilter, argues that you should hold buy-to-let property alongside a portfolio of more liquid investments such as funds and shares that could more easily be sold to provide money if necessary, and can be held within tax-efficient wrappers.

Future-proofing is also important: if you are receiving a rental income from the second property, consider what you would replace that income stream with – and if you could do better by, say, investing the money you realise from a sale.

Last resorts

For those aged over 55, equity release is an option – but it has a lot of downside risk. It involves buying a financial product that provides money as either a lump sum or a series of smaller amounts, secured against some of the value of your home. Typically, the older you are, the more you can release. You may also qualify for an enhanced lifetime mortgage if you have a serious health condition or an unhealthy habit, such as smoking. This can enable you to borrow more or to pay lower interest.

Equity release debt is settled when you die, go into care or sell the property.

However, rates of interest for equity release products are typically more expensive than for ordinary mortgages, with an average rate of 6.61 per cent in February 2023, according to Moneyfacts.co.uk – up from 4.22 per cent in February last year. This means that it is particularly expensive if you let the interest this roll up. 

You also have to pay arrangement fees for equity release products, which can be between £1,500 and £3,000. These include valuation, arrangement, solicitors’ and advice fees, as you cannot take out equity release without consulting an adviser.

If you release equity from your home, you might not have as much value in your property to meet costs later in your life, such as for care. If you take out an equity release product against the value of your home, when you die your children or other beneficiaries will not receive the property’s full value.

Because of high interest rates and the loss of choice over what you do with the property in future, Atticus Kid, wealth planner at JM Finn, argues that equity release should be the last resort when seeking extra income.

Another way to remain in your home but make money out of it is to let a room. You can earn up to £7,500 a year tax-free for letting accommodation in your home. If you earn more than this you must complete a tax return. Taking in a lodger can provide a regular income but having another person in your household could increase your utility bills, eroding some of that profit. And if the lodger moves out it might take some time to get another one, leaving void periods in your income. Sharing a home with a stranger is also, unsurprisingly, not a choice that many enter into lightly.

Changing your asset allocation

Changing the allocation of your investments could improve their return profile and represents a more straightforward choice than some of the options above. First, cash: it is generally recommended to hold at least six months’ worth of expenses in easily accessible cash – or around two years-worth if investment income forms part of your retirement income. This is so that you can avoid crystallising losses when markets fall. A cash reserve is also important for covering the costs of emergencies or big-ticket items.

With base rates having risen so quickly over the past 12 months, your cash holdings may not be earning the best rate of interest possible – so consider moving these assets to a higher-paying account. If you are part of a couple and one of you is in a lower tax band, that person could hold more of the cash so that they could benefit from more of the personal savings allowance of £1,000 for basic-rate taxpayers and £500 for higher-rate payers.

You should invest cash you have in excess of the reserve unless you need it to cover a known expense in, say, the next three years.

Equity income, bond and some alternative asset funds are good options. But it is important to maintain a balanced portfolio, even if investing for income is your principal requirement. In the equity market, you could do this by adding to both higher-yielding investments, and growth investments of which you could sell shares or units to create an income.

“Having only high-income investments can result in a stylistic bias and loss of balance,” says Rob Morgan, chief analyst at Charles Stanley. “In equities, you may end up being concentrated in certain sectors and miss out on the best long-term returns from markets. For instance, a strict yield discipline would have resulted in missing much of the significant outperformance of the US stock market, powered by the technology and ecommerce giants, over the past decade.

“You should be able to support income from the natural yield of your income investments. If growth investments disappoint, you could top them up with income, and if they do well you could rebalance into income-producing ones to grow your income stream and maintain a good stylistic balance.”

The exact asset allocation you need will depend on a number of factors including how much income you need, and age, life expectancy and time horizon. You can see suggestions on appropriate asset allocations in our regular articles in the pensions and financial planning sections of the magazine.

Alternately, Kid suggests using some or all of your pension assets to buy an annuity. If you have not yet drawn from them or are struggling to generate income, this would give you a guaranteed payout. If you have a medical condition you may qualify for an enhanced annuity, which offers higher income. And the older you are, the higher the annuity rates you tend to receive.

Annuity income has significantly improved over the past year, to the point where it may now be better than what you get from portions of your investment portfolio. However, while the income is guaranteed, it is likely to be lower than that which you could receive from your investments at times of good dividend growth. And you cannot pass on an annuity to beneficiaries after you die as with a personal or self-invested personal pension (Sipp).

One option is to use just some of your money to buy an annuity, and keep the rest invested to have both a safety net and the potential to capture better investment returns.