Bridging Fund to DB Pensions – Invest or not?

Ian [STRIKE]Triumph[/STRIKE] (edit reason: idiocy) you are in good shape. $25k should be no problem and you could take out a bit more if you stay aware of your returns and balances and have the flexibility to reduce your spending if the markets fall. As you have significant guaranteed income in pensions I thought of you when I saw this recent article. It is interesting.

https://www.onefpa.org/journal/Pages/APR17-The-Impact-of-Guaranteed-Income-and-Dynamic-Withdrawals-on-Safe-Initial-Withdrawal-Rates.aspx

Ian66 wrote: »

So the challenge is how to effectively “front fund” the profile in a different way to provide an additional @£10k pa over the initial 8.5 year period to Oct 2026. Some initial thoughts on options I have had are:-

• Downsizing is planned 6 to 12 months after April 2018 which we expect to release @ £50k. This could cover @ 4.5 years of the initial period and fund additional NIC’s.
• OH could exchange part of her DB for an enhanced TFLS at Dec 2022. Scheme provision is TFLS increased by 12 times the value of Pension exchanged, so an additional £40k would require a Pension sacrifice of @£3.4k pa
• Kidsmugsy proposed a mortgage to provide additional funds earlier in the thread. My thinking here is to borrow @ £40k on an interest only basis to cover the 4 year period to Oct 2026 and facilitate full repayment of this utilising part of my £50k TFLS and/or enhanced TFLS via Pension Sacrifice as (2) above . What would be tricky here I expect would be securing this borrowing when neither of us are in work?

As others have said, your best plan is probably to secure a mortgage whilst still in work so that you can use that to get you over the tricky period if necessary. Rather than pay my own mortgage off I got an offset mortgage and keep enough in the associated current and savings accounts to have a roughly nil balance and pay no interest, but I get to keep the line of credit as an emergency fund. You may wish to look at something similar.
Downsizing may solve the problem for you, but beware - many people seem to find that after all the costs are taken into account it realises a lot less cash than they hoped.
OH taking her pension early wouldn't help as the crunch doesn't come until after the date already planned.
If you want to live off £35k pa then by the day before your pension kicks in you will have burnt through roughly £110k - including most of OHs voluntary NICs, but leaving most of yours for later. That number is exactly what you have in cash and ISAs so you can, theoretically, fund it from what you have if your cash / investments just keep pace with inflation. It leaves you with no breathing room at all though - which is why a mortgage facility you can draw down in in the last 18 months before your DB kicks in and then pay off from your DB lump sum would give you the cushion you need.

You wrote that your work DC pensions are currently being maximised for employer contributions but that's a bit ambiguous. Does this mean that you are only paying in what will get employer contributions, that you are both paying in 100% of gross pay or something else?

You almost certainly should be looking to pay in 100% of gross pay as your gross pension contribution value. This makes 25% of your pay tax free because you can take it out of a pension later as a tax free lump sum, from age 55. Fast and easy gain there, with no investment risk and you seem to have the savings to fund doing it.

Once it comes to time to take money out of pensions a question is whether to stick to just the amount within your personal allowance or not. I'm inclined to go with not in your situation because I think that getting it out and into P2P will better meet your needs for fixed interest investment part than leaving it there. So I'd be inclined to draw from the DC up to your basic rate band for a couple of years, £33,500 a year above your personal allowance.

To avoid paying the £6,700 income tax on that I'd spend £22,000 on buying say the Albion VCT. HMRC will refund 30% of the purchase price capped at income tax payable in the tax year of purchase, so £6,600 back from them. Just £100 of unrecovered income tax so just draw £500 less taxable from the pensions. This VCT expects to pay tax exempt dividends of about 7%, equivalent to about 10% on the net after tax relief amount invested. That's £1,540 a year of ongoing tax exempt income per £22,000 buy. A VCT must be held for at least five years or the initial tax relief has to be repaid. A net capital loss on sale of around 10% plus 1% per year held should be planned for given the level of the buyback guarantee and initial purchase costs. 1% is because there might be that much beyond income bring paid out, though sales within the VCT or eventually if that doesn't happen a lower dividend might happen instead. You don't have to sell and since the tax exempt income is useful I don't think that you should.

I like that particular VCT because it does only asset backed investing, in things like some new care homes, some hotels, a couple of schools and assorted green power things, so there is protection from large value drops and fairly stable values. It's my own largest VCT holding.

For money left within the SIPPs you could use a global equity tracker fund, since you'll have lots of fixed interest outside the pension.

If you do all of these things I don't think that you should be planning for much if any loss of capital. The VCT and P2P investments look able to meet your income need with no ongoing tax cost at all.

Looking long term you're expecting £32k a year from DB pensions plus I assume £16k from two state pensions for a total pre-tax household income of £48k. £23k within personal allowance so £5k income tax due if you don't use VCT buying to eliminate it, so net £43k a year of guaranteed income.

While you wrote about only £6,500 a year each of state pensions due to being in contracted out workplace pensions, that's not your true sensible position. You get a foundation amount as of 6 April 2016 then 1/35th of the flat rate amount is added for each year paying in. £6,500 is £125 a week and using £155 a week as the flat rate level even though it's last year's rate that's just £30 a week short of the maximum. With each year paying in adding £4.42 you're only seven years from getting the maximum if £6,500 doesn't allow for future years. Given your DB payment years it seems as though you should have no trouble getting to the flat rate maximum before reaching your state pension ages. Class 3 NI current!y costs £14.25 a week so £741 a year and the deal is good enough that you should plan to do this for as many years as are needed.

Since I don't know your ages or genders I don't know when the state pensions start. I'll just pretend it's October 2026 for both of you. If not there might need to be some money found to bridge a few years of not getting them.

Don't neglect the £720 a year per person available from continuing to make pension contributions after stopping work, it's available until age 75.

While £25k a year seems easy using secured P2P and VCT investing it's worth wondering how close you could get to that long term £43k.

The DBs are expected to produce £80k of capital by October 2026 that could through mortgage borrowing be spread over the roughly eight years from 2018 to 2026. Ignoring the gain from investing vs mortgage interest that's potentially £80k / 8 years = £10k a year you could pay yourselves.

That takes you to say £35k a year.

Downsizing to get £50k of equity in 2019 adds another £50 / 8 = £6,250 a year of potential income, taking you to £41,250 a year.

It's easier to get a mortgage while working so I suggest downsizing and taking equity out while still working. Say you were on top of the DB £80k to take another £50k. Nil effective interest cost because of investment income and that should cover the mortgage capital repayments for a while and get you some more margin, though with no need to spend the initial £230k you have quite a bit of that already. Go for the longest possible mortgage term to keep the mandatory mortgage payments as low as possible.

Provided you get the mortgage to bring forward the availability of the DB lump sums it seems entirely viable to start to pay yourselves net £43k a year from 2018.

As your DB pensions arrive you can use their lump sums to reduce the borrowing if desired, or invest the money and use the investment income to do that. Once all pensions are being paid you can consider making voluntary extra mortgage payments out of capital or investment income. That's the time when your situation is nice and stable. I suggest not using capital because the investments can cover the interest cost and the capital and income on investments can cover the interest cost and should make paying for possible care costs for one person easy enough. Though the mortgage capital payments might make some drawing on capital necessary either now or earlier in the plan.