Drawing Income From Bonds and Cash

Why fixed interest still earns a place in later life

Once the salary stops, the question changes from "how much can I grow?" to "how much can I safely spend?" That is where cash and bonds come into their own. They will not set the world alight, but they offer something that equities cannot: a reasonably predictable stream of income and, in the case of cash, a very high degree of certainty about the capital itself.

For many people in their sixties, seventies and beyond, that predictability is worth paying for. A pension drawdown pot that lurches 15% in a bad year can make you reluctant to take a withdrawal at exactly the moment you need one. A ladder of fixed-interest holdings and cash can smooth that out, letting you draw an income without being forced to sell growth assets into a falling market.

Know what you actually hold

"Bonds and cash" covers a surprisingly wide range of things, and they behave quite differently when it matters.

• Cash — easy-access accounts, notice accounts, fixed-rate savings bonds and cash ISAs. Capital is stable, rates move with the market, and money is normally accessible within a few days.
• UK gilts — loans to the UK government. You receive a fixed coupon twice a year and your capital back at a set maturity date, provided you hold to redemption.
• Corporate bonds — loans to companies, typically paying more than gilts because there is a risk the issuer cannot pay. Credit quality matters enormously here.
• Bond funds and ETFs — convenient, but they have no maturity date. Their capital value rises and falls as interest rates move, so they are not a substitute for holding individual bonds to maturity.

A common mistake is treating a bond fund as if it were a savings account. In 2022, many investors discovered the difference painfully when bond prices fell sharply as rates rose.

Building a withdrawal plan that lasts

A simple, robust approach is the bucket or ladder method. Set aside one to two years of spending in cash, so market wobbles never force your hand. Then build a ladder of fixed-interest holdings maturing in successive years — perhaps gilts or high-quality corporate bonds maturing in two, three, four, five and six years' time. As each rung matures, you spend what you need and reinvest the rest at the prevailing rate.

Suppose you hold £300,000 and want £12,000 a year, rising with inflation. That is a 4% starting withdrawal rate. If your ladder yields around 4.5% to 5% while it is running, the maths broadly works — but only if inflation stays modest and you are disciplined about reinvesting.

Think in terms of total return rather than yield alone. A bond bought at a discount can deliver a return through capital gain as well as coupon, and gilts held to maturity outside a wrapper can produce a CGT-free gain. Chasing the highest headline yield usually means taking credit risk you may not want at this stage of life.

Tax wrappers matter as much as the yield

Where you hold a bond or cash balance can change your net income considerably.

• Cash ISAs shelter interest entirely. If you expect to exceed your personal savings allowance (£1,000 for basic-rate taxpayers, £500 for higher-rate, nothing for additional-rate), an ISA is usually the better home for cash-heavy holdings.
• Gilt capital gains are exempt from capital gains tax, which makes low-coupon gilts maturing at a discount attractive for higher-rate taxpayers holding outside a wrapper.
• Pension drawdown means withdrawals are taxed as income at your marginal rate, but 25% of the fund is normally available tax-free. Taking it gradually can keep you inside the basic-rate band.

A sensible split is often to hold the highest-yielding fixed interest inside ISAs and pensions, and to use non-wrapped accounts for gilts where the capital gain does the heavy lifting. If your affairs are at all complex, an hour with a regulated adviser can pay for itself many times over.

Inflation: the quiet drag on your spending power

Here is the uncomfortable truth about income from bonds and cash. The coupon is fixed in nominal terms. Inflation is not. At 3% inflation, £12,000 of income buys what £8,900 buys after ten years and roughly £5,900 after twenty. At 4%, it is worse still.

Cash suffers most, because savings rates rarely keep pace with inflation over long periods. Fixed-coupon bonds suffer too, unless you deliberately hold index-linked gilts, whose payments and redemption value rise with the Retail Prices Index. These usually offer a lower starting yield for exactly that reason, and they are worth considering for at least part of the ladder.

The practical implication is that a portfolio of nothing but cash and conventional bonds may fund a comfortable first decade and a much tighter second one. Most people need some exposure to assets with genuine growth potential — equities, or perhaps property funds — to keep pace over a 25- or 30-year retirement.

A workable routine for reviews

You do not need to watch markets daily. A calm annual review does most of the work.

• Check how much cash you hold. One to two years of spending is usually plenty; much more is a slow leak of purchasing power.
• Note which ladder rungs mature in the next eighteen months and what rates you can get when reinvesting.
• Confirm the credit quality of any corporate bonds you hold has not deteriorated.
• Compare your total income against your actual spending, and adjust the withdrawal rate rather than the plan.
• Review your tax position before the end of the tax year, not after it.

Cash and bonds will not make anyone rich in retirement. Used thoughtfully, though, they buy something just as valuable: the confidence to spend your money without watching the market every morning, and the freedom to leave your growth assets alone when they are having a bad year.