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One of the best ‘income’ investments you can make
Yield hunters shouldn't forget the state pension, writes Citywire's Income Investor columnist.
There are many ways to be an ‘income investor’, in the sense that many investments yield an income stream.
This does not have to be restricted to savings accounts and stock market securities (which I focus on). For example, property acquired on a buy-to-let basis will (usually) yield an income stream, although this strikes me as hard work, in terms of the admin and uncertainty involved. (My litmus test for ‘effort’ is: can I do it on my laptop, lying in bed in the morning?)
Because my entitlement to state pension grew without much fanfare in my early working life – and required virtually no decisions – it receded into the background noise of my finances. Much more front and center were decisions about my company pension, including Additional Voluntary Contributions – primarily as a way of avoiding higher-rate tax. So, over my working life (which has recently come to a possibly premature end) I haven’t thought much about my state pension.
For simplicity, let’s consider just the basic state pension for a single person (and ignore other state pensions and related benefits): this is worth up to £107.45 a week or £5,587.40 a year. Not a huge amount (compared to the average salary), although it is expected to increase respectably over the next couple of years. But the point about the Birmingham University study is that they included the entitlement to state pension as part of ‘wealth’. This makes sense, of course, as pension entitlement is – in income terms – no different to any other financial asset. Indeed, the study defines wealth as: ‘a stock of economic resources compared with income which is a flow of resources’.
So how to value this (potential) income stream? I couldn’t find an explanation of how this was done for the Birmingham University study but it is possible to do this fairly crudely, using a benchmark yield - for example those used in calculating annuities. It turns out that these vary, so taking what seems to me to be a reasonable range of investment yields - 4% to 5% - gives an equivalent capital value of £110-140k.
Now, it seems to me that this is a non-insignificant amount of capital and I am glad to be able to add that to my notional wealth.
There is an interesting footnote to add. Payment of the full state pension is contingent on having 30 years’ accumulated contributions. If for any reason you are likely to be short of this minimum, it might well be worth your while to consider making up the difference by voluntary contributions. I myself have made up some missing years, as a result of being out of the country for a while. Another area where this might be relevant is a result of changes in the rules for ‘stay at home’ mothers, which means that those with older children no longer receive an annual state pension credit. As a result they may be invited to pay a one-off annual contribution to help complete their 30-year total contribution record.
Compare the stream of increased pension payments against the cost of the contribution (and making assumptions about - not to put too fine a point about it - survival) and this may be one of the best ‘income’ investments you can make.
If you've enjoyed this article, why not visit DIY Income Investor's blog. The views in this article are the author's own, and do not constitute advice.
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