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Worried about the State Pension? I’d ditch the cash ISA and then do this

The current State Pension pays out £164.35 per week. For many of us, that’s not going to be enough for a comfortable retirement. 

In such a situation, it’s only natural and right for people to look to bulk up their savings as much as possible while they’re still employed with the intention of using this cash to improve on their weekly income later down the line.

My only concern with this is that at least some are using the most ineffective vehicle for doing so, namely a cash ISA. 

Losing value

Their popularity is waning and rightly so when you consider just how poor a deal this kind of account is for savers. 

While inflation may have fallen to its lowest point in two years — mostly due to lower prices for petrol, gas and electricity — the 1.8% recorded in January is still higher than the best instant access cash ISA currently available (1.45%). That means that your money is actually losing value while it sits in the bank.

So let’s be clear: your chances of supplementing the State Pension by a decent amount are pretty rubbish if you stay in cash beyond having a buffer to deal with life’s little emergencies (which should be somewhere between three to six months of expenses). Thanks to the Personal Savings Allowance, which allows people on the basic rate income tax band to save up to £1,000 per year tax-free (£500 for those in the higher rate band), a bog-standard bank account is all one really needs.

So, where should you put the remainder of your cash? I can think of only one destination: the stock market.

Dividend delight

Now, this isn’t to say that you suddenly need to move your money into speculative junior mining companies, oil and gas or biotech stocks. Indeed, unless you have both a high tolerance for volatility and many years in front of you, this is among the worst things you can do.

Here at the Fool, we think a more patient approach — in which wealth is accumulated over years by investing in solid, profitable businesses — is best for most people. And when it comes to eventually supplementing the State Pension, buying dividend-paying stocks — where businesses pay you a proportion of their profits on a (hopefully) regular basis — is a good strategy. What you receive can be reinvested into buying more shares (pre-retirement) or spent alongside the basic pension. 

One option is to invest directly in specific companies. Right now, 28 of the UK’s 100 largest businesses are offering yields above 5%. 

Another option is to buy an income fund, run by a professional money manager. The only problem here is that they tend to charge relatively high fees for their services and any outperformance could be cancelled out by what you pay.

For me, one of the best options for dividend hunters is to invest in low-cost index tracking or exchange-traded funds. I’ve written about these in more detail here

Regardless of your approach, remember there’s no requirement to sell once you’ve hit your desired age for retirement. So long as you can still bear the ups and downs of the stock market (a sober evaluation of your financial situation is essential at this point), you can continue to collect these bi-annual or quarterly payouts long after you’ve ditched the daily commute.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.