How risk averse are you?

nb73

Hardly the same bigadaj

You can't live in a kidney, unless you are really small

Pincher

nb73 wrote: »

Need, or want?

Presumably if push came to shove, you could sell your house and rent or buy somewhere else. Releasing the wealth currently tied up in it

For a private individual, you get no tax relief for renting, but you do get CGT exemption by owning, which is a big plus, hence you should always OWN one house.


For a business, leaseback works really well, because you liberate capital for more investment, and the rent is fully deductible against taxable income.


Buy-To-Let is a variation on this concept.
You are effectively selling the house, but pay rent (mortgage monthly repayment) for the use of it. 100% mortgage would make it a pure leaseback, but a 90% LTV mortgage is hardly different. The important thing is you get tax relief on the mortgage payment, even at higher rate tax. Alas, the party is coming to and end: extra stamp duty, end of higher rate tax relief.


If you earn £30k from a job, you can easily accommodate £10k of net rental income. E.g. £20k gross rent, but you pay £7k on mortgage, £3k on letting commission, maintenance and miscellaneous.

Glen_Clark

nb73 wrote: »

Need, or want?

Presumably if push came to shove, you could sell your house and rent or buy somewhere else. Releasing the wealth currently tied up in it

But that would cost more too, and the estate agent would want more commission, the insurance company a bigger premium, so the higher value actually makes me worse off.
Conning people into thinking they are better off because their house price has increased is whats enabled the Government to get away with it all.

jamesd

enthusiasticsaver wrote: »

Is an annuity risk free then or can the income go up and down?

An annuity is not risk free and the income will normally not go down, only up if the very unpopular inflation-linked types are chosen. They are unpopular because they start out paying substantially less, in part due to the low competition in the market for them.

There is even less competition in the market for the type of annuity that can be purchased with the lump sum from a pension and that means that this type pays out even less than a normal pension annuity. Part of the income is treated as a return of capital and is tax free with this type but this isn't enough to compensate for the low payment levels.

The risks for annuities are

1. the large initial capital loss as you spend so much more to get the income that is often described as guaranteed.
2. the low but present risk that the annuity provider goes out of business and that you end up with 90% payment instead of 100%, that being 90% of what a bankruptcy judge says should be paid, not necessarily 90% of what you were getting. This scenario is very unlikely but possible.

For context, deferring the state pension pays out something like twice as much as the best available standard annuity, inflation-linked for life. For those who reach state pension age from 6 April 2016 onwards the rate is 5.8% increase in the state pension per year of deferral, pro-rated for shorter periods.

enthusiasticsaver wrote: »

We don't really want to invest as our income is dropping by 30% once OH retires. Based on quotes from pension provider though we will have enough income from pension plus substantial lump sum and we just need to see if IFA can recommend any other options than just taking what pension provider is offering.

It's important with annuities to recognise the very high up front price you pay, effectively a large up front capital loss, around 50% compared to deferring the state pension.

Both annuity and state pension deferral spend the money so it's gone. If you want to have a chance of preserving it you'd need to use some sort of investing instead or as well.

Rather than blowing so much of the capital on an annuity, instead look at spending the money to live on while deferring the state pension. With around twice the income available per Pounds spent it's by far the better deal compared to annuities.

If you can't spend all of the money by deferring for at least five years then it's likely that you can get a substantially better deal than the annuity options by investing, without having to lock in a 50% capital loss at the outset. Instead you get the chance that you might have a loss, a far better deal, since on average you'll actually get growth, not loss.

For some examples of how to use a tool that covers the potential income levels from investments to project the chance of having to take an unplanned income reduction late in life have a look at these posts:

Early retirement @ 55 what to do with £ 380000
How to best use my flat to retire and help family member: post 1, post 2.

If you want me to do a custom walk-through for your specific situations I'll need to know the numbers for your income streams and capital that you want to consider, as well as any capital that you want to preserve for inheritance use only.

Annuities shouldn't be written off because starting around age 80 or so for those in normal good health they can become more efficient as a way to produce income than investments. Earlier for those who have health conditions that reduce life expectancy.

jamesd

enthusiasticsaver wrote: »

Our main source of income will be pensions but mine drops drastically due to me retiring early as I have worked part time a lot.

If it drops a lot why take it now when all you're doing is retiring early?

The situation depends a lot on what type of pension it is. If it's a defined benefit pension like final salary or average salary there is normally an actuarial reduction for taking it earlier than the normal retirement age of the scheme that makes it a better idea to live on other money and take the pension only at the NRA. Things like using savings or borrowing on a mortgage are usually better deal than early taking of such pensions.

The other main case is defined contribution types, where there's a pot of money in investments in your name. These types don't decrease based on taking them earlier, since the pot just has whatever value it has at the time. However, if you spend the money to buy an annuity, there is typically a large to very large drop compared to something like taking it at state pension age because annuities pay out much less at younger ages. For this reason it's usually a much better idea to invest the money and then either defer the state pension or buy one or more annuities at ages when they start to offer a good or at least better deal. Drawing capital at a high rate from these to defer taking a final salary pension until NRA is normally an excellent use of the money.

Whichever type of pension this is, you should be continuing to make pension contributions until you reach age 75. This is because you get a free tax gain on the deal, at least £180 a year if all i at basic rate but it can be £720 a year if your personal allowance for income tax has room to accommodate the whole of the taxable part of the pension. This is available to all between ages 55 and 75. the numbers assume no earned income so that you're capped at £3600 gross of pension contributions a year. The potential gain is higher if you have earned income to allow more to be paid in.

jamesd

enthusiasticsaver wrote: »

My reasoning in keeping so much cash is we will have an £8k per annum shortfall between our retirement income and salaries until state pension kicks in. 7 years times £8k is around the amount we have and that is a simplistic way of looking at it but I know you cannot just get money out of an investment pot when you want it without risking consolidating losses if the market is low.

The way you deal with that is by putting either one or two years of the planned investment income into a savings account and draw on that account for your planned income. You have the normal interest and dividends from the investments paid into the savings account. You top up the savings account by selling assets only when markets aren't a ta low time. The payment of the income into the account greatly extends the time that the money will last.

It doesn't take seven years worth in savings, just the regular income top-ups and the occasional capital top ups when markets aren't down.

This is broadly something under the heading of sequence of returns risk and one year in cash is a commonly used way to mitigate the risk. two articles on the broad subject of sequence of returns risk that you may find interesting and/or useful are:

Sequence Risk vs. Investment Risk
Understanding Sequence Of Return Risk – Safe Withdrawal Rates, Bear Market Crashes, And Bad Decades

jamesd

enthusiasticsaver wrote: »

Yes, I get that and one of the questions asked on profile was are you willing to sacrifice higher returns for little or no risk to capital to which we both answered yes.

That's an interesting answer because it would often be taken to mean "sell these people an annuity" (and don't bother to tell them that deferring the state pension pays twice as much).

enthusiasticsaver wrote: »

Maintaining our capital as a buffer and having sufficient income to provide at least the same standard of living as we enjoy now are our priorities even if we end up settling for 3% growth rather than 7 or 8%. Our pensions cover our needs but not our wants without investing or saving the lump sum or using our current savings. If we risk it, yes the returns maybe great in 5-10 years time but we need income when we will be most active, enjoying holidays etc. To us the risk of not having sufficient liquid assets to be able to splash out on a long haul holiday for example is not worth taking.

But this says that an annuity is unsuitable because it spends the capital to buy long term income while you need short term income from relatively rapid drawing of capital.

enthusiasticsaver wrote: »

Of course once we have had the IFA's report once we has all the info from my OHs pension administrators we may take a different view. So far we only know what the company pension scheme will offer so the IFA obviously has knowledge of many other products and companies.

You'll give the IFA conniptions with the conflicting objectives. Two things that an IFA would not normally even consider recommending but that can be excellent deals are:

1. borrowing to allow deferring taking a defined benefit pension until it's normal retirement age, then repaying out of he higher lump sum and income.
2. Peer to peer investing, that can readily pay 10-12% for secured lending, with liquidity for access to the money typically in the few days range if you pick places with offer that.

For an IFA both have risk to their business problems due to the chance that they might later be considered to be unsuitable advice, particularly true if risk tolerance is given as low. in such cases even the higher future income from not taking the pension until normal retirement age might not save the IFA from an adverse judgement, crazy though that world is. It's something that IFAs just have to live with and manage in part by restricting the advice they willl give.

It's quite easy to manage such spending plans in a tool like cfiresim, just add extra spending requirement to the set of options near the bottom of the page and specify how many years the extra spending is for.

Glen_Clark

jamesd wrote: »

it's likely that you can get a substantially better deal than the annuity options by investing.

Yeah but it isn't just about possibly getting a better deal from investments is it?
Peace of mind from a regular income is probably worth more than the possibility of getting more from investments. Especially when you will probably die before you spend it, or run out of money before you die. Or lose your marbles so you can't manage your investments.
You make a great point about deferring the State Pension though. :T

Eco_Miser

jamesd wrote: »

2. Peer to peer investing, that can readily pay 10-112% for secured lending,

Typo?
Or lending at Wonga type rates?

jamesd

Glen_Clark wrote: »

Yeah but it isn't just about possibly getting a better deal from investments is it?
Peace of mind from a regular income is probably worth more than the possibility of getting more from investments. Especially when you will probably die before you spend it, or run out of money before you die. Or lose your marbles so you can't manage your investments.

Right, it's not just about that. You can spend say £10k to get the income from an annuity or invest 5k to get the same income from investments. Leaving you 5k left over, which you can also invest and get a higher income unless you get very unlucky with the investment timing and have a long run of bad years, at which point all that happens if you've used a proper planner is that your income drops to what you would have had with the annuity. But as a worst case, not a normal case which is what it is with the annuity. The normal investment case is twice the income and potentially more than that.

The state pension deferral is a great deal but annuities also eventually do become a great deal as well, it just takes until something like age 80 with normal good health or sooner if not in good health to happen. It's entirely possible that I'll buy annuities around that sort of age, once they do offer good value for money compared to the alternatives.

Losing marbles is one case where the annuity option would start to offer good value for money due to reduced life expectancy.

No real running out of money risk, though, that's what you use the planners for and why you do things like deferring the state pension and setting a minimum income that isn't too high. The pretty assured defined benefit pension and state pension income provides the floor underlying the investment and the more of that you have, the higher the potential investment income because you have a higher protected non-investment floor. If you looked at the planning examples you might have noticed that I observed that one plan was showing the minimum income floor being hit too often and adjusted the spending plan to avoid that and keep it as something for relatively uncommon cases.