Is guaranteed retirement income a fixed interest asset?

bostonerimus

I park my "cash" in a "Stable Value" fund inside one of my DC pensions. It invests in Government and investment grade corporate bonds wth average maturity of 3 years and also stable value contracts with insurance companies. Right now it is paying 2.5% and it's immediate access. I also have about 20% of my allocation in Government and investment grade corporate bonds inside a multi-asset and bond index funds with about 7 years average duration. I'm not going long.

DairyQueen

I am grateful MSE-ers for your contributions. Once again, your info has helped shape our investment and drawdown strategy.

I am in the final phase of positioning our portfolio for retirement and the impact of QE on bonds has been niggling me for some months. Bonds can't be relied upon to behave as in previous decades and that put a question mark against the attributes of bonds assumed within most drawdown strategies.

I am now clear that the percentage of income required from drawdown is a factor that feeds into the split between equities and FI but there doesn't seem to be an algorithm that calculates an optimum range. A range of results that provided %ages relative to risk profile would be nirvana.

I have therefore adapted my strategy to take account of the above. OH retires in 18 months. Guaranteed income will come online between April 2020 and May 2025. The biggie (OH's DB) has been deferred and is now planned to begin in 2022.

If you spot any flaws in the following process then please shout:
- Calculate retirement income required and the percentage covered by guaranteed income (95%)
- Calculate amount required to bridge until May 2025.
- Ring-fence this amount in cash and add the cash required for soon-to-be-spent, just-retired treats.
- The balance is the drawdown pot. This will ideally provide 5% of income from 2025 onward.
- Allocate sufficient to FI/cash/wealth preservation to minimally meet 5% income required from 2025.
- Adjust allocation to take account of attitude to risk.

This has resulted in a combined portfolio of 65/7/28 - equities/FI/cash. Our different levels of guaranteed income dictate different tax positions, drawdown rates and asset allocations for each of our portfolios. Me = 58/14/28, OH = 69/2/29.

As cash is withdrawn leading up to 2025, and subject to a market crash, the equity and FI allocations should increase.

I will aim for a combined portfolio of 77% equities from 2025. The percentage allocated between bonds and cash will depend on how QE pans out. Right now I have no plans to increase the bond allocation so, over time, it should reduce. Rebalancing will primarily be between equities and cash. The impact of inflation seems like the lesser of the evils in our situation.

We have prepared for a crash. If the drop is 50% equity and 15% bonds than roughly 33% would be wiped off the value of our combined portfolio before we begin bridging in 2021. And a higher %age drop from 2021 as cash is spent.

I would be sick as a parrot to be on the rough end of sequence of returns but I won't have sleepless nights. We have sufficient cash to meet our needs until the last of our guaranteed income is online. After that, we can take to the investment bunkers and suspend drawdown when/if our portfolio is the victim of a nuclear crash.

MarkCarnage

If you spot any flaws in the following process then please shout:
- Calculate retirement income required and the percentage covered by guaranteed income (95%)
- Calculate amount required to bridge until May 2025.
- Ring-fence this amount in cash and add the cash required for soon-to-be-spent, just-retired treats.
- The balance is the drawdown pot. This will ideally provide 5% of income from 2025 onward.
- Allocate sufficient to FI/cash/wealth preservation to minimally meet 5% income required from 2025.
- Adjust allocation to take account of attitude to risk.

How much is the 5% of income expressed as a % of the drawdown 'pot' (expected valuation in 2025)? This would presumably define your withdrawal rate. Have you considered using a slightly different combination of assets to cover this? Namely a bias towards equity income in the drawdown portfolio? By withdrawing the natural yield (plus maybe some cash buffer - which could be created by not reinvesting income), you reduce the risk of sequence of return risk.

Clearly, if some fundamental economic rationality returns to markets between now and 2025 you can rethink whether to include bonds. I only hold FI in a couple of niche specialist funds, or as a 'look through' holding in wealth preservation ITs. Even there, quite a lot of it is short dated gilts and Treasury bonds and bills and that is really a cash proxy as these funds can't really hold meaningful cash at bank in case of default (risk maybe remote, but it's binary).

I am gradually moving by SIPP into drawdown on a phased 5 year basis, and using the tax free lump sums each time to augment current spending over that time frame, which is pretty tax efficient. Beyond that, I intend to take a drawdown for a couple of years from the portfolio at a slightly higher rate (maybe 4%) until State Pension kicks in, then reduce it to a natural yield level of maybe 2.5% or possibly even nothing. It would be more tax efficient to take it from my ISA portfolio probably, but I am keeping a weather eye on LTA crystallisation too.

I have deliberately maintained quite significant liquidity from the TFLS's from my DB pension and the phased drawdown, to cover known or expected 'lumpy' spending over next few years, and also have some firepower to reinvest if markets become more attractive. Currently about 20% liquid overall.

I should be reasonably indifferent to a major market setback (equities or bonds or whatever), provided dividend payouts don't take a meaningful hit. My biggest risk is probably the global high growth element of my portfolio but I'm reasonably comfortable with what I hold there, and don't envisage any involuntary selling being required.

DairyQueen

Thanks for the reply.

MarkCarnage wrote: »

How much is the 5% of income expressed as a % of the drawdown 'pot' (expected valuation in 2025)? This would presumably define your withdrawal rate..

On current valuation it's 1.04%. I have tested three scenarios to calculate 2025 valuation:
1) Portfolio matches inflation
2) Portfolio increases by inflation + annual 3%
3) Portfolio loses 33% tomorrow and stays down.
In the worst case the starting rate increases by 0.5%. Still well within safe limits. However, we have the option to suspend drawdown in this scenario.

MarkCarnage wrote: »

Have you considered using a slightly different combination of assets to cover this? Namely a bias towards equity income in the drawdown portfolio? By withdrawing the natural yield (plus maybe some cash buffer - which could be created by not reinvesting income), you reduce the risk of sequence of return risk.

I hadn't considered this. Thinking about it now, if we were more reliant on income from drawdown this would be worth considering.

MarkCarnage wrote: »

Clearly, if some fundamental economic rationality returns to markets between now and 2025 you can rethink whether to include bonds.

Exactly so.

MarkCarnage wrote: »

but I am keeping a weather eye on LTA crystallisation too. .

LTA is also an issue for OH but crystallising his SIPP has reduced the immediate risk.

MarkCarnage wrote: »

My biggest risk is probably the global high growth element of my portfolio but I'm reasonably comfortable with what I hold there, and don't envisage any involuntary selling being required.

Ditto.