Inflation fears

okydoky

My pension pot is predicted to be £260K when I am 60, in five years time, and intention is to take £60K tax free to bridge income to 66 when state pension kicks in. Pot of £200K will buy a level annuity of about £11600 pa, but no inflation proofing.
(I will have other savings of about £150K which I intend to drawdown at about 6% pa)
How dangerous is this in terms of potential damage by period of inflation??

Thanks

dunstonh

How dangerous is this in terms of potential damage by period of inflation??

Depends on the level of inflation we have. With a pot of that size, it may be worth looking at income drawdown instead. Although that introduces other risks. Indeed, phased drawdown seems to fit what you want to do anyway. Basically, its a choice of risks and which you think it most likely. You have to look at other income as well which may be indexed

Linton

okydoky wrote: »

My pension pot is predicted to be £260K when I am 60, in five years time, and intention is to take £60K tax free to bridge income to 66 when state pension kicks in. Pot of £200K will buy a level annuity of about £11600 pa, but no inflation proofing.
(I will have other savings of about £150K which I intend to drawdown at about 6% pa)
How dangerous is this in terms of potential damage by period of inflation??

Thanks

Have a look at http://www.firecalc.com
Its based on US data but will give you a feel for the drawdown issues. 6% seems a bit high to me.

On the level annuity pension - yes it could be dangerous, we both remember the 1970s and early 80s. But the protection against that is the index linked annuity which would be something like half the income.

Of course the drawdown should provide some rough level of long term inflation proofing if suitably invested.

So I guess it depends on your needs and total income. If you have excess income and are prepared to lose some to reduce the risks IMHO it may be worthwhile having some of your annuity index-linked.

okydoky

Thanks for replies - the firecalc stuff is a bit frightening!!

The 6% drawdown on savings is from age 60 but it appears high if "firecalc" is to be believed.


Wonder if "Dunstonh" would care to elaborate on "phased drawdown" as I am not familiar with this concept.

Really appreciate your comments.

StevieJ

I read somewhere that a drawdown of 4% was quite safe over a 30 year period and had been tested over various decades, this was based on 75% of the capital invested in the stock market, so your 6% looks a little high but less risky because it is not your only source of income.

Edit: I just noticed that was what firecalc does, a pretty useful tool.

dunstonh

Generally, 5% is considered as being the level that is "safe" as a long term average. With that you should be able to see little or no capital erosion with some capital growth (obviously depends on level of risk with investments and assumes that long term historical averages will also be long term future averages). Be wary on using US based calcs. Their taxation is different to us on investments.

Wonder if "Dunstonh" would care to elaborate on "phased drawdown" as I am not familiar with this concept.

it is where you crystallise only part of the pension each year, take 25% tax free (and use as that years income) and leave the 75% invested.

By only taking what you need each year, you do not reduce the death benefits as much as taking it all in one go.

You can have variations on that as well. i.e. take crystallise enough to take a level of income from the pension that would be tax free (up to personal allowance) and a lump sum enough to cover that years income.

Income drawdown and phased income drawdown are the old fashioned names that have stuck (a bit like people still using the term unit trust despite most funds no longer being unit trusts). The current name for it unsecured pension.

jamesd

okydokey, do remember that firecalc is using US data and is not including such things as UK returns that tend to be a bit higher. Nor those of emerging or other markets that a sensible UK investor would be using. It's an excellent tool for illustrating possible variation in returns, though.

You also need to remember what it's doing. The bad cases it has are for retirement just before a major market drop. If you were retiring now, you'd be doing it during the early to mid part of a market recovery, so you'd have eliminated many of the worst risks through fortunate retirement timing. Someone retiring in 200 or 2006 would have had an unpleasant surprise pending just after retiring. Five years from now there's a fair chance that the market will be near a peak or just after another significant drop. But you'll probably have avoided most of the inflation risk because that's highest now and is increased by some pretty extreme and uncommon events.

If you're flexible about timing and flexible about income you can greatly reduce your risks. One way is to cut back on capital taken as income when the markets are down. That way the capital will be preserved for the next up cycle. This is harder to do in the US, where the natural income of investments tends to be lower.

6% plus inflation growth is about the limit of sensible UK planning if you don't want a high chance of losing capital over time. Even so, there's a significant chance of capital loss. It'll still do better than an annuity purchase, probably, but subject to market variation. It's what I use for my minimum planning for contingency early retirement. For more cautious plans I either assume a significant market drop or use 5% or 4%.

The phased drawdown that dunstonh mentioned is one useful approach because you get to buy some of the annuities after the inflation has already happened. Also they are bought at gradually increasing ages, so if the annuity market doesn't change, your increasing age will produce increasing payment levels.

okydoky

Thanks for some really considered responses which have produced food for thought.

The very thought of an "unsecured pension" sounds scary but I can see some advantages and is perhaps more appropriate for a phased retirement, has tax advantages and keeps it all more flexible, although with risks attached.

On the question of drawdown from savings, my attitude here is quite clear - I am not at all worried about capital erosion as my savings are for me to spend when I hope to be fit to do so - hopefully for twenty or so years from age sixty so I am quite comfortable with the 6% figure all things considered.

The nagging doubt for me is over the inflation question and how a bad period can destroy even the best laid schemes......................

Does anyone really see it being double digit over say the next fifteen years??

DiggerUK

okydoky wrote: »

......I will have other savings of about £150K ............Thanks

okydoky, You don't say what ammount, if any, you have in gold, or gold exposure, in this pot.
As you have over 400K in your profile, 40K at 10%, would be a conservative figure to get exposure to.
I am happy to be on a higher figure. Have you investigated, total protection against monetary inflation.

We are similar ages, and like you I don't know when to go early until the funding gap between stopping work, and drawing state pension is bridged. Guess we will have no idea on that till the October review.
Fingers crossed eh!

https://forums.moneysavingexpert.com/discussion/2687453

Linton

okydoky wrote: »

.....

On the question of drawdown from savings, my attitude here is quite clear - I am not at all worried about capital erosion as my savings are for me to spend when I hope to be fit to do so - hopefully for twenty or so years from age sixty so I am quite comfortable with the 6% figure all things considered.

The nagging doubt for me is over the inflation question and how a bad period can destroy even the best laid schemes......................

Does anyone really see it being double digit over say the next fifteen years??

The concern at 6% is not to ensure one doesnt have any capital erosion, but rather to ensure that the capital erosion that occurs is not so large that the 6% becomes too small to meet your needs.

On the risk of major inflation, I guess it's a matter of age. Sure when one is young it is easy to say that it's statistically only a small risk and may never happen so why worry.

When one is faced with actually taking retirement a small risk is a worry, and one doesnt want 30 years of worry when it's too late to do anything about it. So I would say your plan should ensure that you can live comfortably with "average" inflation, but wont fall into unacceptable poverty should it reach extreme levels.

Linton

jamesd wrote: »

..... Five years from now there's a fair chance that the market will be near a peak or just after another significant drop. But you'll probably have avoided most of the inflation risk because that's highest now and is increased by some pretty extreme and uncommon events.

......

Do you want to base your whole financial situation for the next 30 years of your life on "fair chance"s and "probably"s?