The current State Pension is just £168.60 per week. That maybe enough to get by on for a few, but it doesn’t leave much room for luxuries.
If you’re lucky enough to have a second pension or retirement fund, you may be thinking about buying an annuity to provide an extra income to add to your State Pension. An annuity is a very low risk product that should provide a reliable income. But in today’s world of ultra-low interest rates, annuity returns are pretty low.
Annuity vs FTSE 100
The latest best-buy annuity rates provided by fund supermarket Hargreaves Lansdown show a 65 year-old non-smoker can get a level income annuity rate of 4.7%. If you want an income that’s linked to inflation, that annuity rate falls to just 2.74%.
At a time when the FTSE 100 has a dividend yield of almost 4.5%, those payout rates seem pretty poor to me. After all, when you buy an annuity, you lose your capital (cash) forever. If you put money into a FTSE 100 tracker fund instead, you can collect a similar income and keep hold of your cash.
I think a FTSE 100 tracker fund is a pretty reliable way to generate an income that should (mostly) rise with inflation. But, personally, I believe a better income is available if you’re willing to build a portfolio of individual dividend stocks.
2 income stocks I’d buy today
One stock I’d be happy to buy and hold for a retirement income is FTSE 100 insurer Phoenix Group Holdings (LSE: PHNX). This life insurance firm specialises in buying ‘closed books’ of insurance policies from other companies and running them to maturity.
It’s a specialist business but, when done well, it generates high levels of surplus cash flow each year. That’s certainly been the case at Phoenix in recent years. For example, last year the firm generated £664m of cash, of which about £330m was returned to shareholders as dividends.
The group’s operating metrics look fine to me and I believe the business should cope well in uncertain market conditions. This is really a pure income play, in my view, so the key valuation measure is the dividend yield, which currently stands at about 6.8%.
I see this as an attractive opportunity to lock in a generous income. I’d be buying Phoenix if I didn’t already own other insurance stocks.
Water and waste = cash
Good quality fresh water and waste management and recycling are essential parts of modern life. Investing in a company which has a good record of providing both services seems like a decent investment idea to me.
My top pick in this sector is Pennon Group (LSE: PNN), whose main operating businesses are South West Water and waste firm Viridor. Pennon’s dividend has not been cut since 2007 and has risen by an average of 6% each year since 2014. That means shareholders have enjoyed an income that’s risen ahead of inflation.
In an update today, Pennon boss Chris Loughlin said the group was on track to meet forecasts for the year. These suggest earnings will rise 2% to 58.9p per share this year, while the dividend will climb 7% to 44.1p. These numbers value the stock on 13.5 times earnings, with a 5.6% dividend yield. Given Pennon’s strong track record, I continue to rate the shares as a buy.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Hargreaves Lansdown and Pennon Group. 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.