How best to plan to use some of a (currently 100% equity) DC for an annuity in six years time?

BookofShadows

Firstly, apologies for the long post - I’m not great at brevity and have attempted to answer many of the typical questions I see in similar posts here upfront.

Planning to retire in around six years (at 57) when I can access my DC company pension.  I’m fairly confident I will have ‘enough’ saved by then across various approaches but now thinking about de-risking as my DC is currently 100% equity and savings outside of pension are around 75% equity (SS ISA vs Cash ISA & PB).  I’ve been happy with that approach as I also have a fairly small DB pension (will be slightly above SP amount if I don’t access it until 65) and am 2 years NI contributions from full SP with the mortgage gone in the next couple of years.  Wife is probably in a lower risk situation too as her pension will be entirely DB.  From SP age either of us will have sufficient in defined income to be at least comfortable (i.e. no need to sell house or drastically change day to day spending habits) without considering survivor benefits or any other left-over DC / ISA savings etc should one of us depart early (and before SP age there should be a good buffer of DC / savings left). 

With that ‘comfortable’ background (and the backstop that 57 is a desire, not a fixed need – worst case I could just work a bit longer) I think I would like to increase our defined income floor to start to guarantee a certain level of discretionary spend – while still leaving some DC pension outside of that, for growth potential and flexibility.   From my reading on here (and down the many rabbit holes that the knowledgeable folk here direct us to) I am now interested in annuities where previously I had discounted them - as the value didn’t seem to be there a few years back.

So, background done – a couple of actual questions / requests for input from the forum.

1. I’m not sure I’ve fully grasped how using part of a DC pot to purchase an annuity works.  Let’s say I wanted to use 25% of the DC fund to by an annuity (RPI linked with some survivor benefits I expect) I think currently I’d like to keep the rest to use with a UFPLS approach.  How does that work with tax free elements (or not) of annuity purchase etc?  I would expect to front load UFPLS withdrawals in the years prior to taking DB / SP – probably up to HR tax threshold. Is there anything I need to consider before doing this (i.e. one-time opportunities to do it, drawbacks, restrictions etc) not sure if my current employer’s scheme is compatible with this, but hopefully there are schemes out there that are.
2. Without going back fully into a life-styling approach in my current pension I would assume it would be wise to start building a tranche of the pot that is not in equities.  Given the timescales I think I have a couple of options – put some (or all / or a growing percentage) of my new contributions into bond / money market funds or swap out some of my existing equities into that type of fund now or at some point in the future.  Any thoughts on the right approach here?  At my current rate of funding the pot I will likely add around half of what it is worth today over the next six years (potentially more if bonuses and pay rises etc allow) so either approach could deliver sufficient ‘safe’ funds over the next six years – but I’m struggling with a decision on how quickly to push (possibly this is driven by a fear of ‘missing out’ on equity growth if I do it too soon).  

If you’ve got this far – thanks!  I’d welcome any thoughts on my two queries above.

Mark_d

If  you're planning to use 75% of your fund as drawdown then I'd look to have it mostly large cap dividend stocks but also corporate bonds.  Buying an annuity is simple.  Just take the money out of your fund and buy the annuity.

SVaz

A:  Either switch your future contributions to a short term money market fund or, if that won’t give you enough, b:  start selling down funds over the next few years and also switch them to income funds if they are acc. funds. 

What you don’t want, is a major crash right before you plan to buy the annuity and no cash buffer. 

You could also look at a 7 year collapsing Gilt ladder but that means selling a big chunk of equity now to fund it. 

I started on A a couple of years ago and have a big chunk in a STMMF,  I’ve lost a bit of equity growth but it could have just as easily gone the other way.  My current contributions are also directed that way plus the dividends from one of my equity funds to the tune of £2k a year. 

leosayer

1. The general approach to buying annuities is that 25% is paid as a tax free lump sum and the remainder buys an annuity. For example £100k (lump sum) + £300k (annuity) = £400k total from your DC. If you plan to buy an annuity in 6 years then perhaps you should consider holding a fund that reduces the impact should annuity rates drop from their current relatively high level.

2. Planning on making future contributions into low risk assets leaves you open to the risk of something unexpected happening in the meantime such as job loss, ill health, divorce etc. Such bad luck would be compounded if it coincided with an equity crash just at the point you need the funds.

BookofShadows

leosayer said:

1. The general approach to buying annuities is that 25% is paid as a tax free lump sum and the remainder buys an annuity. For example £100k (lump sum) + £300k (annuity) = £400k total from your DC. If you plan to buy an annuity in 6 years then perhaps you should consider holding a fund that reduces the impact should annuity rates drop from their current relatively high level.

2. Planning on making future contributions into low risk assets leaves you open to the risk of something unexpected happening in the meantime such as job loss, ill health, divorce etc. Such bad luck would be compounded if it coincided with an equity crash just at the point you need the funds.

Thanks, So the 25% tax free bit is the crux of my issue with buying the annuity with part of the fund.  I guess given I want the remainder of the fund to be taken as UFPLS then it makes it clean for that tax free element to 'have' to be taken out of the fund when buying the annuity - it just means there's less left in the fund for the growth bit.  But then (up to ISA limits at least) I can stick that tax free bit into similar investments outside the pension I suppose or reduce how much I'm taking out over the early part of the pre-SP front loading.

On the bad luck / unexpected happenings front I guess that's the trade off with keeping things in equities and hoping there is no crash just as I 'need' the funds.  I say 'need' as for either best or worst case scenarios (i.e. I can afford to finish at 57 as it looks today, or something nasty happens between now and then) then 57 would become some other number between 57 and 65 and I'd just make the duration to drawing the DB smaller (or take the DB earlier and accept a smaller guaranteed element).   I think this is why I'm leaning towards shifting a proportion of future contributions rather than switching some of what I already have - that existing chunk can continue to grow and some of the new contributions can start to become a buffer as per the SVaz approach above. 

Thanks to all - just typing it out and pondering the responses helps quell the qualms...

OldScientist

BookofShadows said:

1. Without going back fully into a life-styling approach in my current pension I would assume it would be wise to start building a tranche of the pot that is not in equities.  Given the timescales I think I have a couple of options – put some (or all / or a growing percentage) of my new contributions into bond / money market funds or swap out some of my existing equities into that type of fund now or at some point in the future.  Any thoughts on the right approach here?  At my current rate of funding the pot I will likely add around half of what it is worth today over the next six years (potentially more if bonuses and pay rises etc allow) so either approach could deliver sufficient ‘safe’ funds over the next six years – but I’m struggling with a decision on how quickly to push (possibly this is driven by a fear of ‘missing out’ on equity growth if I do it too soon).  

If you’ve got this far – thanks!  I’d welcome any thoughts on my two queries above.

Two possible approaches that depend on quite what you want to achieve are:

1) If you want to secure the amount of money you have to purchase the annuity, then placing it in MMF/short-term bond funds is likely to do the job. However, the amount of income that the money will buy will depend on RPI annuity payout rates in 6 years (which might be more than, less than or the same as now), which in turn depend on inflation linked gilt yields (higher yields -> high payout rates and vice versa)

2) If you want to secure the amount of income on annuity purchase then you can use inflation linked gilts (funds or individual gilts) that match the duration of the annuity (which is roughly life expectancy divided by 2, e.g.  for a male at 57yo about 27/2=13.5 years) plus the delay to purchase (initially 6 years). If yields and payout rates go down, then the price of your bond funds (or individual gilts) will go up and vice versa and, if perfectly matched, in the same proportion.

QrizB

It might be easier with numbers.

Imagine you have £400k in your fund and you want to spend £100k on an annuity.

There might be a step here where you transfer £133k out to another pot somewhere, depending on how flexible your current scheme is.

You'd crystallise that £133k, giving you £33k of tax-free cash that you can stuff into an ISA (over two years, or shared with your significant other). The remaining £100k of crystallised funds are then used to buy your annuity.

The £266k in remaining in your original pension is there for you to take as UFPLS, drawdown or whatever.

leosayer

OP, your first post is slightly troubling because your retirement age seems to be anything from 57 to 65 depending on how things turn out. That's a wide range.

From what you have said, the bulk of your income needs should be met by your guaranteed incomes once state pensions are paid so your DC and other savings only need to last you 10 years if you stop work at 57. 

If you haven't already, I'd recommend doing some cashflow modelling which should hopefully give you some more certainty and direction.

I did this for my wife and I and it gave us the confidence to retire at 54 with full state pensions entitlement, DB schemes, ISAs and DC/SIPPs. It also helped us to decide on the appopriate asset allocation to avoid impact of nasty surprises like an equity market crash

One example on the video below:
https://youtu.be/7Wkr5QtY-G8?si=I_nlvMEw-ljb0rYY

Yorkie1

It might be worth double checking, if it's relevant, whether using part of a pension pot to take an annuity will trigger the MPAA (and so limiting how much you can put in a future pension).

BookofShadows

leosayer said:

OP, your first post is slightly troubling because your retirement age seems to be anything from 57 to 65 depending on how things turn out. That's a wide range.

Not intending it to be troubling, only that I'd like to finish at 57 and as long as nothing unpleasantly surprising happens in the next six years that'll be entirely possible. 
My fall back is - if something nasty does occur (lose job, lose wife, both etc) then I can either carry on working or start to plan for a different retirement. 

With a boring next six years we'll be able to finish with very similar spending power to what we have today - which gives a very comfortable life with plenty of discretionary spend and overseas holidays etc. But the a greater proportion of that income will come from investment performance than I would 'like'. 
I'm not looking to fully provide guaranteed income to cover everything but would like to increase certainty above what we already have in DB.  
I'm not trying to maximise income fully, nor fully minimise risk - just find a steady in between option where we've got a bit of 'fun' baked in to defined income and can then be more comfortable taking our chances with market performance with the rest - 'really fun' perhaps. 

DRS1

Yorkie1 said:

It might be worth double checking, if it's relevant, whether using part of a pension pot to take an annuity will trigger the MPAA (and so limiting how much you can put in a future pension).

I don't think taking an annuity triggers the MPAA but taking UFPLS certainly will.

OP if your current DC workplace scheme has limitations on how you take your benefits you may want to transfer all or part of it out to eg a SIPP once you retire.  I am thinking that maybe you transfer out the part you want to take as UFPLS and leave the "annuity" money behind and buy the annuity from the old DC scheme.  I think most DC schemes will allow for an annuity.  You would probably be advised to take the relevant bit of the TFLS at the same time out of the old scheme so as someone said £100k for the annuity and £33k for the TFLS.

One thing to note is that what you transfer may have to be turned into cash in order to transfer it.  Depends what sort of DC scheme you have and how it is invested.

The suggestion up above of putting the "annuity" money into index linked gilts is a good one - if you are going to buy an index linked annuity.

You do need to decide how much of this DC pension pot is going on the annuity and how much on UFPLS.  That may involve working out how much annuity you want, what it will cost in todays money and then decide if you are going to put that much in index linked gilts straight away (by switching out of equities) or build them up out of new contributions.  If what you are trying to do is capitalise on today's annuity rates (thinking they may get worse) then go for straight away.  Don't ask me if they are going to get worse - I have a nasty feeling they may get better but that could have something to do with me having just bought an annuity.

Your DC scheme may not let you buy individual gilts but it will probably have a fund of index linked gilts which may serve as a proxy.  Just make sure the funds has index linked gilts and not the conventional gilts.