For those approaching or entering retirement, the idea of being able to live off the income generated by their investments and not having to touch the underlying capital is hugely appealing.

For the lucky few who have a ‘pot’ worth millions that dream may well be a reality, but for most of us it is something we are going to have to work on well before we get to the stage where we can finally stop labouring.

In this article we will look at how to best construct a portfolio ahead of time to give you a comfortable income in retirement.

HOW MUCH DO YOU NEED?

According to research by financial trade body the PLSA (Pensions and Lifetime Savings Association), half of us are fully-focused on our current needs and wants at the expense of providing for the future and less than a quarter of us are confident we know how much we need to save.

Therefore, with the aim of improving pensions adequacy, the organisation has developed a guideline called the Retirement Living Standards to help everyone picture what kind of lifestyle they could have in retirement.

The standards take into account the cost of a common range of goods and services and work out how much you would need to achieve one of three living standards: minimum, moderate and comfortable.

The minimum amount is considered to be £14,400 for a single person and £22,400 for a couple, which given the full UK state pension for the current financial year is £11,500 per person means most people should be able to attain this standard of living even with a small private pension or savings pot.

To afford a ‘moderate’ retirement, however, the estimate is £31,300 for a single person and £43,100 for a couple, which is quite a difference in terms of the amount you would need to have put by in private pensions, savings and investments in order to generate the extra income you would need over and above the state pension.

For a ‘comfortable’ retirement, the estimate rises to £43,100 per year for a single person and £59,000 for a couple, which for most people would be a major stretch especially as these figures are calculated net of income tax, which is deducted from everything you earn over the individual personal allowance of £12,570 per year.

TARGETING A ‘MODERATE’ LIFESTYLE

The PLSA bases its assumptions on a set level of spending for each standard excluding costs such as a mortgage, rent and basic energy and utility bills.

For a ‘moderate’ lifestyle it suggests £55 per week on groceries, £30 per week on food-on-the-go, £10 per week on takeaways and £100 per month to take others out for a meal; up to £1,500 per year on clothing and footwear; the usual running costs of a nearly-new car; plus a fortnight’s holiday abroad and a weekend ‘staycation’ in the UK.

Despite the slowdown in food-price inflation, it is quite possible most of spend more than £55 per week on groceries, although on the other hand most of us probably don’t spend £1,500 a year on new clothing and footwear, so there is an element of swings and roundabouts in the figures.

However, if we take the two amounts of £31,300 and £43,100 at face value, how much would we need to have put aside in order to generate enough income to enjoy a ‘moderate’ lifestyle in retirement either as a single person or as a couple?

THE BEST ADVICE: START SAVING EARLY

In order to illustrate the level of private pensions or investments needed to generate enough income without dipping into your capital we have built a table using several different rates of return and two time periods over which you might look to invest.

An individual aiming to enjoy a ‘moderate’ lifestyle in retirement would need to find an extra £19,800 in income per year over and above their full state pension – and bear in mind, to keep things simple we have not factored tax into our calculations.

To fund this additional £19,800 every year, without eating into your capital, you would need a pot of almost £400,000, assuming it paid out a 5% return.

Obviously, the higher the return the lower the size of the pot you would need but even with an 8% return you would still need to have investments worth roughly a quarter of a million pounds.

The next question is, how long would it take to build up such a large pot in the first place?

Again, using a base case of a 5% return, to build up an investment pot worth £250,000 would take 30 years of paying in £300 every month, which may sound like a tall order but is not a bad outcome given a total outlay of £108,000 and clearly demonstrates the power of compounding over many years.

If you started later and only had 20 years to build up your pot, all else being equal you would need to put in over £500 per month to even come close to hitting the £250,000 mark which again shows the advantage of giving yourself a head start by investing early and putting away as much as you can reasonably afford.

For a couple targeting a ‘moderate’ lifestyle the calculations are barely any different – to reach the target income of £43,100 after subtracting two lots of state pension the shortfall would be £20,100, or just £300 more than for an individual, so the sums involved are roughly the same.

WHERE TO INVEST?

The products in the table are just examples to help with your own research but if you were aiming to use your investments to help pay regular bills, it makes sense to consider funds and investment trusts which pay out income regularly. Unlike companies, because these portfolios contain a diversified mix of income streams, you’re less at the mercy of an individual dividend being cancelled or cut.

There are several open-ended funds and closed-end investment trusts paying monthly dividends, so we have compiled a list of some of the highest-yielders, making sure they have assets of more than £100 million to avoid any issues with liquidity. Most of these invest in bonds.

There are also plenty of open-ended funds and trusts paying quarterly dividends, although they vary more in terms of the underlying assets which they own.

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