Switching an investment portfolio from accumulation to income funds is something investors might consider as they approach retirement.

In this article we explain the difference between the two and the costs and tax liabilities (if any) of switching between the two as investors think about ‘drawing down’ their pension income.

WHAT IS THE DIFFERENCE?

When you are looking at funds on an investment platform, or wherever you go to manage your investments, you might see the abbreviation ‘acc’ or ‘inc’ at the end of a fund name.

The letters ‘acc’ stand for accumulation, while ‘inc’ stands for income. They refer to the two different options for how income is paid to investors.

An accumulation unit automatically reinvests the income into the fund rather than paying it out to you. This is useful if you don’t need a regular income and you want to let your investment continue growing and compounding. It also saves you having to set up an instruction on your account to reinvest the income as it is done for you.

On the other hand, an income unit pays the dividend as cash into your investment account or your bank account. Some funds pay annual or semi-annual dividends, while some pay quarterly or even monthly, which can be helpful in paying bills if you don’t want to eat into your capital.

Some funds include ‘acc’ or ‘inc’ as part of their fund title, so it is easy for investors to know which type of units they are buying.

For example, Janus Henderson Global Tech Leaders Acc (0771607) means you are buying the accumulation units, while Polar Capital Global Tech Inc (B42W4J8) means you are buying the income version of the fund.

WHICH SHOULD YOU CHOOSE?

Ryan Hughes, interim managing director at AJ Bell Investments says: ‘Investors should think about the actual level of income they need and construct their portfolio accordingly i.e., don’t generate a high yield if it isn’t required.

‘Fixed-interest yields are appealing right now so it is possible to generate a good level of income from fixed income, allowing the equity element of a portfolio to be invested for growth.

‘While some may see the absolute level of income as important, actually building in a growing income can be far more powerful given the impact of inflation over time.’

Hughes adds investors don’t necessarily have to switch to an income-producing strategy and income can be taken as either yield or as capital.

THE EFFECT OF COMPOUNDING

Compounding is the process where an investor earns income on top of income. It is the result of reinvesting dividends to generate additional earnings over time – it is a way of earning returns on both your original investment and returns you received previously.

Retirees often use income units to increase their pension payments, but if you don’t need the cash now accumulation units offer the benefits of compounding.

Whatever you decide, it is important to find out whether you are liable for any transaction charges if you switch from an accumulation fund to an income fund. This  will depend on the rules set by the investment platform you use.

If you are switching from the accumulation version of a fund to its income version or vice versa – for example from abrdn Global Equity acc (3168273) to abrdn Global Equity inc (B83WC46) – some platforms like AJ Bell allow you to do this for free if it is the exact same fund.

AJ Bell is unable to switch between different funds, however, even if they are run by the same provider.

In the case of an AJ Bell customer, if they would like to action a switch then all they would need to do is send a secure message from their account outlining which fund they would like to action a switch on, then confirm whether they would like to switch to accumulation or income.

The AJ Bell team will then investigate whether this switch is possible and confirm to the customer when this has been completed or whether there are any issues.

This process can take two to three weeks (end-to-end) for daily dealing funds.

If an investor holds a fund in an ISA or pension no income will be taxed, however if an investor holds a fund outside a tax-protected wrapper it may be subject to tax if the gain exceeds the annual capital gains tax allowance for the year.

HOW TO STRIKE A BALANCE

Chartered financial planner Lena Patel tells Shares: ‘Many clients do transition their investment portfolios from accumulation to income-focused strategies as they approach retirement. This shift often involves reallocating assets from growth-oriented investments to those that provide a steady stream of income.

‘There are several ways investors can generate income in retirement, such as dividend-paying stocks, and fixed income investments are also becoming popular for some clients’ annuities.

‘In my view it depends on the individual’s financial goals, risk tolerance and overall financial situation. Transitioning to income-focused investments can provide stability and regular cash flow during retirement, which is crucial for covering living expenses.

‘However, it is essential to strike a balance between generating income and preserving capital, especially considering the potential impact of inflation and longevity risk.

‘Investors should also diversify their income sources to mitigate risk and ensure their portfolio can withstand market fluctuations. Additionally, seeking professional financial advice can help individuals tailor their investment strategy to their specific needs and objectives as they approach retirement.’

Disclaimer: Financial services company AJ Bell referenced in the article owns Shares magazine. The author of the article (Martin Gamble) and the editor (Ian Conway) own shares in AJ Bell.

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