Is guaranteed retirement income a fixed interest asset?

DairyQueen

Thrugelmir wrote: »

Personally I've always viewed our DB pension schemes as being the equivalent of gilts / fixed interest. Thereby allowing a little more flexibility with the investment of the DC\AVC elements.

How did you gauge how much to increase your equity allocation? Is there a formula/strategy?

DairyQueen

Deleted_User wrote: »

In a word, “yes”. DB pension is a type of fixed income, which allows us to have a very high stock-market allocation.

More specifically, I consider DB income as an inflation linked annuity (for the portion that is inflation linked).

Annuities will play a different role in our retirement strategy compared to bonds. They are to deal with the longevity risk, aka risks of

a) outliving your money or
b) making poor financial decisions which people are prone to do after a certain age.

The decision to delay our state pensions (or not) will be taken by simply comparing the total income lost per year of delay vs the cost of an annuity for the added amount the state pension would provide. Usually it’s worth delaying, which means one can actually have a wealthier retirement.

Agreed on all points but tax is also part of the mix. It's straightforward to calculate the amount of cash needed to bridge between retirement and when all guaranteed income is online.

After that, income tax may be an issue. No point in deferring SP if it subsequently pushes you into the HRT tax bracket. Especially if there is a risk of breaching the LTA if you don't crystallise/drawdown sufficient before age 75.

We combine portfolios to determine overall asset allocations. However, the tax issue means we have different drawdown timescales and need different asset allocations for each sub-portfolio.

Our combined guaranteed income will meet 100% of expenses but we will use drawdown for exceptional costs and dollops of jam. We have an emergency cash fund and additional assets that we can use if markets crash. We also have sufficient cash to suspend drawdown completely for three years. A prolonged bear market may require toast-no-jam for a period if we were very high equities.

I wonder whether there is a formula that could indicate the optimum equity allocation in circumstances where drawdown isn't a necessity..

DairyQueen

Although the point of my OP is barely referenced in the paper, the authors' view of guaranteed income as a distinct class of fixed interest stood out. I have never seen it defined in that way nor considered that it could impact equity allocation to that extent.

This is different from knowing intuitively that portfolio risk is less relevant for those with a high %age of guaranteed retirement income. It suggests drawdown strategies exist that use guaranteed income as an input in a different way from those aimed specifically at generating higher than, say, 20% of essential income.

US middle earners have a relatively high percentage (typically 70-85%) of their retirement income covered by state pension. This suggests that they are generally less dependent than us on their assets/investments, and on conventional withdrawal strategies and the asset allocations that typically support them. Our Boston-based ex-pat is a good example..

Drawdown strategies typically deduct guaranteed income from income required and target the balance. Safe withdrawal rates and sequence of returns are the big discussion points as the usual aim is to achieve the maximum income from investments throughout life.

There could be many reasons why guaranteed income nears/meets/exceeds retirement needs for some in the UK: frugal lifestyle, good planning, luck, long service in the public sector. These people will have different aims from their investment portfolios than are typically served by common withdrawal strategies and asset allocations. Strategies that calculate a value for guaranteed income and assign it to the fixed interest class of an investment portfolio may then come into play. Do such strategies exist?

Assuming that some level of drawdown is still required, perhaps to provide a good dollop of jam on the bread for 10/15 years, it would be interesting to review strategies aimed at these circumstance.

An alternative and simpler strategy may be to assign different portfolios to different drawdown timescales and allocate more to equities relative to the investment timescale of each. With such an approach the portfolio invested for <5 years would be 100% cash and the 15+ year would be 100% equities. The 5-15 year portfolio would allocate a higher than usual %age to equities – perhaps 70/80% plus holding sufficient additional cash to suspend drawdown for a few years within this 10 year period.

I may be over-thinking (a bad habit). Maybe I should just be thankful and wing it but I would rather adopt a more disciplined method if it exists.

[Deleted User]

I was surprised that some types of US pensions dictate the min withdrawal rate each year after age 70. Any idea why?

The state wants to get its paws on your tax-sheltered investments.

[Deleted User]

After that, income tax may be an issue. No point in deferring SP if it subsequently pushes you into the HRT tax bracket. Especially if there is a risk of breaching the LTA if you don't crystallise/drawdown sufficient before age 75.

That’s country specific but sounds remarkably similar to Canada. My personal logic is that if I am in a fortunate situation that forces me to pay more tax when I am 80, so be it. I still want to be less dependent on investment and have higher share of DB/annuity type income past a certain age, let’s say 75.

This is because at that point the risk first risk is smaller than the second:

1 A bit of extra tax
2. going a bit senile and screwing up with your investments, and/or outliving your money or forcing a complicated portfolio on the surviving spouse.

[Deleted User]

Also, surely delaying state pension actually means drawing more investment earlier and hence reduces the risk of breaching LTA.

Audaxer

DairyQueen wrote: »

But surely the risk is academic in this scenario. Why accept lower long-term returns if you don't have to. In the accumulation phase with <10 years to retirement I was 100% equities and slept perfectly well. If you have sufficient income to meet your needs and wants, and unless you wish to ring fence a %age as a legacy or for, say, care home fees, why bother de-risking?

If they have more than enough income from DB and State Pensions to meet their income needs and also accumulated an additional significant sum in savings and investments, they may just decide to de-risk in retirement because they want to spend and enjoy that money while they are young enough to enjoy it. If they have no need or desire to make any more money than they already have and do not need to leave an inheritance, then they may not want to risk going 100% equities.

Triumph13

DBs have a similar impact to bonds, but in a quite different way.
Two key strategies for making your drawdown sustainable are a)having an asset allocation that lets you avoid selling too many equities in the middle of a crash and b) having flexibility in spending that lets you avoid selling too many equities in a crash. Bonds / Fixed Interest can be good for the former. DB pensions are excellent for the latter - if DB gives 80% of your income, with the rest from drawdown, then a 50% fall in your portfolio only translates to a 10% fall in your income.

bostonerimus

Deleted_User wrote: »

The state wants to get its paws on your tax-sheltered investments.

Yes it's the US tax authority, the IRS, that dictates Required Minimum Distributions (RMDs) after age 70.5. All DC retirement accounts are included and the withdrawal is calculated from IRS actuarial tables. Of course the money does not need to be spent, but the IRS wants you to pay tax on it before you die.

bostonerimus

DairyQueen wrote: »

US middle earners have a relatively high percentage (typically 70-85%) of their retirement income covered by state pension. This suggests that they are generally less dependent than us on their assets/investments, and on conventional withdrawal strategies and the asset allocations that typically support them. Our Boston-based ex-pat is a good example..

This sounds optimistic to me. The average US social security payment is $17.5k and the average income is $48k. Of course the paper might mean that SS is a large part of the US retirees income because most people have such small personal retirement savings.

Most of the withdrawal strategies have been developed in the US as that's where DC pensions first began to replace DB pensions as employers looked to shift cost and risk onto employees. For me neither SS or withdrawal strategies are that important as I have a DB pension and rental income to cover my spending.

Strategies that calculate a value for guaranteed income and assign it to the fixed interest class of an investment portfolio may then come into play. Do such strategies exist?

I just take the guaranteed income off what I need to generate and adjust my asset allocation along the efficient frontier. As I'm not too worried about losses or sequence of return I've decided to let my portfolio tend towards 80% equities so that I can maximise potential return.

An alternative and simpler strategy may be to assign different portfolios to different drawdown timescales and allocate more to equities relative to the investment timescale of each. With such an approach the portfolio invested for <5 years would be 100% cash and the 15+ year would be 100% equities. The 5-15 year portfolio would allocate a higher than usual %age to equities – perhaps 70/80% plus holding sufficient additional cash to suspend drawdown for a few years within this 10 year period.

I may be over-thinking (a bad habit). Maybe I should just be thankful and wing it but I would rather adopt a more disciplined method if it exists.

The chronological approach is popular, but I just see it as an added complication. I just set my overall asset allocation and take a Total Return approach. But I'm reinvesting dividends and letting the capital gains ride so I don't really need to worry about regular withdrawals...until RMDs start that is.