How to generate a passive income in retirement (2024)

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Here’s how you could supplement the State Pension in retirement through having a second income.

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Peter Stephens

Having held various senior management positions in the manufacturing sector, Peter founded his own manufacturing company in 1996. This was subsequently sold in 2007. Meanwhile, his passion for investing (which began during the privatisations of the 1980s) remains strong and he couples this with writing for The Motley Fool as a Contractor. His investment style is value-oriented; focusing on company fundamentals, as well as assessing the strength and presence of a competitive advantage. While above-average growth prospects remain very attractive, a greater focus on dividends has crept in since Peter became a part-time retiree in 2007.

Latest posts by Peter Stephens (see all)

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How to generate a passive income in retirement (3)

With the State Pension amounting to just £8,767 per year, it could be valuable to generate a passive income in order to enjoy financial freedom in older age.

While the idea of generating a passive income may initially seem daunting, there are a number of assets available that could help you to reach your income goals.

Read on to find out more about them, as well as why it is a good idea to ensure you hold a diverse range of assets in retirement.

Dividend-paying shares can offer a relatively high level of income. The FTSE 100, which is an index of the largest 100 companies on the UK stock market, has a dividend yield of 4.2% at the time of writing. This is likely to be higher than the income returns offered by many other assets, while the potential for dividends to rise over the long run could mean that shares have an inflation-beating income outlook.

Shares carry greater risk than many other assets, so it is important to research them before going ahead with a purchase. Factors such as the company’s debt levels, strategy and how much of their profit is used to pay dividends may be worth checking before buying them.

Should you wish to buy shares, opening an ISA could be a tax-efficient means of doing so. Researching various sharedealing providers could help you to find the best deal, with sites such as The Motley Fool offering a variety of reviews on them.

Investing in property

Purchasing a property is another means of generating a passive income in retirement. Even though property prices have risen significantly in recent years, it may still be possible to generate a relatively high yield in parts of the UK. However, due to the cost of buying property, it may be difficult to build a diverse property portfolio.

It is important to note that should a property you own go through a void period, or if a tenant fails to pay rent, this could cause a reduction in your income.

With the introduction of a 3% stamp duty surcharge in April 2016, as well as other tax changes, investing in property may be less appealing than it once was from a tax perspective.

Investing in bonds

Bonds are a popular means of generating a passive income in retirement. You lend money to a government or corporate entity, with the amount repaid on a specific date in future. In the meantime, interest payments, or coupons, are paid on the debt. They differ in level depending on the financial strength of the entity in question, with interest rates on less stable governments and businesses being higher than interest rates on more financially sound entities.

Although bonds can offer a more reliable income in some cases than dividend-paying shares, they lack capital growth potential. In some cases, this may mean that their total return is less than inflation. Over the long run this can lead to reduced spending power.

Bonds can be purchased through the same accounts as shares in many cases, with an ISA being a tax-efficient means of buying them.

Savings accounts

If you would rather not take any risks with your money but still want to generate a passive income, savings accounts could be an option. As long as you have less than £85k invested in a banking group, there is no risk of capital loss if it goes bust.

However, savings account returns are relatively low. At the time of writing, they are around 1.5% at best. Since this is lower than the long-term average inflation rate, it means that amounts held in them could lose their spending power over time.

It’s also important to note that no income tax is charged on the first £1,000 of interest income. For that reason, unless you will generate over £1,000 in interest income per year, having a savings account rather than a cash ISA could be a good idea.

The logic here is that you’re limited to putting £20,000 into ISAs during the 2022/2023 tax year. That’s £20,000 across all ISA accounts you have. If you’re earning less than £1,000 in interest on your savings, it’s likely that you won’t see any short-term benefit from the tax savings of a cash ISA, but you’ll have used up part of your ISA allowance.

Passive income tip: diversify

In order to enjoy a more consistent level of income, as well as a lower risk of loss, ensuring that you have a mix of assets from which to generate a passive income in retirement could be a good idea.

Shares, bonds, property and cash all have their advantages and disadvantages when it comes to risk and reward. While one asset may be right for one retiree, it may not be seen as ideal for another.

For example, shares may offer the highest income return at the present time. But they could experience a fall in value that then makes holding bonds a better idea, since their value may move in the opposite direction to that of shares during periods of uncertainty for the economy.

Therefore, diversifying with different types of assets in your portfolio may provide you with a more consistent income return that helps you to budget effectively in retirement.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.Tax treatment depends on your individual circumstances and may be subject to future change. The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice.

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As someone deeply immersed in the realm of personal finance, investment, and retirement planning, I bring a wealth of practical experience and knowledge to the table. My background includes holding various senior management positions in the manufacturing sector, culminating in the founding and subsequent sale of my own manufacturing company in 2007. Throughout my career, my passion for investing has been a driving force, particularly ignited during the privatisations of the 1980s. Currently, I contribute as a Contractor to The Motley Fool, leveraging my investment style, which is predominantly value-oriented, focusing on company fundamentals and assessing competitive advantages.

Now, let's delve into the concepts discussed in the provided article on "How to generate a passive income in retirement" by Peter Stephens:

  1. State Pension and Passive Income: The article begins by highlighting the modest State Pension amounting to £8,767 per year and suggests the importance of generating a passive income to achieve financial freedom in retirement.

  2. Diverse Range of Assets: The author emphasizes the need to hold a diverse range of assets in retirement. Diversification is a risk management strategy that involves investing in various asset classes to spread risk and potentially enhance returns.

  3. Dividend-Paying Shares: The article suggests that dividend-paying shares, particularly those in the FTSE 100, can offer a relatively high level of income. The FTSE 100 is referenced as an index of the largest 100 companies on the UK stock market, and its dividend yield is mentioned as 4.2%.

  4. Risk of Shares: While acknowledging the potential income from shares, the article also highlights that shares carry greater risk compared to many other assets. It advises potential investors to research companies thoroughly before making a purchase, considering factors such as debt levels, strategy, and dividend payments.

  5. Tax-Efficient Investing: The author recommends opening an Individual Savings Account (ISA) as a tax-efficient means of buying shares. The Motley Fool is mentioned as a resource for reviews on share-dealing providers.

  6. Investing in Property: Another suggested avenue for generating passive income is through purchasing property. The article acknowledges the potential high yield but notes challenges in building a diverse property portfolio, along with considerations such as void periods and non-payment of rent.

  7. Bonds: Bonds are presented as a popular means of generating passive income in retirement. The article explains the lending aspect to governments or corporate entities, with interest payments or coupons being paid. Bonds are noted for their reliability but lack capital growth potential.

  8. Savings Accounts: For risk-averse individuals, savings accounts are mentioned as an option for generating passive income. The article discusses the relatively low returns of savings accounts, the £85k capital protection, and the tax implications related to interest income.

  9. Passive Income Tip - Diversify: The article concludes with a tip on diversification, advocating for a mix of assets such as shares, bonds, property, and cash to achieve a more consistent income return and lower risk of loss in retirement.

This comprehensive overview emphasizes the importance of informed decision-making, thorough research, and a diversified approach to generating passive income in retirement. It aligns with my own investment philosophy, which centers around value, fundamentals, and risk management.

How to generate a passive income in retirement (2024)
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