The Ermine is advancing of years. It comes to us all, hopefully. I am not yet of the age when I would have quit The Firm after thirty years of service and gone to the pub to celebrate my forthcoming freedom. But it’s not that far off.
Seven years after retiring, I have now burned through half my DC pension AVC savings and invested the other half into the ISA. In cash-flow terms the Ermine is almost skint, and I am on the final approach to taking my main pension, a little early. So I asked them for the information pack.
Every pension is different, and with mine there is the usual option to take some as a tax-free lump-sum. After that there are two options. One is to take a pension that is index-linked up to a cap, and the other option is to take a higher pension that is part non-increasing, and part index-linked up to the same cap.
Why on earth would you do that? Well, the logic is that you get a higher start, since they are paying you to take your claim of index linking off their hands. The higher start makes some sense – one is in best health at the start of retirement than at the end when you’re eyeing up a pine box. They also made something of the fact that the State Pension will turn up later, which should fight some of the later attrition.
Inflation can easily kill the higher start
It looked reasonable at first sight. There’s a common argument that people spend more in the early years of retirement, and less as they get older. Unless they are unlucky enough to end up in a care home, but fewer than 20% of us end up in a care home1. The difference between the higher start and regular isn’t huge, however, it is about three grand p.a. after tax. But it doesn’t take much inflation to erode that, it falls behind in my early seventies and typical inflation rates of ~3%. Some people take the argument that it is the cumulative shortfall that matters,and it is true that this falls below zero later on, a few years past the age that my Dad died. But I am in much better health than either of my parents were at my age. So I might be leery of assuming I cark it at the same age, though of course I could be flattened by a bus tomorrow. Risk is tough to qualify, eh?
What is also bad is this erosion is progressive, and erodes Mrs Ermine’s pension benefit from this after I am gone. The higher start is the theft that keeps on taking, and since there is a significant age difference this loss compounds for longer. I had to run the simulation to 100, not particularly because I believe I will live to 100, but it’s reasonable to anticipate that Mrs Ermine may still be living on what would be my 100th birthday
Another option is to take a lump sum. This reduces the pension, but I am not looking to max this, the commutation rate is 26% post-tax2 which is good though not fantastic. However, I could invest this into my ISA for a few years, with a quicker start because I can repay into Charles Stanley what I borrowed from my ISA, because without an income you are a pariah to the financial system. So I had to borrow from myself. The lump sum can pay back that withdrawal and take out this year’s ISA allowance, and I can then fund some more years.
There are other ways to smooth income
I concluded that the principle of the higher start is good, but giving up my inflation-linking isn’t. There are other ways to do this. I will run down some of the lump sum at about 3k p.a. to augment my income. I will invest into my ISA to the maximum allowed, from the lump sum. When the lump sum falls to zero I will then start to take an income uplift from the ISA of about 3k p.a. until I get my State Pension. The numbers aren’t set in stone – I could take about 6k which is the difference my SP would make (I pay tax on all of it due to having existing income) and/or vary it with what I am doing that year.
Beware the inflation monster
I was surprised at the difference inflation made. Particularly inflation early on. What could cause high inflation in the near future? Well, even Brexit fans seem to think it will bugger the economy. When I say high, I only modelled inflation of 5% for a couple of years, followed by inflation of 2% p.a. for the rest of my life. We aren’t talking the near~27% inflation that has been known in my living memory. In an ideal world I would Monte Carlo simulate this. I know how to do that for circuit design in filters, but I am not clever enough to make Excel do that3. It’s probably possible using something like R, but I would be drawing the pension by the time I learned how to wrangle that. Fiddling with the values in Excel shows me that most of the danger is early on, in the first five-to ten years.
Inflation is tough to model in Excel. You can, of course, apply the compound interest function FV. Good luck with that if you are trying to simulate varying interest rates over the years. I chose to use the gonzo method, which is to track what inflation does to £100. So in any one year, if inflation is 3% then you need 100 * (1+3%)=£103 to buy the same amount of stuff the next year. My years are in columns, and I repeat this exercise each column to show what I need to have £100 in value after cumulative inflation.
I then divide the non-inflation adjusted amounts by the inflation adjusted value fo £100 and multiply by 100.
I confess that seeing this makes me wonder if all those people taking CETVs of DB pensions have balls of steel. Big numbers can turn into smaller numbers counter-intuitively quickly. Or maybe I am just a pussy. This is a fight I don’t want to fight as I get older, even though I have experience of investing successfully.
The ISA has grown well over the last twelve years and I thought I was going to burn out my SIPP savings in three years on living costs. As it was I used a fair amount in a house purchase and paid more tax on it as a result of that purchase, but investment gains meant that these extra costs and some ISA contributions were covered. In some ways the experience of investing makes me more risk-averse with the pension, after all markets are high and there is plenty of hazard. I have an ISA for that racy stuff, and the principles of diversification point to choosing a balancing asset class with different characteristics. An annuity, which is what a DB pension is, has a very different risk/return profile to an equity portfolio.
With a reasonable stroke of luck if I get to the age my parents got to I could end up retired for longer than my working life. Even modest amounts of inflation look like a bastard over that sort of timescale.
If you’re fortunate enough to be offered a higher DB pension start in return for surrendering inflation protection, then look that gift horse very carefully in the mouth. At least consider the alternative of taking a bigger lump sum and subbing yourself until you get the State Pension. I do not need to take more risk to get an adequate income. So I won’t. The words of Warren Buffett on the clever sods at Long-Term Capital Management still echo across the years, though they were uttered when I was a young pup trying to make money in the dotcom boom4.
…But to make money they didn’t have and didn’t need, they risked what they did have and did need, and that’s foolish. That is just plain foolish. Doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense. I don’t care whether the odds are 100 to one that you succeed or 1,000 to one that you succeed. […] And yet people do it financially without thinking about it very much.
There’s still truth in those words. I have no human capital left, so I need to be more careful with my financial capital. The guys from LTCM had the advantage of being young enough to be able to start again5.
- https://www.mha.org.uk/news/policy-influencing/facts-stats/ “Approximately 416,000 people live in care homes. This is 4% of the population aged 65 years and over, rising to 16% of those aged 85 or more.” ↩
- The lump-sum is tax-free so the commutation rate must be calculated on the net of tax value. I don’t give a shit about money the taxman gets, it’s no use to me. This lifts the commutation rate a few percent as tax-free lump sum is more valuable than taxed income. Up to a point, because more tax-free cash also increases my risk profile as some needs to be invested to get an income. ↩
- A few years ago I did try a Monte Carlo simulation using Excel in this post. You have to run multiple parallel traces of data and use the RAND() function. It was enough to convince me that Excel was the wrong tool for the job, and there is limited use in an Excel spreadsheet that gives you a different answer each time you open it due to RAND(). ↩
- I did make money in the dotcom boom, despite churning, having a cavalier disregard for dividends or indeed fundamentals. It was losing it in the bust and quitting around the low-water mark where I went wrong. The training for my future self was cheap at the price ;) ↩
- though it appears that some of ’em didn’t learn from the experience since they went titsup again. Shoulda listened to Warren…. ↩
Simple Living In Somerset 
Trouble is often the DB scheme inflation protection is limited. In my case, a big chunk was RPI up to 5% and then a lesser chunk RPI up to 2.5%. OK, pre-retirement it’s done in a big lump rather than year-by-year, but after retirement it’s done each year. I am not (particularly) worried about inflation of 2.5%, it’s a couple of years at 15%+ than concerns me. At least with the cash in my SIPP I can (hopefully) do better than the 2.5%/5% in low inflation environments and have a chance of not losing so much in the 10% (or 15% or 25%) years.
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It’s always a balance – it is a different type of asset class than equities. A SIPP and a DB pension is a good mix – in my case I have equity investments in an ISA now. But yes, high inflation above the cap is a serious hazard, which is much worse in the early years, because any year where inflation overtops the cap reduces the real value of the pension permanently by the amount exceeding the cap.
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Apparently history suggests that equities don’t protect you from inflation. What they do is compensate you for inflation after the event.
I’ve been thinking about 15% – 30% inflation. That Index-Linked Gilts return 1.5% below RPI inflation (or whatever the figure is today) would be a pain in the neck at inflation of 2.5% but wouldn’t bother me in the least at 25%. So maybe they are a way to insure against 70s-style inflation. Or, and I speak with no expertise at all, perhaps I should buy an ETF of TIPS not hedged into GBP. Can anyone recommend one?
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Ishares ITPS could suit Sir well? You could argue that the TER of 0.25% isn’t stellar, but it’s not dreadful either.
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Commenting on Ermine’s choice of ILG, I hold all my fixed income exposure in this etf partly due to concerns of medium term inflation but more pertinently declining sterling. Over the past 18 months it has done very well due to sterling decline (Brexit + UK persistent current account deficit) but also a decline in US rates. Which is the problem in a way – the duration is 8 years odd so if rates rise then the decline in the fund value might more than offset any inflation. I think Monevator wrote a nice article (as ever) on this. Anyway as someone more clever than me said, ask me what I invest in, not what I think I should invest in. And I invest in this. Just making the point that it could go the other way.
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As an IFA, I regularly deal with this intractable problem. It’s terribly hard to persuade individuals to perceive the difference between big numbers and little numbers where lifetime income is concerned. Most I meet, with a few exceptions, don’t understand ‘nominal’ yields and ‘real’ yields.
Over the last 30 years, I have arranged hundreds of guaranteed lifetime annuities and looking back I can see that the majority were RPI-linked or had a fixed percentage escalation. That’s very unusual as, anecdotally, 90%+ of lifetime annuities purchased by private individuals are ‘nominal annuities’ (thanks, Zvi Bodie), i.e. fixed in payment. Whilst there may well be extenuating circumstances (occupational and state pensions, for instance) and other sources of retirement income, I think that this is a worry; a big worry if the inflation rate creeps up as the price of fossil fuel and food increases.
The FCA insists that pension illustrations assume and RPI linked annuity is bought at the selected retirement age, for good reason.
Don’t get me started on ‘safe withdrawal rates’ in flexi-access drawdown – there are none!
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> 90%+ of lifetime annuities purchased by private individuals are ‘nominal annuities’
From what I saw in my model that’s horrific. I do agree that it’s very counter-intuitive how quickly inflation seems to erode a level annuity. I was surprised how fast it eroded value, surprised enough to start with a blank sheet and try again in case there was some subtle error.
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We each have DB pensions: hurray! But the two principal ones are in the same scheme: boo! If that scheme ended up in the PPF we’d neither of us get any useful inflation protection. Boo and thrice Boo!
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One issue is that increasing annuities (with inflation-linked or fixed increases) are generally more expensive than fixed annuities.
I mean this in purely expected financial value terms (i.e. fair value calculated using mortality tables and long term gilt yields) without weighting for the individual’s desire for security if their retirement is longer than average.
The reason being that there’s more risk for the insurers if you back-load income further into the unknown future as well as it being harder for them to hedge the risks.
I don’t think that’s a calculation most individuals perform when they choose an annuity though – they just see a higher initial pension if they take a fixed annuity.
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I actually think the Monte Carlo scenarios in Excel are pretty good. It’s a feature rather than a bug that you get a different answer each time. It’s the future and uncertain – you’re asking yourself a question along the lines of if I live a hundred lifetimes how many of them would I run out of money. Lars Kroijer has a decent video series on building a financial planning spreadsheet but specifically covers Monte Carlo – maybe worth a look just in case there’s way of looking at this you hadn’t considered.
In excel there are quite a few ways to deal with inflation. When building a pot I think it can be safely ‘ignored’ i.e. just use an investment return that’s post inflation and update the spreadsheet yearly to see how things are going. Otherwise you end up trying to forecast inflation and investment returns decades ahead – pointless. As you get closer to needing to draw on that pot inflation needs much more consideration – I just have an inflation column which is treated as a negative investment return or another tax.
I find it much more useful to try and keep everything in today’s money – you just get a better gut feel by comparing against today’s outgoings.
Regardless of what method is used inflation is a killer. Either slow death over time or an upfront hit when an index linked annuity is purchased.
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@Rob
“…just use an investment return that’s post inflation”.
I like that approach, but I forecast somewhat differently.
Forecast investment return = last 5-year average RPI inflation. i.e. post RPI inflation return = 0.
DB growth (a small but not insignificant amount) = last 5-year average CPI inflation.
Cost and expenses growth (required drawdown ex DB (and eventually ex-OAP)) = RPI inflation.
My reasoning is that this is sufficiently cautious that it makes RIT look like an insane gambler.
Back testing this against (a) 30% FTSE TR + 60% UK 10-year gilts, for the last 30 years instead of (b) RPI, and randomising (a) shows that I should be ok. But no plan survives contact with the enemy, and 25% inflation will screw us all anyway, unless you went to Eton, Oxbridge or are a member of some other elite organisation.
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40% FTSE TR
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> My reasoning is that this is sufficiently cautious that it makes RIT look like an insane gambler.
I have also become more risk averse as I got older. I am happy to take the risk of about 90% equity exposure in the ISA, but the balance of what is basically an annuity in the pension makes that equity risk sit easier with me.
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The whole DB pension scheme was simpler for us in Canada – assuming you have a DB pension. Few do have one anymore.
The only options were when to take it and how much your spouse got upon your demise. No lump sums available. As far as inflation goes my wife’s is fully indexed and I have partial protection.
We are both older than dirt and have done well. I believe that our kids will not be as well off as we are because neither will have a DB pension. My SIL has a decent DC scheme but my daughter wants to change careers and will likely commute her DB pension early.
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I’m assuming you can’t or don’t want to transfer this DB scheme to a DC scheme where you could go into draw down. With UK dividend yields paying about double a 3% escalation pension, and 20% more than a level pension then draw down looks attractive to me. You get to keep the capital too. You could still buy an annuity later if things change.
A current best annuity rates table for age 60 shows that the 3% escalation pension started 43% lower than the level pension. I calculate that it won’t catch up until age 79, and the total payout will only catch up at age 95. Given that choice I’d pick the level pension over the 3% escalation pension.
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I could probably exchange for the CETV and go into drawdown. Big numbers, but I absolutely don’t have the balls of steel to invest and rely totally on the income. And I’ve had a pretty good experience of investing over the last few years.
> With UK dividend yields paying about double a 3% escalation pension, and 20% more than a level pension then draw down looks attractive to me.
You have have more fortitude than I. That might be the right call for some, although my case may be distorted by having the ISA. It already throws off a little more than the 20% extra than my pension in tax-free dividends, so I don’t need to take the extra risk.
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Hindsight is 20/20 I suppose, but I’m grateful my wife and I just collected our pensions. Mine could not be commuted; my wife would have had to quit her job a couple of years before her retirement date to commute hers.
Most retired teachers are either risk-averse or foolhardy. I have heard stories of commuted sums being swallowed up in high fee mutual funds by self-serving advisers, or capital lost in some harebrained real estate scheme. The teachers’ pension plan in Ontario is one of the lowest cost and best-managed funds I know of. If you don’t have to take risks to have a good retirement, why bother?
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> If you don’t have to take risks to have a good retirement, why bother?
Indeed – the Warren Buffett principle 😉
Readers here are probably better qualified to assess their risk profile, but what happened to some poor devils at British Steel is definitely a cautionary tale. You can imagine the scene:
Act 1:
Sharp-suited incoming adviser dude to steelworker “Come with us for you pension and you could get a million pounds”
Steelworker “A million pounds? That’s more than I’ve ever seen in my life. Yes”
Sharp-suited dude “Sign here.” wafts small print that says they take a 30% cut quickly past punter
Punter signs. Instantly 30% worse off. Plus in an ideal world he now has to enter the stock market from a standing start. Sharp-suited dude offers him a hand with that too, in some funds with exorbitant fees and things like land investments in Uganda and windfarms. Nary a mench of VWRL.
Punter looks at massive sum in his bank account and goes out and pays off his mortgage (FFS in a time of low interest rates, just no…, that massive sum needs to generate an income, PDQ) and buys a new caravan and other consumer doodads like this fellow four years from retirement.
Act 3: ex Steelworker sitting in the freezing cold in a bedsit in front of t’telly eating dogfood 20 years down the line
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I’ve never seen the point of an escalating pension. I’d go for level, or index-linked, or drawdown. An escalating annuity seems to fall between stools.
A distant cousin has a With Profits annuity. I can see the point of that for someone who doesn’t want to manage investments himself.
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As ever your thoughtful blog posts get me thinking. I am due to retire in 18 months at 55 and have modelled my finance projections based on taking the 20% actuarial reduction hit on my civil service pension. A lightbulb moment after reading your blog means I will now consider using my DC pot for a couple of years first. I had got into my head that I would be mid 70s before worse off taking pension early and I could do with the money at 55.
Need to think about it a bit more but definitely another option to consider. Think the dread of what Brexit is going to mean has unsettled me and security in retirement income seems more important.
Thanks so much for your posts, I really look forward to reading them.
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> and have modelled my finance projections based on taking the 20% actuarial reduction hit on my civil service pension
Definitely worth modelling running the DC pension flat first. In general you pay more tax if you are drawing your DB pension and taking a DC pension. This is the long form post on that
There are arguments for running both at the same time if you want to smooth your income a bit before your State pension kicks in, but you will pay more tax and have a lower income after 67. Other than that taking an actuarial reduction is usually not ideal, a DB pension is only defined at the nominal normal retirement age (NRA). Pension trustees can hide a lot of loading on actuarial reductions. DB pensions are usually predicated on you living 20 years after NRA so actuarial reductions are normally about 5% p.a (1/20th) though this rises if drawing > 5 years early. Yours sounds par for the course if the NRA for the pension is 60.
One other thing to bear in mind is that when people want to featherbed their feckless adult children then it is possible leave a DC pension in a will. This is not the case in a DB pension, and changes the equation for such cases.
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You could even consider borrowing to help cover the years 55 – 60 e.g. by increasing your mortgage loan. If the return is equivalent to a 4% p.a. index-linked annuity, and the cost is a fixed interest repayment at current low rates it might be a very attractive deal. That might be particularly true if you can arrange that paying back the loan could be attempted mainly after your State Retirement Pension is flowing into your coffers. Nowadays some of the providers will let you run a mortgage until as late as age 85.
One way to look at the proposal is that (a) an excellent defence against inflation is to borrow at a low, fixed interest rate and invest at a higher index-linked interest rate, and (b) borrowing while your income is lower and paying back when it is higher is an attractive way to even out your net income over the years.
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> increasing your mortgage loan.
That’ll be the mortgage I haven’t got 😉 As an impoverished Ermine with a low headline income no blighter will offer me a mortgage. Even explaining the fact that I wanted to buy the new house cash but hadn’t sold the old, owned outright one, didn’t help with a mortgage broker, I had to borrow the bridging loan from my ISA and elsewhere.
But I agree totally, to early retirees everywhere, when interest rates are low, think long and hard about paying off your mortgage particularly in the early (pre-55) days, and make sure you are not on a short-term fix where they will qualify your income when it is low or non-existent, ‘cuz computer will say no. Paying that off early was a tactical error, I was poorer over the last few years and will be richer for the rest of my time because of that mistake.
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Sorry, I should have said I was addressing Anne D. She’s 53 or so and still employed. She presumably either has a mortgage or could arrange one. If she were to take out a loan she might very well have capacity to shovel a lot of it into (say) a SIPP over the next couple of tax years and then take it out again tax-free until she starts her DB pension.
What an opportunity! Mind you, this is a suggestion, not Advice. I’ve read MSE often enough to know that I am not qualified to give Advice.
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Anne: any use?
https://www.theguardian.com/money/2019/sep/16/remortgage-aged-62-bank-equity
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Thanks Dearieme. Both you and Ermine have caused me to spend a lot of time this weekend reviewing my plans (in a good way.) I thought they were pretty much set in stone but I am now going to defer my DB pensions until 60 and live off my D.C. pot first. Before this post I had planned to start them at 55.
The only fly in the ointment re the mortgage is our youngest son is 16 so we don’t feel we can move to where we want until he is at least 18 because of schools. My worry now is that by the time we can move if I am not earning we won’t get the mortgage we require. I think it’s a great idea to defer paying some of it until we are 67 and state pension starts.
Thanks again
Anne
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Thanks very much Ermine and dearieme. You have given me even more to think about. I am currently paying the max I can into my D.C. pot. If you only knew how much time I had spent on spreadsheets looking at my options. Added complication is we rent out a couple of houses so pulling anything over £7k from my D.C. pot, above the 25% tax free with be subject to tax.
We were considering moving after I retire but would need a mortgage to get the house we want. Think we may have to consider this now before I retire in view of what you have said, as our only income in retirement will be my husbands current £20k DB pension and my £10k DB Pension but not until 60, would be approx £8k at 55.
I really appreciate your thoughts. I am an avid reader of MSE and have picked up loads of tips.
Just wish I had learnt all this 10 years ago.!!!
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> moving after I retire but would need a mortgage to get the house we want.
For God’s sake get the mortage before you stop work. The finance industry has no conception of capital – anybody needing to borrow money is a wage slave with no savings, ‘cuz why would they need to borrow is the thinking. If necessary pay the exit penalty, and don’t take a short-term fix, else you will be in trouble when the term is up. You will get ‘Computer says No’. I had a fully owned house on the market and over 50% of the purchase price of the new place, the sale of the old place would have been over paying off the capital. No mortgage broker wanted to know, because I have no income. I had to borrow from myself in the ISA. Don’t do that to yourself 😉
You could, of course, choose to liquidate one of the places you rent out, which would give you more working capital and reduce your aggregate tax rate. You could maximise the DC pension utility. An offest mortgage lets you realise a better interest rate from capital that using savings rates, if you will be calling on the capital in two years it doesn’t really make sense to put it in the stock market.
Deferring the DB pension till normal retirement age is usually a good thing, it is only really defined at that point. As AlCam observed any flexibility you take with a DB pension is not unfavourable to the pension scheme, the corollary is that it tends to be unfavourable to you.
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Early retirement factors (and for that matter late retirement factors, too) are often said to be actuarially neutral. So definitely not unfavourable to the scheme!
The cynic in me however tends to sympathise with Ermines sentiments that “Pension trustees can hide a lot of loading on actuarial reductions”.
For what it is worth, my own view is that taking your DB at the NRA (if you can bridge the “Gap” from date of quitting to NRA) is the best plan because (a) this approach maximises your safe (if you like floored) income when you get older and will be less able to flex; and (b) gives you the most opportunities (inc. taxation, etc) in the “Gap”.
One possible draw back with this approach (that clearly really bugs Ermine) is that during the “Gap” you may appear to some systems to have no income. However, IMO if you are drawing sufficient funds annually from a DC / SIPP scheme this may not actually be the case – I cannot actually say if this is true as I have never actually tried to borrow or apply for additional credit during the “Gap”.
There is also the risk of the DB scheme hitting the rocks before you draw a penny from it – but I guess this is quite unlikely for a civil service scheme!
Other things to look out for are DB revaluation whilst deferred and any issues with DB death benefits during deferment.
Lastly, as usual, please DYOR.
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> However, IMO if you are drawing sufficient funds annually from a DC / SIPP scheme this may not actually be the case – I cannot actually say if this is true as I have never actually tried to borrow or apply for additional credit during the “Gap”.
It really is a problem. BTDT. I had a decent amount saved in AVCs. I sprang that into the SIPP I had been using ever since Osborne’s pension freedoms. Took the TFLS, I think that went into the ISA, then started running the SIPP out at whatever the personal allowance was for the year, less anything I earned. I tended to do that as about £1k in one month to initialise the tax coding, then pull out the rest towards the end of the tax year when I knew how much it should be.
Lenders don’t like that. They want payslips. Then I wanted to move. Talked to a couple of mortgage brokers. Yes, my income was the personal allowance, because I don’t like paying tax. And I have savings. They don’t like that one bit. I am on the poverty line, probably living under the railway arches in their minds.
Really, just assume you won’t be able to borrow money in the Gap unless you can show a respectable income. Above all if you do carry a mortgage through The Gap, then don’t use short year/two year fixes that revert to the lender’s SVR in the gap, because you will be a mortgage prisoner even though you would be perfectly able to pay. It’s all about income, because 99.9% of Britons seem to live paycheque to paycheque and the reason they want to borrow money is to spend more than they earn. It’s just not something systems know, people wanting to borrow money to manage tax liabilities, or keep capital invested or whatever. If you’re one of those edge cases you are just SOL. If I look at my credit score it is fine, well above average. But I probably wouldn’t be able to get a mobile phone contract or a new credit card. MBNA refused me an increase when I wanted to use an offer of theirs to carry spending over a tax year to be able to use the entire ISA allowance.
One of the benefits of taking the DB pension is that I will return to the land of the living as far as finance companies are concerned – because I will have a decent monthly income, and finance institutions understand monthly income 😉 But of course I will have passed through The Gap, which si the very time that I wanted that flexibility
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About to link to you sir, and that is a very weird slug you have on this here post:
https://simplelivingsomerset.wordpress.com/2019/09/12/__trashed-2/
Hope it’s right!?
Good luck with your deliberations. I fear pensions without inflation-linking (such as mum’s — not my choice, and arguably wouldn’t have been my father’s if he’d known how the dice would roll) but it’s worth remembering you have your own house as a massive hedge against cost of living inflation.
Shame you don’t have cheap fixed-rate debt but hey ho, pros and cons there obviously. 😉
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Oops, my bad – thanks for the link and heads-up. Sorted. That’s learn me to start with some old stuff 😉
Interesting differing perspectives in the comments here, the younger folk are more gung-ho, older ones not so much. I guess it’s the way of the world since forever. I still have the ISA for all that racy stuff…
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I’d like to say “with age comes wisdom”, but of course, the reality is, to quote the Sage “It’s insane to risk what you have for something you don’t need”.
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Is there a chance someone will take away the inflation index from you in the future? Either by jiggering the inflation formula or unilaterally canceling the indexing?
I ask this because in the USA our politicians are forever trying to deny the pension promise made to government workers. As an early retiree from government work, I have to consider the case.
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“Is there a chance someone will take away the inflation index from you in the future? Either by jiggering the inflation formula …” It’s happened already. When Gordon Brown was Chancellor of the Exchequer he announced that the old Retail Price Index was double plus ungood, and introduced the Consumer Price Index which was compatible with EU habits and had other supermanlike merits too. As the papers pointed out, it practically always gives a lower measure for the inflation rate (on average 0.8% p.a. lower) and has since been adopted by almost all pension schemes that had the legal right to switch to it. (Some, apparently, didn’t have that right.)
“… or unilaterally canceling the indexing”: if my principal DB pension falls into the care of the Pension Protection Fund it will lose practically all its inflation protection. So will my wife’s. Scorchio!
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> Some, apparently, didn’t have that right.
Mine is one of them, though it’s not for the want of trying on The Firm’s part. I am more chilled about the risks of the PPF. Sure, there’s always a chance of something going titsup, such is the way of life. I think I can avoid dogfood with just the income from my ISA and the State pension, since I own mortgage-free.
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@Anne~: new comment from me to you, up above in wrong spot.
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It’s ‘fun’ to look at the problem from the other side, what outgoings can you fix?
House is the biggie, renter’s biggest outgoing is inflationary, owners not so much.
I managed to talk myself into a National Trust Lifetime membership, partly on the basis of it handily beating an equivalent annuity. I know you’re an English Heritage man, the same principle applies.
One of the internet meal companies are guaranteeing never to increase their prices for me.
Err a water butt decreases your exposure to water price inflation?
Once you’re an OAP a whole world opens up, 10% off at B&Q, OAP specials at the chip shop, free buses, so in the medium term you do actually have deflationary pressures.
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> National Trust/EH lifetime membership
The Torygraph tells me that I should wait to 60 for that although I think EH have changed organisational structure since 2014. And the inflation shows in the numbers…
> a water butt decreases your exposure to water price inflation?
I’ve got two of these, took them with me from the old house so the marginal cost is low. But I’m not gonna drink that stuff. No. Just no. I did know a fellow in Lancashire who used a 12V pump to fill his toilet cistern from rainwater. But that’s Lancashire, it doesn’t rain that much here, we run out of water for gardening in the summer even with two.
Round here the bus pass is at State Pension Age, so it’s a way off yet
> One of the internet meal companies are guaranteeing never to increase their prices for me.
Counterparty risk is in there – the restaurant biz isn’t known for business longevity!
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All options I have ever examined in DB schemes (by which I mean (tax free) lump sum by commutation, pension increase exchanges (PIE), and CETV’s) seem to be calculated to reduce the schemes actuarial liabilities.
That is, as far as the scheme is concerned, it never loses no matter what option you select.
On the other hand, there are some specific circumstances where you as an individual may actually win.
That is the scheme can afford to work with the statistics of large numbers, whereas you as an individual “only get one whack at the cat”.
One option you have not mentioned is a partial CETV – if this is available from your scheme then it may be more cost-effective than lump sum by commutation. However, CETV’s always effect the spouse pension while lump sum by commutation may not.
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> there are some specific circumstances where you as an individual may actually win.
Most of them are pretty rough. I am very happy not to have health issues (fingers crossed, touch wood etc) that would make CETV more attractive ;). The Firm has no taste for extra paperwork. I would have preferred to only transfer some of my DC AVC (to increase the lump sum later) but they weren’t having it, it was all or nothing sonny Jim. Which is why I had to invest some of it.
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Agree that most circumstances where you as an individual may actually win are pretty grim. However, it could be that taking a PIE option (and/or a CETV) could be, at least, a partial mitigation to a subsequent PPF “haircut”, irrespective of health, etc.
Re partial CETV’s, I agree they are not yet widely available. However, some schemes are considering offering them (or at least amending their scheme rules to allow them to be offered in due course) and it may be worth a letter/phone call to find the current state of play with your own scheme. Currently, using a partial CETV to take a lump sum is generally far more efficient for you than going the commutation route. But, depending on the rules of your scheme, the commutation route may not have a detrimental effect on spouse pension.
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I’ve pretty much rolled the die. I have scheme-specific reasons for being particularly chilled about the PPF risk. But I was totally surprised that the commutation doesn’t hit the spouse pension, which seems against logic. I knew one fellow who had bowel cancer around 60 as he was taking this decision and hit the commutation hard, to the benefit of his wife who inherited the lump sum and whose pension was unaffected. Fingers crossed eh – this fellow was fit as hell and could power a bike up hills I’d have considered pushing. But his stress levels were off the scale.
I have the suspicion that stress is the killer in your fifties and up, judging by the small piles of earth that once were colleagues and friends that you get to stand by and think is this all there is to a human life?
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> I’ve pretty much rolled the die.
OK, got it
> I have scheme-specific reasons for being particularly chilled about the PPF risk.
That sounds like a good place to be
> judging by the small piles of earth that once were colleagues and friends that you get to stand by and think is this all there is to a human life?
Gets me every time too!
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And one last Q if I may – how do you feel now about the idea of using the tax free PCLS to pay down your mortgage?
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Not sure if this was for me or for AnneD. It would have been a terrific idea to carry the mortgage through until drawing the pension, my lovely offset mortgage would have allowed me to borrow money through the 55 to DB pension gap etc etc. But the fearful younger me paid it off around 50 because I saw that my career was burning out and wanted to batten down the hatches. It was a foolish move but fear makes people do stupid things.
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It was for you. And thanks for the feedback to my comment to AnneD above. I appreciate the further details you provided. My SIPP drawdown approach is similar to yours – albeit I am paying tax at basic rate.
I also keep a fair bit of cash at hand to deal with emergencies, etc in The Gap. Opportunity cost vs liquidity is how I looked at this, and, IMO, liquidity wins every time! Liquidity seems to often be over-looked in the blog discussions on [early] retirement.
I guess what it all may come down to as far as lenders, credit cards, etc are concerned is what (to use your words) is “a respectable income” during The Gap. Or, if you want to play it even safer, as you suggest, do not plan to borrow in The Gap.
I paid off my main mortgage somewhat earlier than you did. The average rate I paid was a bit over 6%. However, irrespective of the rate paid, I know that achieving that milestone had a transformative behavioural impact – and had I not done it, I would possibly not have progressed to the obvious next stage, so called FIRE. Thus, I am afraid I cannot agree that it is foolish to clear your mortgage early. Having said that, knowing what I know now there are plenty of other errors I made along the way – but hindsight is always 20/20!
Also, I do not view PCLS from a DB scheme by commutation to be good value at all – even if it is tax free!
I reckon the best way to look at all of these things is to try and avoid strategies that would keep you awake at night; and that will vary quite dramatically from person to person.
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> Opportunity cost vs liquidity is how I looked at this, and, IMO, liquidity wins every time! Liquidity seems to often be over-looked in the blog discussions on [early] retirement.
With you on that too. I carried about three years of essential running costs in cash until recently. That’s insane by many people’s reckoning, but a fellow who is living off capital in the gap that is otherwise 100% invested needs that sort of buffer to avoid the hazard becoming a forced seller. Most stock market crashes come back in that sort of period, though the dotcom crash was a very protracted grind out from the low-water mark, worse than the GFC I think. Had that happened to me when I was six years from drawing the DB pension I would be a lot poorer now, even with the three year buffer, and drawing that down to the ground in the end would have been tough on the nerves.
> The average rate I paid was a bit over 6%.
That changes the paying off mortgage equation totally. And although I do look enviously at the young ‘uns with the heady attitude Can you afford not to have a big cheap mortgage [to invest instead] I am not Monevator, I have no human capital left and while competent I don’t have his talent or passion for investing. So I should play it safer than him because I am me and not him.
Another issue with carrying a big mortgage through the Gap is that if you do want to move then your income gets qualified. It’s quite likely that someone may want to move from a high-cost more job opportunities place to a lower-cost fewer job opportunities but greater natural beauty/better leisure amenities place. If you need to carry through the mortgage for that then you will be requalified for affordability and may find yourself stuck in the old place.
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I think your being overly critical of yourself regarding paying off your mortgage. I did exactly the same thing, but the sense of relief, of freedom, of throwing off those shackles, outweighs any restrospective “if only”. At least it did for me.
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> That’s insane by many people’s reckoning
In which case I am completely barking, and then some!
Personally, I am not a fan of SWR (4%, 3.25%, etc), and am more inclined to the so-called Floor & Upside
approach, with the initial objective being to Floor “The Gap”. DB and SP then provide the Floor for the rest of life!
This bifurcated approach does cost significantly more but, at least in principle, takes a lot of risk
off of the table.
One of the key factors to consider in assessing required liquidity is the length of “Your Gap” and what major changes
you may want to make during that time.
Of course, reality will intervene and inevitably your plans will change, so also trying to make financial decisions
that retain flexibility and/or are easily reversible (irrespective of the state of the markets) is also key.
But as I said before, each to his own!
> Another issue with carrying a big mortgage through the Gap
I get your points, but my view is just eliminate the debt before you “jump ship”.
Out of interest, Mike Rawson at 7 circles (https://the7circles.uk/) reckons that:
a) debt increases sequencing risk EVEN IF returns exceed debt cost;
b) debt only really works well when you do NOT need it; and
c) owning your own home reduces sequencing risk.
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“Also, I do not view PCLS from a DB scheme by commutation to be good value at all …”
It was for us. I was (unusually for me) supremely optimistic that I’d find an investment that would return much more than the pension income I’d given up. And, by God, I did! I discovered that deferring the old-style State Retirement Pension would give us a return of 10.4% extra pension for each year of deferral. But the comparable figure for the loss of DB pension by commutation was about 5.5%. Roars of jolly laughter!
There were also second-order effects that were entirely in our favour. For example, deferring SRP also gave us non-negligible “pay rises” on our DB pensions (for arcane reasons I used to think I understood but can’t now remember) – partly temporary and partly permanent. Commuting pension let me avoid a marginal income tax rate of 33% because of the now defunct “age allowance trap”. And part of my wife’s extra SRP comes to her tax-free because in the interim the Personal Allowance against income tax has been increased a lot. (In other words we’d shifted a useful amount of income from me to her with a resultant tax advantage.)
All-in-all, spitting on my finger and holding it up into the wind, closing one eye and squinting with the other, I estimate the net effect was as if Odin had said “here you are, laddie, a hundred thousand pounds of free money – spend it on an index-linked annuity, eh!”
\
In our world a hundred thousand gratis is a hell of a lot.
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There is another advantage I forgot to list. Had I not commuted, my bigger annual DB pension would have ceased with my death. But now when I die my widow retains all her extra SRP and she inherits 90% of my extra SRP. So on my death it will be as if Odin will say “here you are, lassie, another hundred thousand pounds of free money – spend it on an index-linked annuity, eh!”
It’s maybe not too surprising that the deferral deal on the new-style State Retirement Pension scatters much less largesse in the pensioners’ direction.
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Re new state pension – and as far as I can tell no inheritance of spouses pension either!
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Good one – as usual the devil is in the details!
Will you get the old state pension deferral rate?
By my calcs £ for £ taking a lump sum by partial cetv (if available) pays getting on for twice what would be paid by commutation!
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My apologies I failed to notice that the response was from dearieme and I addressed my responses thinking I was speaking to ermine, doh!!!
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My husband and I have spent the weekend looking at properties and have arranged to get the house valued as thanks to Ermine and Dearieme have realised we need to decide if we are going to move whilst I am still working if we want a mortgage.
Now I need to consider should we get repayment mortgage or see if we could get an interest only mortgage. Our income once retired from 55 to 67 will be £47k increasing to £63k at 67. Current income is £65k.
We reckon we need to have an income of £38k to have the lifestyle we want not including any mortgage payments. It is tempting to try and defer paying off the majority of mortgage until after 67. Not the norm I know as everyone seems to talk about paying mortgage off as soon as possible. However the nice residential area we currently live in is going downhill as there is a plan to increase number of trucks going near our house as they extend the port in Liverpool as they travel to Motorway network. This is our chance to move to a village location near a beach.
Sorry for War and Peace, and thanks again all.
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> It is tempting to try and defer paying off the majority of mortgage until after 67. Not the norm I know as everyone seems to talk about paying mortgage off as soon as possible.
I have been cynical on occasion about retired people with an IO mortgage suddenly acting all surprised when they find need to pay down the capital. However, there’s nothing wrong in interest-only if you have the funds (PCLS?) secure to discharge the capital at a later stage. The capital stays the same in nominal £ terms, it does not increase due to inflation, so as long as your PCLS+savings are good to cover it then IO is fine, and will smooth your income more to DB+SP time. Back in the day, paying off your mortgage was the canonical thing to do with the lump sum, although that has somewhat gone the way of the mortgage burning party.
What you do need to avoid are fixes with a duration that end in the interregnum between leaving work and getting your lump sum to pay it off, if your income is lower in that period. You also need to be wary of making a plan to move in that interregnum, because I believe even if you carry over your mortgage from one house to another, the property the the mortgage has a charge against will change so the mortgage may need to be requalified. That is another chance for them to assess your income, which may be wanting. This is a question you’d need to ask before assuming you can move with a lower income even if you are porting the mortgage. If you are downsizing then your new mortgage may be smaller so you may get away with it with a lower income, but it’s a hazard that needs planning.
Once you have a mortgage as long as you keep paying it on time and don’t move they don’t usually requalify it against income. Make any changes while you are still working and don’t breathe a word to them about future plans to stop working in the mortgage period.
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Really good points Ermine, I definitely owe you a drink. I have been looking at fixed term rates but based on above would make sure they didn’t run out until I am 60 and my DB pensions kick in . I have a repayment strategy for interest only, well several I suppose. We could use my pension lump sum to pay off part, we have 3 rental properties which we could sell or potentially move into one of them, or downsize.
Though saying that from what I have read it isn’t easy to get interest only mortgages on residential properties. Wouldn’t be the end of the world if it was a repayment mortgage, however would be nice to have more income to spend between 55 – 67 as we always intended to sell off our rental properties as we receive State Pension. Though want to be fair to our tenants and give them a couple of years notice etc.
The plan is definitely starting to come together.
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> as we always intended to sell off our rental properties as we receive State Pension.
Maybe I am missing something here but it appears to me that you are short of income more in the 55-67 period. Logic would lead me to sell at least some of the rental properties at the 55 end rather than the 67 end, or are these totally leveraged? In which case you have a serious hidden risk exposure to negative equity, unless the terms of a BTL mortgage are without recourse.
I will confess a personal prejudice against residential property as an investment class from rotten experience of it early in my working life but even allowing for that it appears odd to be exposing capital to derive a BTL income and then use some of that income to borrow money for your own housing needs on top, where you might be able to derisk your finances by selling up the BTL, foregoing the income but then run down the capital to top up the shortfall in your income between 55 and 67 when you may be in the best of health and be able to use it.
The interest (and repayment) you would then not be paying are a notional income of sorts which would offset some of the loss of income from the rent. After all, as Monevator said, a mortgage is money rented from a bank. Seems an odd way to carry on use the income from charging others rent so that you can then rent the money you need from a bank 😉 There may be external factors I am not aware of, but retirees should be all for simplifying their financial arrangements. Chains of rentals and borrowings make a system with more moving parts and more things that can go wrong.
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My reading of your figs /scenario suggests
a) c. £17k pa (for ever) from non db/dc sources (I refer to this below as other income sources)
b) the figs you mention are gross – ie before tax.
c) if you take on the IO mortgage you will be on the hook to make the interest payments until at least 67 ie 12 years (are fixed rate mortgages available for such periods?)
Assuming this is roughly correct, may be worth you considering some stress test scenarios, e.g. other income sources dry up/reduce for a period, one person passes in the interim (survivor(s) needs are usually somewhat >50% & you would lose one tax free annual allowance, too), period of rampant inflation, unexpected but recurring need to spend somewhat more than forecast (38k + IO interest payments pa), unfavourable tax changes, interest costs increase, etc to see if the plan is robust to such risks and/or combination of risks, before committing. That is, I guess, more spreadsheets!
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While there is a lot to be said for stress testing, it’s also worth remembering that most people are in better health at the start of retirement than at the end.
My 52-year old self was overly fearful, both paying down the mortgage before I left work (D’oh) but also possibly underspending over the last few years. Now that’s not such a terrible thing, getting shot of the stress of work was the big win and has probably been good health-wise. I have been fortunate to not experience health problems so far.
But it is worth bearing in mind that there is such a thing as excessive caution, and unfortunately the Gap tends to happen over people’s likely period of best health. So you may need enough to cope with any of those scenarios, but not all of them.
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@Al Cam
“am more inclined to the so-called Floor & Upside approach, with the initial objective being to Floor “The Gap”. DB and SP then provide the Floor for the rest of life!”
My plan is similar – my Gap will likely be between 10-12 years. However, I currently don’t have a residential mortgage and from what Ermine says, I’d need to get one (if I want one) before I jump ship, so it’s possible that not all of my debt will be eliminated.
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The F&U approach does not seem to be written about much in the UK.
The main idea behind F&U is essentially “safety first”.
The best source of info I have found is the US book: Retirement Portfolios by M Zwecher. The book is at times a tad technical, but IMO is full of good stuff!
There are also some good US blogs too.
Translating US info to the UK context may take a little bit of effort, but is generally not too hard.
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Thanks Ermine and Al Cam.
We currently have about £100k equity in the 3 properties and after tax clear approx £10k per annum profit. My probably naive thoughts are to take the £10k income over 12 years, then sell them to release the £100k equity. Whereas if I sold them now I would make £100k I would forgo the £10k per annum income.
Though I stupidly hadn’t considered potential for interest rate rises on the 3 rental properties as well as our residential property.
Our actual net income when I have worked it out if I leave work at 55
£20k husbands DB
£12k per annum from D.C. pot of £60k. Changing to DB Pension of £10k at 60.
£10k rental income profit
TOTAL £42k per annum from 55 reducing to £40k from 60 -66
From age 67 increases by approx £15k net SRP, though won’t have rental income.
£20k husbands DB
£10k my DB
£15k. SRP
TOTAL – £47k.
Apologies I got it totally wrong saying our income was £63k at 67 as was still factoring in rental income.
Our current outgoings on all bills and food is £14k and we would both like an allowance of £10k per annum each for holidays and general spend. £34k, though could easily reduce this by £4K.
Have been really lucky so far with our tenants, they all have links to the local area eg their kids are in local schools etc and we met and interviewed each of them as well as doing thorough credit checks etc. Though I appreciate how easily things can go wrong.
As advised I need to stress test the potential for interest rates to go up etc and one of us dying. After reading Ermine’s house rental experiences will stress test properties being empty etc.
Think we would have to lend about £100k to move to area we want.
I have gone from euphoria to fear at the thought of everything that could go wrong.
Would feel terrible on my tenants if I sold up now as i appreciate them as good tenants and I know they appreciate us as landlords eg everything in excellent order and let them decorate as they want and charge a fair rent. Can you tell I am not very business minded!!
Really appreciate all the advise.
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A further thought – is your property equity figure gross or net of CGT? Usually, only your main home is exempt!
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Al Cam – The £100k is net of CGT. So hoping the properties will provide an income of £10k per annum for next 12 years. Then realise at least £100k when we come to sell based on today’s values.
Though I take Ermine’s point that we could sell the properties now for £100k which would be enough to pay the new mortgage off now.
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Thanks for clarification.
As I see it, whatever you do with your rental properties, you will still have a mortgage to pay down on your own home – whether you move or not.
If I were you I would now take some time to review all the info you have gathered and develop some preferred options. Then, run the numbers for them (inc stress tests) and see what that tells you!
Ideally, I would not want to rush into anything irreversible, such as drawing a pension (db or dc) if I was not comfortable with the overall plan.
Generally, the numbers may help, but, I would imagine, that a lot of other factors will play into your final decision making.
Key things to keep in mind are that you do seem to have options – which is usually better than not having any choice, Ermines comments about simplifying matters, and that there seems to be no pressing need for you to rush your decision making.
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Thanks Al Cam. Yes I have been working on my spreadsheets and will not rush into anything. I have 18 months to decide re DC/ DB pensions but at moment inclined to live on DC until DB pensions start at 60.
And as attractive as an IO mortgage sounds now think I would get a repayment mortgage so that when the fixed term is up on our DB income would be sufficient to get a new mortgage.
One of the reasons why I think we should do it sooner rather than later is that there is likely to be a redundancy scheme in work soon that.
Though if that happened we could still move to the area we wanted but would have to cut our cloth.
Really appreciate the advice.
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To Ermine:
In the discussion above are you primarily writing about:
a) a conventional mortgage that needs servicing each and every month until paid down;
OR
b) a line of credit, facilitated via a flexible mortgage, that could provide temporary borrowing (similar to a bridging loan) for a, hopefully short, period of time?
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w.r.t. Anne D’s I am puzzled by carrying a res mortage while owning three res properties but carrying an (unspecified) leveraged risk on the mortgaged part of the BTLs. I know everybody in the UK thinks res.prop = money tree and 95% of the time it is. But a 4x higher than normal res property exposure in the second half of life seems a high risk to carry, though I appreciate there is an associated income stream.
An IO mortgage, or even a regular one, where the PCLS can be set against the capital repayment is OK IMO because the capital remains the same in nominal terms. Even if the value of the house falls to 50p, you still have enough to clear the principal.
You tend to be short of cash in the Gap, a mortage of any sort set against a defined lump sum at 60 seems a good way of drawing that lump sum forward. It’s not a short period of time, 12 years in Anne D’s case, and the lump sum is consumed to boost income. But it smooths income over the Gap to post-Gap, which improves the lived experience of retirement.
But it’s compicated in this instance by the desire to move two years in the Gap, when the son comes of age and leaves school. The need to take out a mortgage because a lot of capital is sterilised in the BTLs compropises that goal. I was able to move in the Gap because it was a cash sale and I raised the bridging loan from my own ISA and private soures. I would have been unable to raise a mortgage or bridging loan because my income is too low, a mortage broker saw no way forward. I would have been in trouble there if I’d had a mortgage, even if I wanted to port it.
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To Anne D
It is not unknown for some DB schemes to have enhanced terms under redundancy. Maybe another thing to check out too
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We had a mortgage that started life as a conventional 25 year repayment deal, and ended up as a 31 year flexible IO deal. When I retired we owed £200; before we finally paid it off the loan had increased to £20,000. In other words we’d borrowed back a chunk of our overpayments during The Gap.
It might be worth exploring whether anyone offers that sort of flexibility today. I’ve seen references to RIOs – retirement interest only mortgages. Might one of those suit?
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“Mind the gap” & “computer says no”
I have 3 identical BTL properties – only one with a mortgage (lifetime tracker base rate + .25% LTV ~ 60%, them were the days!).
Ideally I’d like to sell one property – the mortgaged one, and move the mortgage (same balance etc) to one of the other properties.
After providing every piece of documentation requested on my income and net worth : HMRC past 3 years, pension, investments etc that were approx 4x my total mortgage debt (I have a residential mortgage too) – the final comment was “the underwriters said no”.
After this comment I didn’t even bother enquiring about moving myself – although I did have a 10 minute fantasy about having an asset/leverage mortgage along the lines of fvL.
It’s a real PITA being unable to juggle finances whilst being asset rich(ish) and income poor.
Anyway – Suffolk isn’t that bad.
Regard
B
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My take on the question I posed to ermine above goes as follows:
Carrying a conventional mortgage through a period that is largely funded by a systematic withdrawal plan is not without risk. The potential impact of the risk is related to the size of the mortgage payments relative to your other nominal spending. On average it will probably work out ok, but not for all cases. As usual, forewarned is forearmed and taking this risk may or may not pay off! A good and IMO even-handed analysis is contained in Big Erns safe withdrawal work (part21) – see earlyretirementnow.com . This work is the main input to Mike Dawsons conclusions that I summarised above.
With regards to carrying a line of credit (LoC) to manage an unforeseen liquidity shortfall in the period in question, this is a similar but different case. At one extreme if the LoC is never used then it is risk free, but if it is constantly used from day 1, then it is the same as a conventional mortgage. Intermediate LoC situations obviously lie between these 2 extremes.
For either a mortgage or a LoC, the message seems to be that these need to be established, with a view to the duration of your Gap, prior to jumping ship.
As I see it the safest strategy, but by no means the only strategy, is to be debt free through the period.
For example, if the period in Q is funded using something more like a floor and upside approach and the mortgage payments are fully floored (with no need for inflation protection) then the risk is contained.
As ermine and boltt have both explained liquidity during the Gap is very important and acquiring debt (albeit even for a short time to fund any shortfall) is extremely difficult if not impossible during the Gap.
“Mind the Gap” is clearly a good suggestion!
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Hi all,
many thanks for your helpful advice and explanations. I have definitely took it all on board and am trying to persuade my husband that we should look at pretty much like for like price wise properties when we move. We have a 5 bedroom house with only 3 of us at home so although houses are more expensive where we are looking could easily downsize to a 3 bedroom. we are getting the house valued on Thursday!!
For any mortgage we do require I will get a repayment mortgage so at least the balance will have reduced when we come to remortgage.
I will also consider selling properties as tenants leave.
I was talking to a self employed builder this week and he is trapped in an IO mortgage. He is paying £700 per month on a balance of £85k with an interest rate of over 4%. He has tried to change to a repayment mortgage but they have told him he does not earn enough. A sobering story as his mortgage is due to end in a couple of years.
Thanks again, I am not looking at the lovely detached properties any more.
Plus I may have to think the unthinkable and work longer than planned, though think I would rather be poor and less stressed.
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A speculation anent Ermine’s Conundrum:-
Suppose you want a mortgage loan but are rejected for lack of income even though you have quite a bit of capital. Could it work to buy a fixed term annuity – say, one that will last until a DB pension or a State Pension will begin?
To the bank it looks just like income because it is indeed guaranteed income. To you it’s just a combination of returned capital and a little bit of interest. If it’s bought with money in a DC pension then it’s taxed in the obvious way – it’s a bit like drawdown but the bank will be cheered up by its guaranteed and regular nature.
If it’s bought with spare non-pension capital then it would be a Purchased Life Annuity, which means that the bit that’s treated by HMRC as return of capital is tax-free, and the bit treated as interest can exploit the Personal Allowance and Savings Allowance against income tax.
Of course you might argue that someone with the capital to afford this wouldn’t be looking for a mortgage in the first place, but might there be niche opportunities where it might make sense? Any views?
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That would be one way to floor the mortgage payments – but at the cost of, at least, no flexibility!
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Really useful post, thanks for sharing.
It’s great to see such a well informed debate about these sorts of things. In my work as a Certified Financial Planner, I rarely find that clients understand the difference, and even if they do it’s rare that they appreciate the impact that inflation can have over time.
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Somewhat late in the day: an advantage that some DB pensions have (I don’t know how common it is) is that they offer “allocation”. You give up a bit of your monthly pension so that your widow will get extra pension once you’ve snuffed it. In our case the ratio offered was approx that the surrender of £100 p.m. (index-linked) generated an extra £400 p.m. (index-linked).
For a couple with unbalanced pension provision it can be rather handy.
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Dearieme – that sounds a good idea, though don’t think it works for my DB pensions. My oh has a police pension and if he dies first then I get over two/ thirds of his pension so financially very fortunate. He would be entitled to 50% of my civil service and NHS pension.
We also have life insurance, quite a lot on his life, so joke about how he is worth more to me dead than alive, in a purely fiscal sense of course. I keep telling him that I will go to the Bahamas to grieve.
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Well I know I said I would stress test my figures with regard to increasing our mortgage if we move, but fear I may have let my heart rule my head. We have put our house up for sale and been offered full asking price of £225k. We went to see several houses in our chosen sea side village and have had an offer accepted on a lovely, modernised detached house for £267,500. Really is a lot cheaper “Up North.”
Our son has been surprisingly ok about the move, he can stay in same school etc and think he appreciates himself that it is a much nicer area we will live in.
Our monthly repayment mortgage payments won’t change, though we will now be nearly 75 by the time we pay it off instead of 65.
We are going to borrow another £45k to fund the purchase.
We have taking out a 5 year fixed term mortgage and I will consider taking my DB pension at 59 if required to provide the necessary income proof. Though we may have enough income not to have to do that.
For now I will continue to save max allowed into my DC salary sacrifice scheme.
If the interest rates did rocket, then my husband will have to consider returning to work, in some capacity.
Most important thing for me is to move away from this busy main road. Hope I am still saying that when I have my 50/60 minute commute in to work!!!
Thanks for all the advice, your blog and the Comments has been the catalyst for some radical decisions for my husband and I.
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Nice to hear your update. Hope it all goes well for you & your family.
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To Ermine,
I think I may have inadvertently come upon at least part of the real explanation for why you and Boltt had such bad (re-)mortgage experiences. And also why FvL could proceed the way he did with his “dream house” purchase.
Please see the chat between myself and Mike Rawson earlier today at https://the7circles.uk/weekly-roundup-13th-january-2020/
I have also done a bit of follow up work on Mike’s statement that “you can’t borrow against tax-sheltered accounts” and from what I can find it certainly seems to pass muster.
Why somebody did not just tell you this at the time does seem a tad odd though?
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It could be, although I think they wanted to give me the bum’s rush as soon as they heard my age and ‘no income’. If you look at FvL’s profile it’s a much more dynamic, younger and to be honest better bet all round, I’m not sure you’re comparing like with like. Oddly enough I would be in a much better position now – pension income is provable and I am unlikely to be made redundant from a DB pension. But I don’t need to borrow money. Ain’t that always the way…
Is Mike’s statement “you can’t borrow against tax-sheltered accounts” a general case? I know you can’t borrow against a pension, or indeed foreclose a debt against a pension because they are supposed to be inalienable. The reasons for that are understandable. There seems no obvious reason why this should apply to ISAs.
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Re ISA’s: FWIW I would suggest that you take a look at
https://forums.moneysavingexpert.com/showthread.php?t=3191506
Personally, I would far rather believe rational reasons had been applied to your case than judgmental biases.
I do, however, generally live in the real world!?!
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> I would far rather believe rational reasons had been applied to your case than judgmental biases.
In fairness I only rang up one mortgage broker, and they gave me the answer I kind of expected anyway. I had another way to raise the difference privately, but it was a bit more aggravation.
Age is a fair enough judgemental bias, I have no complaints. FvL clearly has more human capital than I. What I was after was more like a bridging loan but for several months, and I didn’t want to pay the cost of a bridging loan. I also wanted a route out should the property market turn against me. I view residential property as a dangerous illiquid and evanescent store of capital rather than a money tree, purely from my experience.
Interesting that there is this embargo on ISAs too. I am pretty sure that I recall PEP mortgages and ISA mortgages in the 1990s and early 2000s where the capital was secured on an ISA in a similar way to endowment mortgages being secured with a charge on a with-profits fund. For example this article from 2009, so something must have changed since then.
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I vaguely remember pension mortgages. If I recall correctly these were only accessible via a business – so not available to the man in the street. In fact, I knew somebody (who was a self-employed contractor) that got into rather a tricky situation with his pension mortgage. With hindsight his situation was probably not that different to those people with interest only mortgages that have apparently only just realised (as they retire) that they have to pay back the capital.
Personally, I fell foul of the endowment trap with my first mortgage – but never again!
Later, one of the most impactful lessons I ever learned was acquiring a spreadsheet that demonstrated the power of over-paying a C&I mortgage.
Thus, to this day, I remain firmly of the belief that you should pay off any mortgage you have just as fast as you can.
BTW, FvL seems to have raised his money using a margin loan backed by his, presumably taxable, IB portfolio. I am not therefore really sure if his age / potential HC played such a significant role!
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Seems there might just be a bit more to the ISA side of this story:
Comment 32 to this recent Monevator blog (https://monevator.com/how-pensions-will-help-you-reach-financial-independence-quicker-than-isas-alone/comment-page-1/#comments) caught my eye earlier this week, specifically
“another trick with (cash) ISAs that very few people seem to be aware of is that most mortgage providers allow you to offset against them (or at least did a few years back).” This seems to be confirmed, at least to some extent, by Barclays bank at https://www.barclays.co.uk/help/savings-and-investments/isas/offset-savings/. But only applies in Barclays case to instant-access cash ISA’s.
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> You can offset instant-access cash ISAs against one of our offset mortgages
Presumably that means a Barclays cash ISA against a Barclays mortgage. But it’s still a very valuable way to thin out your mortgage interest while not demolishing your previous years’ ISA allowances. Although it’s not yer classic PEP/ISA mortgage of days gone by, they have clearly tightened up on the liquidity requirements.
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this is correct. My margin loans are both on portfolios that are not tax sheltered.
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Re: “Some, apparently, didn’t have that right.”
Please take a look at the comments to this post for the latest wheeze re the RPI:
https://the7circles.uk/budget-2020/
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Hi
Going back to the original article and as a financial planner, the impact of inflation cannot be underestimated. With the prospect of higher inflation for the next few years, I’m sure a number of ex-employees that have transferred out of Final Salary Pension schemes might wish they hadn’t. Some financial planners use cashflow software assuming between 2 and 2.5% inflation. However, data over the longer term shows inflation to be on average 3.8%.
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Blimey. I didn’t realise one you can like your own comment. I’d venture it isn’t quite cricket 😉
However, on your point, heck, it’s only two years after this post and already it looks like my pussycat timid younger self was right not to give up that index linking for a higher start. Which is exactly the point you (and I) made. Well done that fearful younger self, as it turns out. Obvs I have to survive to 70, or perhaps Mrs Ermine make it to 70.
As for taking the CETV, I had a finametrica score of 75 a standard deviation off the mean in the bonkers appetite for risk department. I considered taking the CETV for all of about five minutes before thinking I don’t fancy that one bit. I heard all the good folk talking the tough talk about how it’s such a great deal on MSE etc, and thought I ain’t got the balls to invest that enough to replace the security across 30 years. And do I want to be doing that in 10 years time? And if it’s such a terrific thing, then why is the original pension scheme so desperate to off the job, given it is rammed full of actuaries who have more experience of doing this and the risks than I am. We shall see, eh?
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