Tips and tricks on how to generate a sustainable monthly income

Since the pension freedoms were introduced in April 2015, it has become increasingly common for individuals to use their pension to pay themselves an income at retirement.  

For most, the aim will be to secure a reliable and regular income from their investments, with the intention of not inflicting too much harm on the capital.

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The good news is that for those who arrange their investments carefully, a monthly income can be achieved. There are several ways to go about this, as we explain below.

Doing the sums

First some groundwork needs to be done. The starting point is to calculate what your existing provision will provide right now, and then compare this against what you need. 

To calculate how much income you need to generate, factor in the state pension (if you are at an age where you can claim it), as well as any other assets that can be drawn on in retirement, such as ISAs and, for those who have them, defined benefit pensions.

Once you've done all the sums, you can work out the size of your income gap, which will determine the return you need to generate.

It could be the case that your pot size is too small to achieve the target you have in mind, or that it requires stomaching a higher amount of risk than you are comfortable with.

For example, to generate income of £20,000 a year, a pot size of £400,000 would require an investment return of 5%. For larger sums, the dividend yield target would be lower, 4.5% for £450,000 and 4% for £500,000.

Another thing to bear in mind is that the sooner you retire, the longer you will need your pension pot to stretch to last the course (assuming you choose income drawdown). There’s always the risk of draining your pension too soon if the investments underperform and if the withdrawals are overly aggressive. 

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Generate the natural income

There are various ways to arrange investments to pay an income at retirement, with the most obvious being to focus primarily on income-generating assets.

To reduce risk, which is particularly important in retirement, one approach is to draw only the income produced by the underlying investments held by professionally managed funds and investment trusts (the “natural yield”), rather than eating into capital growth.

This is because in a scenario where stock markets fall sharply and income withdrawals are maintained or increased during that period, it is difficult for a retirement fund’s capital value to recover afterwards.

That’s particularly the case if you’re drawing on capital to maintain the required level of income when the market falls (as opposed to taking only the “natural” yield), as reducing the number of fund units you own makes it much harder for the fund to regain value.

For those who continue to draw income from a pension pot at that stage, a vicious cycle is created, resulting in the number of units and value of investments reducing further. In the worst-case scenario, this potentially means the pension pot running out before you die.

The phenomenon is known as pound-cost ravaging, which is the inverse of pound-cost averaging.

Is 4% a safe withdrawal rate?

As a rule of thumb, withdrawing 4% a year is potentially considered a safe withdrawal rate. The theory is that by taking this percentage as an income, adjusted annually to account for inflation, retirement pots will potentially last 30 years or more. However, this rule by no means offers cast-iron certainty. There are many unknown future variables that can impact whether 4% withdrawals will prevent you draining your portfolio too soon.

Chief among the problems with this strategy is that, in the absence of a crystal ball, investment performance is impossible to accurately predict. If your portfolio gets off to a bad start, continuing to draw 4% could mean your pot drains quicker than planned.

That said, 4% a year isn’t an overly aggressive withdrawal rate. It can certainly be a good starting point, so long as you review where you are annually to make sure any withdrawals are sustainable.

Monthly income funds

The hassle-free route is to focus solely on funds paying a monthly income. Around a decade ago there were only around a couple of dozen funds paying monthly, but now there’s more than 150.

The downside is that there’s only a small number that solely invest in equities. Most monthly income funds invest in bonds or adopt a multi-asset approach. The latter invest in both shares and bonds. For those in retirement, a balanced approach such as this helps to both protect and grow capital.

Bear in mind that some of these monthly income funds invest solely in, or have big weightings to, high-yield bonds, which is the risker end of the fixed-income universe.

With monthly income funds, the amount of income generated is based on the dividends or coupons the underlying holdings have paid each month. Therefore, as with any fund, the income can vary, but to counteract this most funds smooth the dividend payments into 12 equal amounts, holding back some income in good months, which is then used to top up leaner periods. Any excess cash left over at the end of the year is then handed back to investors.

Two of interactive investor’s Super 60 investment ideas, Man Income, and Artemis Monthly Distribution, return income to investors monthly.

Man Income, which has a current yield (as at 17 February 2025) of 4.8%, invests in UK stocks that have above-average dividend yields.

Artemis Monthly Distribution, a multi-asset fund, invests around 60% in bonds and 40% in shares, and has a yield of 4%.

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Mix growth and income strategies

However, it is prudent to avoid betting the house on income strategies. Given that average life expectancies are in the mid-80s, a pension portfolio also needs exposure to growth-producing assets to strike an appropriate balance.  

Having exposure to growth strategies will also help give your portfolio greater diversification. It also offers the flexibility of less exposure to bonds, assuming you can tolerate the higher volatility associated with shares. 

Most income funds tend to aim to generate capital growth, as well as income. However, some put more focus on income generation. As ever, it is a case of looking under the bonnet to find out which approach is being taken.

City of London (LSE:CTY) investment trust, one of interactive investor’s Super 60 ideas, aims to provide long-term growth in income and capital by buying mainly FTSE 100 companies. It has a yield of 4.5%, and has raised its dividend for 58 consecutive years.

Going for growth?

However, there’s a potential downside if you opt for the convenience of taking a regular income from income-producing investments. This is because those who buy funds that focus more on capital growth could benefit from higher overall total returns.

However, adopting this approach means the required income would need to be funded by selling fund units rather than relying on the income generated from the underlying investments in the fund.

Terry Smith, the well-known stock picker and manager of Fundsmith Equity, recently made the case for taking this approach. In an interview with interactive investor’s On The Money podcast he said: “You should really look for companies that have very high returns and invest in them. Don’t worry about getting a dividend and just sell a bit occasionally.”

Smith said the problem is that this approach “unglues the mentality of most investors” who think that by selling some of their investment they are disinvesting from the stock market.

Don’t overthink how regularly income is paid

Avoid overthinking how frequently dividends are paid.

Selecting funds or trusts just because they pay income out in a particular month should not be the main reason you buy those investments.

Given that most funds and trusts pay quarterly or twice a year, you could manually spread the income produced into regular payments throughout the year. Not focusing solely on when dividends are paid or monthly income funds gives you a much bigger pool to fish in.

Dividend calendar trick

One strategy for a mix of growth and income is to consider exposure to “dividend hero” investment trusts that have long track records of growing their dividends year in, year out.

Most investment trusts, as well as funds, pay income quarterly these days, although some continue to pay twice a year. Therefore, to achieve a monthly income, you need to choose dividend hero trusts that pay dividends at different times during the year.

Ten investment trust dividend heroes boast more than 50 years of consecutive increases. They are: City of London, Bankers (LSE:BNKR), Alliance Witan (LSE:ALW), Caledonia Investments (LSE:CLDN), The Global Smaller Companies Trust (LSE:GSCT), F&C Investment Trust (LSE:FCIT), Brunner (LSE:BUT), JPMorgan Claverhouse (LSE:JCH), Murray Income Trust (LSE:MUT) and Scottish American (LSE:SAIN).

For some dividend heroes, the dividend yield is fairly low, which reflects the trusts’ broad emphasis on growing the capital and raising the payout, rather than offering a high level of income.

Investment companies’ ability to hold back up to 15% of the income they receive each year in a revenue reserve gives them an advantage over funds because they can deliver consistent income to investors. In contrast, funds have to distribute all the income generated by the underlying investments each year.

The investment trust structure came into its own during the global financial crisis and during the Covid-19 pandemic. Boards dipped into their reserves to top up income shortfalls from underlying investments so they could maintain their track records of raising dividends year in, year out.

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All-out income attack

For those who are happy to prioritise income and seek a high income of over 6%, there are fewer options, and they are more adventurous.

For equities, you could consider the small number of funds that artificially boost their dividend yields through a special technique that involves selling derivatives to other investors to boost the income. Under this strategy, the fund manager agrees to share any future capital gains with a third party. A fee is paid for the agreement, which creates immediate, up-front income. This can be distributed to unit-holders in the fund as a stream of income.

The downside is if the fund's holdings rise in value, as some of that gain goes to whoever bought the derivative. Therefore, such funds lag the pack in rising markets. 

But, seeing as the buyer has paid up front, the risk of not being able to deliver a chunk of extra income is limited.

Three UK equity income funds offering an income boost are Schroder Income Maximiser, Premier Miton Optimum Income and Fidelity Enhanced Income. The trio yield between 6% to 7%. 

For bonds, it is the riskier end of the market, high-yield corporate bonds and emerging market debt, that offers the highest income. Super 60 fund M&G Emerging Markets Bond is yielding 6.5%.

Elsewhere, some property and infrastructure funds and investment trusts offer yields above 6%. Both areas have been out of favour over the past couple of years amid interest rate rises.

As noted in a recent feature, James Carthew, head of investment company research at QuotedData, points out that investors could pick almost any investment trust in the renewable energy sector and receive a very high, growing dividend (although of course this is not guaranteed). 

It’s also an area that James Calder, chief investment officer at City Asset Management, is looking at. Calder says that the revenue streams from this sector is government-backed and long term, adding: “They have gone out of favour and the share prices have dropped, but they are still generating the same strong cash flows. That means the level of yield has got higher and higher.”

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How to reduce the risk of an income shortfall

Turbulent times for stock markets serve as a reminder of the challenge of paying yourself an income and attempting to keep capital intact.

As mentioned at the start of the article, taking only the “natural yield” is considered a prudent way to reduce risk during turbulent times.

Another tactic is for an income-producing retirement portfolio to have a separate cash pot, which can be used during lean periods. This cash pot ideally has a year or two years’ worth of spending ready in cash. This gives you the flexibility to postpone drawing income to give your investments a chance to recover.

This cash could be held in a money market fund, which invests in safe bonds that are due to mature soon, meaning that investors can get a modest income without taking much investment risk.

Fund industry trade body the Investment Association (IA) categorises money market funds into two buckets: short-term and standard-term funds.

Short-term funds are lower risk. Fund managers try to ensure the highest possible level of safety by keeping very short duration bonds and high-quality bonds in the portfolio.

Standard money market funds generally deliver slightly higher returns by owning bonds that have slightly longer maturity dates.

The highest-yielding short term money market funds on the ii platform (as at end of January) include Royal London Short-Term Money Market (4.8%); L&G Cash Trust (4.7%); Fidelity Cash (4.75%); BlackRock Cash (4.56%), and Vanguard Sterling Short-Term Money Market (4.61%).

The highest-yielding standard money market funds on the ii platform include Premier Miton UK Money Market (4.69%); Invesco Money (UK) No Trail (4.61%) and abrdn Sterling Money Market (4.82%).