Retirement strategy, for comments

aroominyork

Triumph13 said:

I'm another one voting for annuities.  If we say 5% for an RPI joint life annuity, then using half your assets for an annuity, plus 3% drawdown on the other half gives you your desired 4% income, and is heavy odds on to leave more than 50% to your heirs vs your 30% target - especially if you accept some volatility in income and take a fixed percentage 3% from a largely equity portfolio.  It is also going to be way easier to manage as you get older.

Interesting idea, similar to Boston's of using your bond portfolio to buy an annuity. Would a fixed % from the equity fund, say 3%, be the right way to manage it?

I expect annuities are going to become more popular post-2027 when SIPPs are (correctly, in my view) brought into estates for IHT purposes.

Linton

aroominyork said:

Thanks Boston, we’ll do estate planning, though you’re perhaps a little over-optimistic about any scenario working out fine. On dividends, our global equity index fund (where, partly thanks to you, we are mostly invested – I hope others have been equally influenced by your incessant badgering 😊) shows a historic yield of 1.64% so surely we would need to sell units alongside the yield to have enough income and not be repeatedly rebalancing between asset classes?

masonic, very useful re. annuities and gilt laddering. I’ve split the timeframe into five year blocks, taken the YTM for gilts maturing in the middle year of each block and shown the return on £100,000 invested, frontloaded given the lower yields for shorter duration. I then powered the gilt yield to the middle year of each five years to show the returns. (I have quietly ignored that gilt coupons cannot be reinvested at the same YTM for the rest of the gilt's life.) I’ve assumed half the gain will come from coupons and half from capital gain, so have applied a 10% tax rate on the gain. But is the tax correct? The annuity comes from a SIPP (£133.33k liquidated, £33.3k TFLS and £100k to annuity) and is taxed on annual income, while the gilt is from an unwrapped account to minimise tax. Am I comparing apples and pears? 

The outcomes show higher net income for the DIY option (slightly offset by the coupon reinvestment issue mentioned above). DIY also leaves your heirs with cash in the bank if you die before age 90, if starting out at 65, but leaves you with nothing to spend on the day after your 90th birthday. I expect any actuaries reading this will throw their hands up in horror, but does it seem close enough?

1) If you want income dont invest in a global index fund. My criterion when buying income (both bonds and equity) funds is  >5% yield. After you have bought the income the yield no longer matters since variation in yield will generally reflect variation in price rather than any change in your income.

2) How will your nominal bonds generate capital gains? The value at maturity will be equal or close to their value when created.  Unless you strategically and consistently bought below par you would expect a zero capital gain on average.

3) If you are bucketing according to objective I suggest you keep the link simple.  If you want income focus on income, if you want growth focus on growth, then size the buckets on the relative importance of each objective.  Dont try to get all your buckets ticking every box - you may end up in a messy and sub-optimal compromise.

aroominyork

Linton said:

aroominyork said:

Thanks Boston, we’ll do estate planning, though you’re perhaps a little over-optimistic about any scenario working out fine. On dividends, our global equity index fund (where, partly thanks to you, we are mostly invested – I hope others have been equally influenced by your incessant badgering 😊) shows a historic yield of 1.64% so surely we would need to sell units alongside the yield to have enough income and not be repeatedly rebalancing between asset classes?

masonic, very useful re. annuities and gilt laddering. I’ve split the timeframe into five year blocks, taken the YTM for gilts maturing in the middle year of each block and shown the return on £100,000 invested, frontloaded given the lower yields for shorter duration. I then powered the gilt yield to the middle year of each five years to show the returns. (I have quietly ignored that gilt coupons cannot be reinvested at the same YTM for the rest of the gilt's life.) I’ve assumed half the gain will come from coupons and half from capital gain, so have applied a 10% tax rate on the gain. But is the tax correct? The annuity comes from a SIPP (£133.33k liquidated, £33.3k TFLS and £100k to annuity) and is taxed on annual income, while the gilt is from an unwrapped account to minimise tax. Am I comparing apples and pears? 

The outcomes show higher net income for the DIY option (slightly offset by the coupon reinvestment issue mentioned above). DIY also leaves your heirs with cash in the bank if you die before age 90, if starting out at 65, but leaves you with nothing to spend on the day after your 90th birthday. I expect any actuaries reading this will throw their hands up in horror, but does it seem close enough?

1) If you want income dont invest in a global index fund. My criterion when buying income (both bonds and equity) funds is  >5% yield. After you have bought the income the yield no longer matters since variation in yield will generally reflect variation in price rather than any change in your income.

Most equity income funds yield around 3% and, on a total return basis (5 year view on Trustnet for global equity income) 75% of funds underperform a vanilla global index fund (though I expect the Mag7 years have skewed results away from dividend payers). I get why some people like ultra-high yielders but it feels to me like the tail wagging the dog. 

Linton said:

2) How will your nominal bonds generate capital gains? The value at maturity will be equal or close to their value when created.  Unless you strategically and consistently bought below par you would expect a zero capital gain on average.

Low coupon gilts. There are still plenty around, albeit more with short/medium maturities. Those created when interest rates were 0.5% have seen their prices plumet. There are half a dozen gilts maturing in between 20 - 30 years with prices under £50.

Linton

aroominyork said:

Linton said:

aroominyork said:

Thanks Boston, we’ll do estate planning, though you’re perhaps a little over-optimistic about any scenario working out fine. On dividends, our global equity index fund (where, partly thanks to you, we are mostly invested – I hope others have been equally influenced by your incessant badgering 😊) shows a historic yield of 1.64% so surely we would need to sell units alongside the yield to have enough income and not be repeatedly rebalancing between asset classes?

masonic, very useful re. annuities and gilt laddering. I’ve split the timeframe into five year blocks, taken the YTM for gilts maturing in the middle year of each block and shown the return on £100,000 invested, frontloaded given the lower yields for shorter duration. I then powered the gilt yield to the middle year of each five years to show the returns. (I have quietly ignored that gilt coupons cannot be reinvested at the same YTM for the rest of the gilt's life.) I’ve assumed half the gain will come from coupons and half from capital gain, so have applied a 10% tax rate on the gain. But is the tax correct? The annuity comes from a SIPP (£133.33k liquidated, £33.3k TFLS and £100k to annuity) and is taxed on annual income, while the gilt is from an unwrapped account to minimise tax. Am I comparing apples and pears? 

The outcomes show higher net income for the DIY option (slightly offset by the coupon reinvestment issue mentioned above). DIY also leaves your heirs with cash in the bank if you die before age 90, if starting out at 65, but leaves you with nothing to spend on the day after your 90th birthday. I expect any actuaries reading this will throw their hands up in horror, but does it seem close enough?

1) If you want income dont invest in a global index fund. My criterion when buying income (both bonds and equity) funds is  >5% yield. After you have bought the income the yield no longer matters since variation in yield will generally reflect variation in price rather than any change in your income.

Most equity income funds yield around 3% and, on a total return basis (5 year view on Trustnet for global equity income) 75% of funds underperform a vanilla global index fund. I get why some people like ultra-high yielders but it feels to me like the tail wagging the dog. 
........

Perhaps you are looking at things the wrong way round.  You seem to have decided what the answer is and are now trying to make it work. You say "I get why some people like ultra-high yielders but it feels to me like the tail wagging the dog". I would say in retirement the required income is the dog and how you achieve it the tail.

The way I approach the problem (now, not when I retired!) in a top-down way is...

1) What do I need?  Eg £20K/year guaranteed inflation linked income to cover absolute essentials with SP paying £12.5K from year 3.  Generally secure ongoing inflation linked income of £20K.  Safe pot of £100k to provide a feeling of security, one-off major expenses etc. Long term growth (amount tbd). Avoid having to sell equities unless absolutely necessary.

2) Top level design (for example)
a) a pot of 3X£12.5K  + £100K cash (or near to)
b) inflation linked annuity of £8K/year to guarantee essential expenditure can be met
c) Diversified income portfolio  providing £20K/year
d) Long term growth portfolio to ensure the income portfolio increases with cost of needs and to provide for beneficiaries

3) Costs

Annuity: about £100K X £8K/£7500= approx £110K
Initial cash pot: is say £140K
Income portfolio at 5% yield:£400K
Amount left over for growth portfolio: £>1M - £110K-£140K-£400K=£>350K

4) Implementation

The income portfolio would be 50% equity and the growth portfolio 100% equity.  So that gives an equity/FI/Cash split after buying the equity of 62%/22%/16%.  The Growth portfolio could be a single index tracker and the income portfolio a diversified set of high income managed funds.

You may well come up with a different final answer, but I believe working from objectives through to a solution in terms of investments and their % is the most effective process to getting your finances right in retirement..

aroominyork

Thanks, Linton - very useful. Writing "in retirement the required income is the dog and how you achieve it the tail" clicked into place the need to re-frame one's view of investing when moving from accumulation into retirement. This has been a useful discussion; I'll now start working through needs/options; who knows, I might even discuss the 'a' word with OH. (Views about the calcs/tax in my 0750 post this morning would still be welcome.)

masonic

aroominyork said:

(Views about the calcs/tax in my 0750 post this morning would still be welcome.)

Your estimation looks to be in the right ball park. The principle of a DIY ladder vs annuity is that the former leaves you some capital if you die earlier, but the latter doesn't run out, and the placement of the breakeven point may vary depending on the accuracy of your assumptions. It comes down to your risk tolerance for outliving these investments. But if you both do die relatively young, you'll be oblivious to the fact you could have saved some capital by not annuitising, whereas if you live to a ripe old age, you will need to live with the fact the annuity would have been the better option.

You've only examined nominal gilts. Index linked gilts vs a RPI linked annuity would be worth considering also. If you frame this in today's money then the calculations are no more difficult, and your nominal strategy could be derailed by a period of very high inflation, especially in the early years of retirement. It would really depend how important this tranche of your retirement funds will be in your later years. Potentially it could prevent you consuming other assets that you'd prefer were passed on. There's little risk of not meeting this objective if you die young, but a great deal of risk if you outlive your expectations.

aroominyork

Thanks All for your comments, especially masonic and Linton. I have taken on board your comments about annuity which I will keep in mind, but it is a big and irreversible decision so it is one to ponder; instead I am following masonic’s advice of a detailed, short term plan that gives flexibility to adapt things in future. I want a logical and relatively easy structure, and Linton’s income + growth portfolios seem to provide that. Your last post was especially helpful (What do I need, Top level design, Costs, Implementation). I previously looked at what our capital would generate based on 3.2% income but had not sufficiently calculated what we need, so I went over our last few years expenditure (quite easy: nearly everything is on credit cards apart from council tax, gas/elec direct debit, house repairs, charity donations, and animal care when on holiday). Expenditure came to just a few thousand Pounds less than 3.2% would generate, so that small surplus plus a little more will be taken up by more regular holidays. 

I drew up a spreadsheet which lets me enter different income targets and play around with varying asset allocations based on estimated returns from each class. In my previous accumulation mindset, I viewed everything in terms of total return and expected to sell units to fund retirement; I now see the purpose of (tail wagging the dog, Linton) looking at yield to generate most income. The asset classes are: cash, gilts/ILGs of varying durations, fixed term savings, corporate bond index funds, 2 x Man Group bond funds, equity income index fund (since, on first glance, Vanguard’s UK equity income index fund has performed well), actively managed equity income funds/ITs, selling equity units. Is there anything important I have missed? I thought about REITs for a few minutes (and infrastructure for a few seconds) but wonder whether they add more useful diversification than they add complexity?

My first pass on possible asset class mixes to generate target income used about 60% of our capital, leaving 40% for growth (which I expect would mostly be in equity index funds). That feels very comfortable. 

So now to my few questions, please:

1)      Looking at capital growth of corporate bond funds since 2000 (on Trustnet Charity, ie without income reinvested), growth averages 3.8% pa. So is it correct to assume fund growth broadly reflects inflation so I can assume bond income will rise with inflation?

2)      Maybe it is recent performance of the two Man bond funds (Dynamic Income and Sterling Corporate Bond) that makes me see corporate bonds as a good risk-adjusted source of income. 20% of our capital is in those two funds and I would not add to that, but I am looking again at Royal London Short Duration Credit which I owned for a few years. At what point do you think I should put the brakes on this asset class?

3)      Trustnet Charting shows the global equity income fund sector performing similarly to global equity funds over the long term, with a little less volatility. Linton, you say you only invest for >5% yield. Where do you go for that? On Trustnet, only 4/56 OEICs and 1/6 ITs yield that much (searching on global equity income).

masonic

aroominyork said:

1)      Looking at capital growth of corporate bond funds since 2000 (on Trustnet Charity, ie without income reinvested), growth averages 3.8% pa. So is it correct to assume fund growth broadly reflects inflation so I can assume bond income will rise with inflation?

That looks to me like an overgeneralisation. It may be the case that coincidentally capital growth of such funds has matched inflation over that period, but the way in which bond funds generate capital growth is to invest in bonds trading below par and hold until they appreciate in price. Is there a relationship between the magnitude of those opportunities and the level of inflation? I don't know, but I suspect not.

aroominyork

masonic said:

aroominyork said:

1)      Looking at capital growth of corporate bond funds since 2000 (on Trustnet Charity, ie without income reinvested), growth averages 3.8% pa. So is it correct to assume fund growth broadly reflects inflation so I can assume bond income will rise with inflation?

That looks to me like an overgeneralisation. It may be the case that coincidentally capital growth of such funds has matched inflation over that period, but the way in which bond funds generate capital growth is to invest in bonds trading below par and hold until they appreciate in price. Is there a relationship between the magnitude of those opportunities and the level of inflation? I don't know, but I suspect not.

I was about to correct that figure as it didn't account for compounding, since I divided total growth of 95% by 25. Probably around 2.7%, but thanks for the answer.

aroominyork

I’ve settled on an income fund and a growth fund. It is intuitive and flexible, eg for any future annuity. I've learned over recent years that you do not fully grasp an investment issue until experiencing it, and I'm sure that applies to generating an income. Here is where I am up to: 

1   Asset allocation for income fund (with estimated income %):

i   10% - 20% in equity income fund, either Schroder Income Maximiser (8%) or Vanguard FTSE UK Equity Income Index (4.5%)

ii   35-50% in corporate bond funds: keep Man Dynamic Income (7.8%) and Man Sterling Corporate Bond Fund (6.1%) at current levels, maybe add Royal London Sterling Extra Yield Bond (8%)

iii   30% - 50% in cash/laddered gilts/<2 year fixed term funds if attractive (4.7%, but expect cash returns to fall with interest rates). 

2   £75k in reserve fund, either cash or short duration nominal gilt. 

3   Invest balance in growth fund.

i   First run of calcs means c.40% of assets would be in growth fund. Sell existing UK index Acc. to fund the equity income fund; total equities (growth + equity income fund) are c.47% of total assets which I might be able to sell to OH.

4   Annual rebalancing, with capital gains in income fund potentially moving to growth fund. 

5   Next task: run five years cash flow for up to and after mid-2028 when my SP kicks in. This will help determine how to invest the third income pot of cash/laddered gilts/<2 year fixed term funds.

6   Where possible, income generating equity and corporate bond funds in ISA, growth fund in SIPP, nominal gilts in GIA.

PS Comments/critiques very welcome, masonic, Linton, others.