Cash Buffer in case of poor sequence of returns

Dazza1902

Hi All, i am planning for retirement  at, 60 oh at 62 and will need to use our sipps to fund about 22k a year on top of final salary scheme's. This will /may half our sipps value by 67 at which time the drawdown will move to sustainability.
My question is this, in such circumstances how much cash should be held outside the sipp and should it be in cash  in the event of a major market drop.?
Hope this makes sense. 

Dazza1902

Sorry should have said 22k for 5 yrs

JohnWinder

Here's a back of the envelope guess....

Five years of withdrawals will halve the fund's value sounds like you'd take about 10% of the fund in each of those years.

If half of your fund is the minimum needed to sustain you from age 67 years, then you'd not want it to be less than half after the next 5 or 6 years, so I'd agree you need to 'separate' the 5 years of 22k money from the rest which you'll begin using at 67 years. I don't know whether this 5 years of 22k should be outside a SIPP, but it needs to be in a form that is low risk for the next 5 years. Cash is low risk for all risks I can think of except inflation, the magnitude and timing of which can't be known. Individual, inflation linked government bonds would deal with the inflation risk, but you lose a bit on the yield at present. And nothing else I can think of is as low risk as cash.

Linton

For the 5 year period when you will be dependent on your savings for day to day expenditure I would put it all in cash at least a year before you retire.  For a 5 year period inflation is unlikely to be a major issue and you cannot safely get protection anyway.  Inflation linked gilts have the disadvantage that because their price is very high you will make a loss in £ terms unless inflation is significantly higher than at present.

Whether the cash is in a SIPP or outside I think is largely a matter of your circumstances, particularly tax planning. Can you use the availability of tax allowance prior to taking your DB and State pensions to drawdown significant otherwise taxable money from your SIPP tax free?  Also, a good repository for the cash would be Premium Bonds which of course cannot be held in a SIPP.

MK62

As no figures have been supplied for the DB pensions, I'm guessing a bit here.......but you'd have to be careful to make sure you don't end up paying more in income tax getting the cash buffer out, than the cash buffer might save you in the event of a downturn....

I'm guessing your SIPPs are iro £220k.....£55k of that would be available tax free.....that alone would allow you to buffer half your income needs from the SIPP for the next 5 years......

As to what to do with 55k in the meantime......Linton's suggestion of Premium Bonds is probably as good as any at the moment.

JohnWinder

Linton said:

 For a 5 year period inflation is unlikely to be a major issue and you cannot safely get protection anyway.

The UK Debt Management Office says: 'Index-linked gilts differ from conventional gilts in that both the semi-annual coupon payments and the principal payment are adjusted in line with movements in the General Index of Retail Prices in the UK (also known as the RPI). https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

So that's a government guarantee that you can safely get inflation protection. You'll lose purchasing power because those bonds currently have a negative yield. Readers need not confuse the two although it's easy enough to do.

Dazza1902

Both just turned 56 now, i get 6kpa db at 60 wife gets 8.5 k pa db at 62 IF she wants to retire.(She may work on which will only improve her db and l reduce sipp drawdown) 
No major saving (17k in bank and 12k in isa). Need 30 _35 k pa in retirement both full state pensions.
My main concern is that IF the market crashes and IF my wife decides to retire we have no major savings to fall back on.
I am plowing through ss 1.5 k pm into a sipp  plus £200 pm (95k) wife in Tps, plus  saving £500 pm into a sipp (45 k).
So basically at drawdown i plan to take whatever i can through tfls to act as a buffer and household /car calamities.
So i guess it would d make sense to hold a portion of cash in my sipp  unless other reserves are enough(all relies on my wife's plans i guess). 

Linton

JohnWinder said:

Linton said:

 For a 5 year period inflation is unlikely to be a major issue and you cannot safely get protection anyway.

The UK Debt Management Office says: 'Index-linked gilts differ from conventional gilts in that both the semi-annual coupon payments and the principal payment are adjusted in line with movements in the General Index of Retail Prices in the UK (also known as the RPI). https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

So that's a government guarantee that you can safely get inflation protection. You'll lose purchasing power because those bonds currently have a negative yield. Readers need not confuse the two although it's easy enough to do.

I am not a bond expert but my understanding is.....

Yes coupon payments and payback of the principal is increased with inflation.  However the market cost of an IL gilt is significantly higher than the basis on which these values are calculated.  Thinking about index linked gilts is complicated but the general principle can be explained with normal gilts. A 10 year £100 3% normal gilt will yield £3/year interest for the next 10 years after which it is redeemed for £100.  However you cant buy a £100 gilt for £100, it may cost you £130.   So your total cost is £130 and your total return £130 - ie zero net return.

Break even inflation rates for index linked bonds are now at around 3.1%- see https://www.ft.com/content/0ed2d31c-2c14-4090-97eb-83f75f83f532 dating from November 2020.  ie the market was pricing IL bonds as if the inflation rate was 3.1% and comparing the resultant total return with the interest rate of standard gilts.  So bearing in mind that the rate for normal 10 year bonds is just under 0.5% that means that if inflation were to remain at 2% you would lose money in £ terms.

This is less of an issue in the US where the 10 year TIP breakeven rate is just under 2%.

michaels

Linton said:

JohnWinder said:

Linton said:

 For a 5 year period inflation is unlikely to be a major issue and you cannot safely get protection anyway.

The UK Debt Management Office says: 'Index-linked gilts differ from conventional gilts in that both the semi-annual coupon payments and the principal payment are adjusted in line with movements in the General Index of Retail Prices in the UK (also known as the RPI). https://www.dmo.gov.uk/data/gilt-market/index-linked-gilts/

So that's a government guarantee that you can safely get inflation protection. You'll lose purchasing power because those bonds currently have a negative yield. Readers need not confuse the two although it's easy enough to do.

I am not a bond expert but my understanding is.....

Yes coupon payments and payback of the principal is increased with inflation.  However the market cost of an IL gilt is significantly higher than the basis on which these values are calculated.  Thinking about index linked gilts is complicated but the general principle can be explained with normal gilts. A 10 year £100 3% normal gilt will yield £3/year interest for the next 10 years after which it is redeemed for £100.  However you cant buy a £100 gilt for £100, it may cost you £130.   So your total cost is £130 and your total return £130 - ie zero net return.

Break even inflation rates for index linked bonds are now at around 3.1%- see https://www.ft.com/content/0ed2d31c-2c14-4090-97eb-83f75f83f532 dating from November 2020.  ie the market was pricing IL bonds as if the inflation rate was 3.1% and comparing the resultant total return with the interest rate of standard gilts.  So bearing in mind that the rate for normal 10 year bonds is just under 0.5% that means that if inflation were to remain at 2% you would lose money in £ terms.

This is less of an issue in the US where the 10 year TIP breakeven rate is just under 2%.

I guess you could look on that as the price to be paid to remove inflation risk.  In order to avoid principal risk (investing in 10 year index linked carries capital risk if withdrawals are made before 10 years) the OP would want a ladder of index linked bonds maturing each year in the next 5, not sure if such products are available nor what the 'cost' of the inflation protection is for those durations.

tigerspill

My plan is to always try and have 5 years in cash.  Each year I calculate Money Needed less Income from DB/SP pensions.  Sum for 5 years and hold in Premium Bonds and other accounts.
My plan is the to sell investments each year to replenish cash.  My basic trigger for withdrawing investments is that they have covered inflation.  If they don't cover inflation, then I won't withdraw until they increase again above inflation.

Dazza1902

I think i will take the max tfls and keep safe (premium bonds etc). Most of my sipp is in high yielding trusts, think I'll build up a csh buffer.