Can i afford to retire (if pushed)

jamesd

Robwales said:

• I am 50 yr old – and to date ive managed to save £850k in 2 individual DC pension pots – one via work worth £250k (I match their 4% contrib) and the other bigger one (£600k) I try and top up annually to the max total allowance.
• My other half is 47, doesn’t earn a wage – has £30k in a DC pension (ie via £2880 per yr). 
• We also have
•       £400k share ISA
•       £150k cash 
• On the HMRC website, it looks like we will get the full SP
  
•        Me in 2.5 years time,
•        Other half in 5 years time – but NI credits (child related) will just about cover that

Basic Questions:

1. If I retired before I completed my 2.5 yrs NI years….could I pay for these?

2. What kinda annual income could I expect to get from the assets we have to date…I estimate about £50k per anum before we collect the SP (if we reach that far) ….does this seem feasible?

1. Yes, about £800 a year.
2. Around £75k with flexibility or £53k without should work. Before tax effects.

Drawdown: safe withdrawal rates is the thread I created to introduce that subject, please read the initial posts and follow the links to at least some of the research; it gives you the background on how safe withdrawal rates work and sequence of return risk that you should know, including understanding why spreadsheets with fixed growth rates aren't an adequate stress test. I created it so I could refer to it once instead of trying to cover it all in every reply.

Lifetime allowance first.

It's not increasing with inflation and you're likely to exceed it. This means that as soon as you're 55 you should look to take the tax free lump sum from all of it, or perhaps do it over a few years. As soon as you take the tax free lump sum from part of a pot you've frozen the lifetime allowance usage for that part of the pot and future growth won't then immediately count. So it's a good way to prevent growth from pushing you over later. The limitation is that you then have to find ways to efficiently invest the money and only 40k a year can go into ISAs for the pair of you so you'll need to do some work to minimise CGT outside any tax wrapper. You can also give money to the children to reduce this problem via their own ISAs and pensions.

Once the initial crystallisation is done by taking the tax free lump sum there's another test at age 75 on just the growth in value of the pot size in the drawdown pension that it creates. You avoid this one by drawing out money at least as fast as it grows so there is no growth when you hit 75. As a fair approximation, anyone who starts out around the lifetime allowance should be thinking of drawing their full basic rate band from the pension every year for at least the initial years, and reinvesting what isn't spent. This is in the hope that you might get ahead of future growth while only paying (in theory) basic rate income tax on the money you withdraw, which might not be possible if you have to do more urgently later on. But this is taking out for tax efficiency, not what you should spend, though it does give a very strong clue.

Basic rate tax is payable in theory because you can and I am offsetting most of it by buying VCTs with their 30% of purchase price initial tax relief. Still taxable but you can tell HMRC and if you've bought early enough they adjust your tax code to give you the relief or you can ask for a lump sum.

Safe withdrawal rates.

These are based on research into what percentage of total spendable capital (all savings and investments other than primary home unless you plan to downsize or want to dedicate some to inheritance, a bad idea because you'll normally die before the end of your planning horizon and leave plenty).

US research found that from the start of around 1900 to thirty years ago if you took a hair over 4% of your starting capital and increased it with inflation every year your money would last thirty years even if you lived through a repeat of the worst time encountered in those years, which was a 1967 high inflation rate start. No failure at all in any of the cases. The average was better: 7% of starting capital and the odd starting year went as high as 12% of starting capital - including inflation increases on that for thirty years!

The 4% rule is formally called "constant inflation-adjusted income" and because all it does is pick a starting value and increase with uncapped inflation it's extremely conservative and way below historic average. But that's the initial price you pay for a simple rule. You normally can adjust this upwards over time and you're allowed to recalculate at any time. In the UK the rate is 0.3% lower for thirty years using UK investments and another 0.2% lower for forty years, taking it down to 3.5%. In addition you need to reduce it by about thirty percent of total costs, which includes costs incurred by funds and investment platforms, though some of that is paid out of your pocket and has to be withdrawn to pay some of the costs. Assuming 0.9% total costs that's a further reduction to 3.2%. The UK worst case is 1937, affected by WW2 and the subsequent tough conditions.

More modern rules include Guyton-Klinger, which varies the income depending on the times you actually live through. Normally it increases by uncapped inflation but in bad years it'll skip this and it might take a cut of 10% once a year if thresholds (upper guard rail) are exceeded. Or take a greater increase if it's gone well. That's still well below the historic 4% rule average. In exchange for the flexibility the UK 40 year plan starts at 5.5% with 65% equities and 35% bonds. Subtract the same 0.3 for costs and that takes you to 5.2% initially.

You have total spendable household assets of £1.43 million.

Assuming retirement immediately and age 68 or state pension age I'll deduct £9,400 for 17 years for you and 20 for you OH, which reduces the SWR pot by £347,800 leaving you with £1,082,200 for SWR calculations. Three or a few more years of the state pension allowance should be uninvested while the rest could be in low to medium risk or perhaps average depending on how comfortable you are with variation.

Using a 40 year plan for each of you the £1.082 million can provide:

1. £34,630 at 3.2% increasing with inflation each year using 4% rule. Plus two state pensions you'r paying yourself of £18,800 for a total annual spendable income of £53,430 a year, tax effects ignored and there will be some to pay once you reach 55.

2. £56,270 initial at 5.2% using Guyton-Klinger rules, usually but not always increasing with uncapped inflation, sometimes taking greater cuts or increases depending on the times you live through. Add the two state pensions you've provided for and that's £75,070 a year initially.

While two state pensions is covered until state pension age if one of you dies that income won't happen and some adjustment will be needed.

GK is not more risky, its benefit comes from your flexibility and rules that do a better job of starting you closer to the average expected times people live through. Among its other benefits it does a better job of getting you money while you're young and more likely to enjoy spending it, while the 4% rule recalculations you optionally do increase later when that's less desirable. It's also possible to mix up rules and have some using one and some another. You should also ignore all talk about it being too risky now because the threshold is set for conditions far worse than the ones we have at the moment. We're actually in mediocre conditions that merit increases in expectation, not decreases, mainly due to low inflation expectation and the originator of the 4% rule is drawing 5%.

For all rules you can choose to chop out some capital for purely discretionary use, perhaps whatever gets you to a 50k target with the rules you choose to use.

Forty years is a bit short for your OH and maybe for you but the difference between 40 and 45 or 50 isn't worth worrying about at this point. Ten and twenty years from now you can tweak based on what you actually live through.

If you aren't retiring yet you could choose to use some of your savings to buy VCTs and eliminate your income tax bill while still working. I did when that made sense for me. VCTs normally pay dividends and those are tax exempt, which is handy. You have to repay the initial 30% tax relief if you sell within five years, not if your estate sells after your death. Buy at least two or better three VCTs each year for diversification if you do this.

ex-pat_scot

jamesd said:

Robwales said:

• I ….does this seem feasible?

Drawdown: safe withdrawal rates is the thread I created to introduce that subject, 

James-  marvellous, as ever. 

german_keeper

ex-pat_scot said:

jamesd said:

Robwales said:

• I ….does this seem feasible?

Drawdown: safe withdrawal rates is the thread I created to introduce that subject, 

James-  marvellous, as ever. 

Indeed. I haven't read the post to be honest because investments really don't float my boat. Me and Mrs GK are fortunately in the predominantly DB/SP game with a bit of DC in lifestyle type funds.

But I have read some incredibly disrespectful and at times quite nasty stuff recently aimed at people who in my opinion post with a genuine desire to help others and spend an awful lot of time in doing so. In the last 2 or 3 years since reading this forum I have seen lots of useful, interesting and informative posts from these people with thousands and thousands of posts to their name. So thanks to all of you.

Robwales

jamesd said:

1. Yes, about £800 a year.
2. Around £75k with flexibility or £53k without should work. Before tax effects.

Drawdown: safe withdrawal rates is the thread I created to introduce that subject, please read the initial posts and follow the links to at least some of the research; it gives you the background on how safe withdrawal rates work and sequence of return risk that you should know, including understanding why spreadsheets with fixed growth rates aren't an adequate stress test. I created it so I could refer to it once instead of trying to cover it all in every reply.

Lifetime allowance first.

It's not increasing with inflation and you're likely to exceed it. This means that as soon as you're 55 you should look to take the tax free lump sum from all of it, or perhaps do it over a few years. As soon as you take the tax free lump sum from part of a pot you've frozen the lifetime allowance usage for that part of the pot and future growth won't then immediately count. So it's a good way to prevent growth from pushing you over later. The limitation is that you then have to find ways to efficiently invest the money and only 40k a year can go into ISAs for the pair of you so you'll need to do some work to minimise CGT outside any tax wrapper. You can also give money to the children to reduce this problem via their own ISAs and pensions.

Once the initial crystallisation is done by taking the tax free lump sum there's another test at age 75 on just the growth in value of the pot size in the drawdown pension that it creates. You avoid this one by drawing out money at least as fast as it grows so there is no growth when you hit 75. As a fair approximation, anyone who starts out around the lifetime allowance should be thinking of drawing their full basic rate band from the pension every year for at least the initial years, and reinvesting what isn't spent. This is in the hope that you might get ahead of future growth while only paying (in theory) basic rate income tax on the money you withdraw, which might not be possible if you have to do more urgently later on. But this is taking out for tax efficiency, not what you should spend, though it does give a very strong clue.

Basic rate tax is payable in theory because you can and I am offsetting most of it by buying VCTs with their 30% of purchase price initial tax relief. Still taxable but you can tell HMRC and if you've bought early enough they adjust your tax code to give you the relief or you can ask for a lump sum.

Safe withdrawal rates.

These are based on research into what percentage of total spendable capital (all savings and investments other than primary home unless you plan to downsize or want to dedicate some to inheritance, a bad idea because you'll normally die before the end of your planning horizon and leave plenty).

US research found that from the start of around 1900 to thirty years ago if you took a hair over 4% of your starting capital and increased it with inflation every year your money would last thirty years even if you lived through a repeat of the worst time encountered in those years, which was a 1967 high inflation rate start. No failure at all in any of the cases. The average was better: 7% of starting capital and the odd starting year went as high as 12% of starting capital - including inflation increases on that for thirty years!

The 4% rule is formally called "constant inflation-adjusted income" and because all it does is pick a starting value and increase with uncapped inflation it's extremely conservative and way below historic average. But that's the initial price you pay for a simple rule. You normally can adjust this upwards over time and you're allowed to recalculate at any time. In the UK the rate is 0.3% lower for thirty years using UK investments and another 0.2% lower for forty years, taking it down to 3.5%. In addition you need to reduce it by about thirty percent of total costs, which includes costs incurred by funds and investment platforms, though some of that is paid out of your pocket and has to be withdrawn to pay some of the costs. Assuming 0.9% total costs that's a further reduction to 3.2%. The UK worst case is 1937, affected by WW2 and the subsequent tough conditions.

More modern rules include Guyton-Klinger, which varies the income depending on the times you actually live through. Normally it increases by uncapped inflation but in bad years it'll skip this and it might take a cut of 10% once a year if thresholds (upper guard rail) are exceeded. Or take a greater increase if it's gone well. That's still well below the historic 4% rule average. In exchange for the flexibility the UK 40 year plan starts at 5.5% with 65% equities and 35% bonds. Subtract the same 0.3 for costs and that takes you to 5.2% initially.

You have total spendable household assets of £1.43 million.

Assuming retirement immediately and age 68 or state pension age I'll deduct £9,400 for 17 years for you and 20 for you OH, which reduces the SWR pot by £347,800 leaving you with £1,082,200 for SWR calculations. Three or a few more years of the state pension allowance should be uninvested while the rest could be in low to medium risk or perhaps average depending on how comfortable you are with variation.

Using a 40 year plan for each of you the £1.082 million can provide:

1. £34,630 at 3.2% increasing with inflation each year using 4% rule. Plus two state pensions you'r paying yourself of £18,800 for a total annual spendable income of £53,430 a year, tax effects ignored and there will be some to pay once you reach 55.

2. £56,270 initial at 5.2% using Guyton-Klinger rules, usually but not always increasing with uncapped inflation, sometimes taking greater cuts or increases depending on the times you live through. Add the two state pensions you've provided for and that's £75,070 a year initially.

While two state pensions is covered until state pension age if one of you dies that income won't happen and some adjustment will be needed.

GK is not more risky, its benefit comes from your flexibility and rules that do a better job of starting you closer to the average expected times people live through. Among its other benefits it does a better job of getting you money while you're young and more likely to enjoy spending it, while the 4% rule recalculations you optionally do increase later when that's less desirable. It's also possible to mix up rules and have some using one and some another. You should also ignore all talk about it being too risky now because the threshold is set for conditions far worse than the ones we have at the moment. We're actually in mediocre conditions that merit increases in expectation, not decreases, mainly due to low inflation expectation and the originator of the 4% rule is drawing 5%.

For all rules you can choose to chop out some capital for purely discretionary use, perhaps whatever gets you to a 50k target with the rules you choose to use.

Forty years is a bit short for your OH and maybe for you but the difference between 40 and 45 or 50 isn't worth worrying about at this point. Ten and twenty years from now you can tweak based on what you actually live through.

If you aren't retiring yet you could choose to use some of your savings to buy VCTs and eliminate your income tax bill while still working. I did when that made sense for me. VCTs normally pay dividends and those are tax exempt, which is handy. You have to repay the initial 30% tax relief if you sell within five years, not if your estate sells after your death. Buy at least two or better three VCTs each year for diversification if you do this.

Thanks for takling the time for the detailed reply James- really insightful.  Im afraid i will need to read it a few times to digest and understand it properly.

One thing you can immediately clarify i hope - is there 2 ways of looking at this problem - essentially, top down, or bottom up?

ie you can apply various historic rules/research and methodologies to determine the % you "should" look to draw down maximum per year eg 4% and that determines the £ value....as you have done in the two examples above?

Or you look at the ammount you need to live on, and then model that draw down and with assumptions for growth, and inflation, to determine if it will see you through?

This latter exercise is what i did last night - starting with 50K target income and £1.75m starting pot...assumes 2.25% inflation for the next 40 yrs (guess?!), 2.5% State Pension growth, and a 4% increase in pot, with 3 crashes (timing is puely guess work and their frequency and number of course has a v dramatic effect on the on outcomes):

As said - really appreciate the time you have taken...still trying to get my head around things!

Robwales

oh and to clarify - in the above model i have assumed my income requirement reduces over the years in 3 steps:  the first 21 years are £50k + inflation, and then after that (in blue) for 10 years it reduces by 25%,and the remaining years reduces by 25% again...logic being my expenditure will diminish when (if) if get to these kinda ages.

Robwales

whats key is where that first crash happens...(if it happens!)...in my model with £1.4m if it happens  within the first 12 years its has a major major impact...£1.75m mitigates that.  Of course this is all hypothetical...depth, timing and frequency is all in my head...but interesting to see how the different scenarios play out.  I might need to keep working i fear for a few more (maybe upto 5) years. 

PS

i deliberatly havent put inheritance into the model  - but this would make a considerable impact also.

jamesd

german_keeper said:

But I have read some incredibly disrespectful and at times quite nasty stuff recently aimed at people who in my opinion post with a genuine desire to help others and spend an awful lot of time in doing so.

If you see nasty stuff please report it, whatever section you see it in. Even people who've never posted can help out in this way.

Here's the body of the first and most relevant forum rule and the forum team do act on reports when they think that's merited. 

"1. Conduct and behaviour

We value this above all else: be kind and respectful of all your fellow MoneySavers. You never know when they can help.

Always be friendly

There is no place for trolling, harassing, bullying or deliberately provoking others here. Treat others as you like to be treated.

It's OK to disagree, but be civil, keep your tone friendly and don't be aggressive or make personal attacks on other members of the community. Before you post, think, 'could what I have written be read as unfriendly and upset someone?' and/or, 'how might this be perceived/make someone feel?'.

We want this Forum to be a safe and encouraging place for people to share their experience and information relating to all things MoneySaving. Abusive, manipulative and passive-aggressive behaviour is unacceptable, as is being provocative for the sake of it. Put that energy into MoneySaving instead.

There is zero tolerance in our community for hate speech, bigotry or prejudice, including, but not limited to, race, colour, nationality, sexuality, gender, disability or religion. Absolutely zero tolerance!"

If you report something, don't say you have and unless a correction is needed, don't reply to the post you're reporting, because the forum team will normally remove all posts mentioning it. They also normally review the whole discussion and act on anything else of interest that they find. If you do reply with a correction, either don't quote or very heavily edit the quote, so they might not need to remove yours, but don't be surprised or alarmed if they do as part of their general cleanup.

It's our reports and the forum team responses that can help to make and keep this a friendly and productive forum.

As a poster, there's probably no need to worry about the forum team acting against you. So far as I can recall at present in some fifteen years posting here I've not been warned, though perhaps came close on the odd occasion, most likely after going a bit far in warning someone about something unwise. From time to time they have asked me to explain something investment-related, where I did so and they raised no objection. I'm not perfect and sometimes post and quickly delete or edit but on the whole just try to be nice and criticise ideas and not people and you'll be fine.

One trap that's easy to fall into is too many people being critical of a poster asking a question about something they are contemplating that seems unwise. While the first few posts explaining why it's unwise can be good and provide helpful reinforcement, lots of people piling on and perhaps edging towards comments about the poster being silly can create a hostile atmosphere even if every post individually isn't against the rules. The forum team wants to know about those as well and in general wants to try to protect newcomers, so try to be particularly nice and understanding towards them.

najan49

Robwales said:

whats key is where that first crash happens...(if it happens!)...in my model with £1.4m if it happens  within the first 12 years its has a major major impact...£1.75m mitigates that.  Of course this is all hypothetical...depth, timing and frequency is all in my head...but interesting to see how the different scenarios play out.  I might need to keep working i fear for a few more (maybe upto 5) years. 

PS

i deliberatly havent put inheritance into the model  - but this would make a considerable impact also.

This is the sequence of returns risk (SORR.)  More accurately, it demonstrates why the sequence of returns in the first few years is so important vs those returns later on. Once you’ve already drawn down a considerable proportion of your initial capital and the remainder has to fund fewer years the SORR is a bit less impactful.

jamesd

Robwales said:

One thing you can immediately clarify i hope - is there 2 ways of looking at this problem - essentially, top down, or bottom up?

ie you can apply various historic rules/research and methodologies to determine the % you "should" look to draw down maximum per year eg 4% and that determines the £ value....as you have done in the two examples above?

Or you look at the ammount you need to live on, and then model that draw down and with assumptions for growth, and inflation, to determine if it will see you through?

Don't worry about it taking time, just remember that I've been here and learning for fifteen years and still occasionally make mistakes.

There are at least two ways of looking at it but I wouldn't divide as you did.

Yes, the first way of one set of approaches is to see what capital you have or will have and work out what it can sustain. But I'd say that the second way is to work out what you want to live on and plan how to get there.

The issue with your plan is sequence of return risk and I recommend that you read up on that subject, which is mentioned most heavily in the third post in the SWR thread because it's so important. It's absolutely essential that you understand this issue. These places have descriptions of it that won't take huge amounts of time:

The Extraordinary Upside Potential Of Sequence Of Return Risk In Retirement, KItces
How to manage sequence of returns risk FT Adviser

With respect to the FT one, note that small spending cuts that are sustained, like skipping an inflation increase, make much more difference than a big one year cut. Michael Kitces explains why in this interview: podcast with transcript, video.

"Where you're like times are tough right now, markets are down, I'm going to cut 10 or 20% out of my budget for the next two years until these things bounce back, and then we'll try to get back on track again. And I certainly can appreciate that. I think it's an instinctive response for a lot of us when times are tough, we tighten our belts.

The irony though, is that when you actually look at the retirement research, it doesn't help very much. When we're only spending four or 5% of our portfolio in the first place, and you cut your spending by 10% of that, you're talking about a spending cut that might be 0.4% of your portfolio. So if you do that for the next two years, and you shave off 0.8% of your spending, you can make that up in one good day in the market. It's just, the irony is its very impactful for us personally, and actually does almost nothing to get the portfolio back on track because it's not actually high enough impact over a long period of time.
...
What we find actually works better is not large temporary cuts, but small, permanent ones. So think, instead of I'm going to cut my spending by 10 or 20% for the next two years and reverted back again, I'm going to just give up my inflation adjustment over the next year. So, I normally my spending goes up by two or 3% a year, I'm going to give up my two or 3% a year raise.
...
if I just trim like a 3% inflation adjustment out, not only does it mean you don't lift your spending this year, it means your baseline spending is now ever so slightly lower for every future year as well. But if I lift your spending up, that compounds. If I don't lift your spending up, that compounds. And so if I just take out 3% inflation adjustment writ large over 30 years, the impact of that is actually five to 10 times more beneficial for your long term retirement than doing that small but permanent cut for two years. And so the irony is, it's both five to 10 times better for the longevity of your portfolio and hurts far less. Like we barely even notice the inflation adjustment that doesn't happen."

Like occasional inflation increase skipping, guardrails are part of the Guyton-Klinger approach and he does a good job of explaining those too.

But there's another way to look at things covered in the second post of the SWR thread: the division between safety-first and probability-based approaches.It can help to explain why there can be long discussions about defined benefit pension transfers or paying off a mortgage, because people's tolerances for risk taking differ and there's almost no chance of an extremely cautious person accepting something that worked fine for a hundred and thirty years as being sufficient. Even if the alternative choice might in fact be more risky but with a lower risk presentation. DB have a low risk presentation but if you look at what might cause drawdown at a safe withdrawal rate to fail you get to situations where the firms sponsoring a pension might fail and leave people in the Penson Protection Fund, which delivers a ten percent cut and skips all but legally required inflation increases. The FCA transfer requirements don't help with this because they use a combination of gilts and annuities for a comparison to DB and gilts are effectively certain to pay and annuities get 100% Financial Services Compensation Scheme protection of their income, so one comparator is significantly safer at the margins than the DB.

On the other hand, I have a small interest only mortgage due in ten years that I could pay off instantly but I don't because I'm comfortable with borrowing and investing and know that my long term better outcome is most likely to be from staying invested. While a low risk person might perceive this as gambling with their home... regardless of what the statistics say.

cfw1994

michaels said:

Robwales said:

Thanks cfw1994 for his xls - really useful to model a few drawdown scenarios over a 45 yr period (i will be 95)  - factoring in inflation (i have assumed 2.5% in latest model - and applied the same to the state pension) and pot growth (assumed 3.5%) and 3 crashes over 45 yrs (minus 25% that year) - certainly enlightening!    Does these figures feel about right as a first approximation??

Sorry to bank on about this but running a few scenarios in a spreadsheet is not stress testing your portfolio - at the very least run it against the last 100 years historical actuals and ideally also 10k random monte carlo simulations based on real world variance in asset prices and inflation.

Banking on it?  I’m guessing you mean banging on about it!

Of course one simple spreadsheet won’t ‘test’ a huge amount…..but it can help.  
Other sheets are available….whatapalaver made a cool one, see https://forums.moneysavingexpert.com/discussion/6229495/spreadsheet-to-monitor-pensions/p2

For testing 100 years, etc, you would use a cfiresim or similar.  

My point with my comment about nobody having crystal balls to figure out what is reasonable inflation or growth over the years ahead was just that: nobody can predict everything with any hope of accuracy. 

Most important to me is that you have a plan (failure to plan is planning to fail, etc!).  If a simple spreadsheet helps that (fwiw, I think it does), then you are on the way 👍

Beyond that: be flexible!  

If markets and monies take a tumble, particularly in the early years, be frugal, or maybe take a part time job.  
If you are unable to manage that, you can of course work more years for a bigger buffer.

Life isn’t a rehearsal….

BTW, great replies from @jamesd above 😎👍