The flowers are coming out, there is the sound of the robin and the dunnock singing, Spring is in the air, and along with the snowdrops and early daffodils there are some stories in the press that come round every March/April time. Oyez oyez, it’s the last chance for you lucky higher rate taxpayers to get pensions tax relief. And as for you lot expecting to pay off your BTL mortgages with the pension commencement lump sums, well, better do it now while you can[ref]what with some of the changes to BTL tax relief on leverage there is more sense to that, but for different reasons[/ref]. ‘Twas ever thus
Going, going, gone…It’s the oldest trick in the book
Sale – Must end Now – punters are suckers for a bit of FOMO, and pension providers always like to hit us with a quick giddy-up at this time of year. It’s always the same old story, sometimes it’s the PCLS that’s due for the chop, sometimes the tax relief. That’s not to say that adverse changes don’t happen with pensions, but they tend to come from left field – the reductions in the annual allowance ,and the introduction of the Lifetime Allowance are two, although these only hit the well-heeled. Presumably these well heeled got to be well-heeled because they had the odd brain cell to rub together; if they can’t be bothered to work it out for themselves Merryn Somerset-Webb of the FT is there to sock it to you straight between the eyes.
The result is still up for grabs but one thing at least is clear: the game is up for higher earners. Whatever the new system is, it will further cut the reliefs given to them.
Well, yeah, but it’s going to be more of a whimper than a bang, at a guess – they will be sliced and diced.
The PCLS was introduced in 1988 I think, when the concept of a personal pension came into being, and every year since then the same stores have been trotted out by the pensions industry trying to stampede the rich into getting their money into a pension, like NOW. The poor, of course, well, they don’t save for retirement anyway.
Despite having told HL for the last three years that I am an Ermine of very modest means, less than £3600 p.a. indeed, which is all I can save for a pension, they clearly think I am still one of the movers and shakers with a six-figure salary. As such I got my very own copy of this missive. No wonder HL is so damned dear for holding investments, as opposed to cash, if they have to mail so much cruft out to us all. I have nothing against them, well, apart from them demanding I pay £500 to be advised that transferring my AVC funds was a good idea, something I had worked out quite nicely for myself thanks. I observe they have got themselves into this advice game themselves, nowadays, clearly jobs for the boys is a revenue stream too good to miss.
I am just a poor boy[ref]Irony,dear reader, irony… ‘ere I take heat for being a PT b’stard.[/ref] though my story’s seldom told
There’s a corollary here, which in fairness HL did list in a throwaway paragraph
Quite. Your impecunious scrivener, having failed to avoid earning about £5k can put this into his SIPP for the initial outlay of £4000. I’ve never really understood the status of the remaining £1k, obviously if I had been earning £20k then it would have disappeared into the taxman’s maw, but instead remains to be spent on beer and fast cars, or beaten down stocks. Anyway, the taxman adds the £1k back into the SIPP despite not taking it off me. The speculation on changes seems to vary between divvying up the HRT break into nothing extra for anyone, 25% tax relief for all, 33% tax relief for all, and zero tax-relief for all but the chance to have any gains tax-free in an ISA-like savings vehicle, but presumably one you can’t access before you are grizzled of years. I struggle to see the attraction here. Most people don’t save £15k a year into their pensions, so they may as well fill their ISAs first. The average DC pension capital on retirement is about £100k , elementary arithmetic indicates this is not saving £15k p.a. for 30 years. You read about all the options here. I am not sure that the savers of Britain are ready for a second major overhaul in the retirement savings structure and ethos in as many years without becoming suspicious refuseniks, but there we go.
Should this go the 25% relief I guess I can hope for £1250, so there’s a potential £250 in it for sitting on my backside for a few weeks. Because I am entirely a cash saver in a SIPP, I always leave it to the last minute to contribute, because there’s no point in locking money away before I need to (to get the win of the tax break). Obviously the big money for HL is with the well heeled, but there are crumbs in it for the little sparrows in doing exactly the opposite of what is advocated in that HL exhortation. Indeed, for someone who is post 54 and intending to retire next year, the difference is respectable if they are earning, say £32,000 and toss the lot in. They could get £6400 at the moment going up to £8000 if the 25% tax relief happened. Of course it may not, or it may be deferred, but a potential £1600 would be worth waiting three weeks for. Obviously if you are one of the six-figure vHRT fellows then throw caution to the wind as HL advocate!
Lifetime Allowance, Marginal Tax Relief, Annual allowance – one, not three
I benefited well from higher rate tax relief, but even then my higher rate tax paying years were perhaps a third of my working life. Careers tend to be more contrasty now, they peak earlier, but people also burn out earlier. I’ve already put my colours on the mast for the lifetime allowance, which most accurately defines the ambition of tax-privileged pension savings to my eyes. All this fiddling with marginal tax relief and annual allowances sucks IMO – you should be able to get to the LTA in a couple of furious years in finance or 30 years of steady Eddie saving. It’s about the destination, not the journey.
All the annual and lifetime restrictions combine to make tax-privileged pension saving more suited to your grandfather’s career arc than today’s sort where even the better off are likely to experience feast and famine, or burn out prematurely. Even I would have rubbed up against the annual allowance at the end of my career, and I got nowhere near the LTA.
Erstwhile pensions minister Steve Webb scares the horses on the PCLS
Meanwhile, Steve Webb says the pension commencement lump sum is due for the chop. Well, sort of – if the principle of tax-free pension saving on accumulation is iced, then yes. But those of you sitting on a potential PCLS, including me, this doesn’t mean you have to hook it out by the 16th March. Adverse pension changes are usually trailed at least a year ahead – such as the reduction in the LTA which was announced last year. Positive pension changes sometimes have immediate effect – the announcement of the pension freedoms was announced in March, giving me just enough time to open a SIPP in the old tax year.
Pensions are still giving me a hard time to qualify the opportunities
Say I take my PCLS this April, and start to run out the pension below the personal allowance. Let’s ignore that fact I am earning chickenfeed at the moment, say that is £0. I am still allowed to save £2880 a year and the tax man stumps up another £720. By rights 25% of that should be available as a PCLS – after all, say I opened another HL SIPP which had just that £3600 in it, there would be no quibble. I don’t know if HL are smart enough to be able to track that sort of thing.It isn’t as good as the deal used to be for me, because 3/4 of the tax credited is taken back again, so the gain is reduced from £720 to £180, but it’s still free money
In theory, therefore, even I earned £10k all of which would be taxable at 20% because I am drawing pension income up to the personal allowance there would be a win to pass this through the SIPP. Because of the PCLS I could reduce my basic rate tax liability by a quarter. Paying tax at 20% × 0.75=15% seems like a step in the right direction, saving me £500 in that case. Of course changing to a post-tax savings regime would rain on my parade. Pretty much everything about pensions is hard, counterintuitive and full of wrinkles, that’s the nature of the beast.
The deal with pensions is this. In return for saving money for when you get old, you get to save before tax is taken off. There aren’t many legal ways of avoiding tax, but that’s one of them. The downside is that you don’t get your sweaty paws on the money until you are 55[ref]this age is a movable feast drifting upwards with longevity over the years to come, intended to keep 10 years before state pension age[/ref]. And even then, if you want to preserve the tax-free status of that lump you are rate-limited on the amount you can draw, which is also fitting IMO. My pension savings are worth nowhere near the lifetime allowance, I will still be a taxpayer as a pensioner in a few years.
It costs money to run a civil society, and that money comes from taxation. There are issues in that running that society seems to get dearer and dearer and more and more complex with time, but that is a different fight. Nobody likes paying tax. Nevertheless, that civil society would have to support you when you are old, so easing back on the tax early in your life in return for you being less of a burden later on is the rationale for that deal.
I’m not going to be popular for saying this, since many people affected by the lifetime allowance (LTA) are dedicated followers of Ayn Rand, who feel they have the resources to be entirely self-sufficient and apart from the rest of us lowly scum, but the reason that this tax bung is there is to encourage people to do something they otherwise wouldn’t do. It only needs encouraging up to a point, and that point is okay at £1,000,000. The retired colonels of the Torygraph continually spit bricks about how unfair this limit is because it stops them saving more money into a pension, but I don’t see what the problem is, on two counts.
If you can save a million pounds then you are ‘king rich by British standards[ref]To qualify this, you are in the top wealth 5% if your household has £900,000 in assets from all sources including home equity, so if you are bothered by a £1m pension limit you are embedded firmly in that top 5%[/ref]. It’s not like they point a gun at your head as say you can’t save any more, they simply take the tax break off you for any further savings. So save somewhere else, chump. And pay your tax, you aren’t Google, though by all means plan to pay as little as possible, legally. If you can’t manage the concept and you really don’t like it then there’s a whole world out there…
You can buy an annuity with that £1m of £28,000 p.a. for life rising at 3% p.a (presumably retiring at 65), which is more than the average UK household income for working sorts.
That’s a pretty reasonable limit – we will give you a tax break to save enough until you reach the average UK household working income. Where I do think they are wrong is placing an annual limit of £40k. There shouldn’t be a limit IMO – the £1M LTA one is good enough to define the ambition of what this is designed to do. If you want more, then save more but end of the tax break for you. It doesn’t matter if you earned that £1M in three frenetic years as a young finance wallah or you plodded away for forty years. It’s about how much of an income that will buy you. I’m not that exercised about limiting the tax advantage to 20% either. There’s no big deal in having the rich get there faster, as long as the total tax break is limited by the LTA. Good luck to them – the rich still get old like everybody else 😉 I wouldn’t even limit contributions to earned income, your pension would be a much better place for your inheritance than going into jacking up the price of houses for everybody else.
Yes, it doesn’t greatly favour FI/RE because you need more if you are going to pack it in at 30. But in the end exceptional results need exceptional efforts, and until the robots really do come for everybody’s jobs then there isn’t a huge case for incentivising people to retire early. Contrary to much of the bitching about the LTA if you happen to have saved more than the LTA historically when they dropped the limits from the original £1.8m then you can apply for LTA protection to protect your large pension savings from tax. The deal is then that you don’t take the piss by adding to them. Again, this is fair enough – you aren’t retrospectively shorn of your tax-advantaged hoard. You are already rich enough and don’t need any additional incentive to save for your old age. Celebrate your good fortune and knock it off 😉 Obviously if you survey your domain and decide you did build all that and want to live in Galt’s Gulch, well, er, go and knock yourself out. It appears that the perpetrators of this Randian paradise on earth haven’t solved some of the fundamental requirements of a government, such as defence of the realm…
Contrary to much of the commentary on the LTA you are not stopped from saving on reaching it. You are stopped from saving into a pension scheme and benefiting from advantageous tax treatment on your contributions. So save somewhere else FFS.
As the years roll by the Ermine is becoming grizzled of years, and I have the opportunity of becoming a pensioner rather than an early retiree. In the long glide path from leaving work to getting to this stage I have gradually burned through some of the money I had saved as a wage slave, and just like the aeronautical metaphor, my room for manoeuvre drops as time goes by because the reserves are falling lower.
A while ago I opened a SIPP with HL, to make use of my £3600 p.a. tax-advantaged savings allowance. What with Osborne’s changes, I was going to take a portion of the DC AVCs I saved in The Firm’s pension scheme to add this to my HL SIPP, then take my tax-free lump sum and draw down the rest under the annual personal allowance for five years until I reach the normal retirement age for The Firm.
Now I saved in the AVCs pretty much exactly a third of the notional capital that stands behind my defined benefit pension, precisely for the reason that I could take this AVC as the 25% pension commencement tax-free lump sum, If I transfer some of that I give up some of this tax-free capacity, but I can still draw the money tax-free and before 60, just in a different way from how I designed the idea in 2012. The reason I can do that is Osborne’s changes in April 2014, obviously I didn’t know that in 2012 😉
So I take a butcher’s hook at how to actually do this, starting with their guff on transferring pensions, and I discover that the blighters have tossed rocks all over the runway as I am coming in to land. To wit:
An Additional Voluntary Contribution (AVC) linked to a defined benefit scheme could give a higher pension and/or tax-free cash if not transferred. We normally insist you take advice to confirm it is in your interests to transfer such pensions.
Which s a bastard, because this is not a huge amount of money I want to transfer, it’s a few tens of thousands of pounds. I don’t know exactly how much financial advice is but I figure it’s going to be about £400, most of which is going to be to write the letter on fancy headed notepaper that it’s okay for me to get a hold of my own bloody money. It’s a bit like solicitors who don’t get out of bed for much less than a few hundred if you want them to dirty up some of their nice headed notepaper with their laser printer to threaten some oik.
So basically HL want me to pay about 1% of the transfer to an IFA to cover their arse. I rang them up and outlined what I want to do and why and they said nope, rules is rules. IFA signoff required. So I am now investigating other SIPP providers to see if I can avoid paying swindlers and leeches IFAs for access to my money, but it’s not looking good. I observe that Cavendish Online take a similar line so I may be stuffed on dodging the IFA tax
Unfortunately you will not be able to transfer from any of the following sources:
Additional Voluntary Contributions schemes (AVC) linked to defined benefit schemes
I have only ever taken financial advice once in my life, and it was disastrous
– which is why I am trying to avoid this. Not just to save myself a few hundred pounds, but my only experience of finacial advice stank. When I was 29 and looking for a mortgage the lovely green-eyed LAUTRO ‘adviser’ Sue persuaded me to go for an endowment mortgage, dangling the potential possibility of the endowment doubling. The young Ermine had no dependants and no use for the life insurance. If I had that need, The Firm’s pension scheme had death in service insurance worth more than the mortgage which was the grounds I finally got a claim settled for reinstatement to where I would have been with a repayment mortgage.
However, even if endowments hadn’t started to fall short I was shit for brains to be swayed by that promise anyway. A mortgage term is 25 years, if you take £100 in crisp £20 notes and stick it in your mattress in year 0 then half the value of what you can get with it dies in about 10 years due to inflation, so if the endowment nominally doubles in 25 years you’ve still been stiffed. The Bank of England’s inflation calculator tells me indeed that £100 in 1989 would be worth £222 in 2014 when that mortgage would have been redeemed had I not moved and paid it off early. Precisely what the endowment industry managed to do to screw this up so royally still escapes me.
It was galling for my parents, who had taken the trouble to properly educate me in things financial. Although this is not a job that parents seem to consider part of their domain nowadays, my working-class parents did, and they made a decent fist of it. My parents taught me among other things don’t spend more than you earn son, that the NAV of an IT differs from the share price, and my mother had described to me how a mortgage works down the the detail of the payments being mainly the interest to start with and repayment of the capital speeding up towards the end. They had strongly advocated repayment mortgages and told me why, and with the hindsight of a quarter of a century they were absolutely right, but in the tragedy for parents the world over there is no antidote for youthful stupidity and black-and-white thinking – to ask a 29-year old to qualify the double your money promise against effect of inflation on period of time that is nearly the same as his age is a big ask. It takes time and life experience to turn some kinds of knowledge into wisdom. I had the knowledge, but not the wisdom 😉
Or maybe I was a particular twit. They were strange times, the late 1980s, though the housing market feels the same now, there are people in Britain today who may be on the verge of making a similar mistake…
Anyway, while I now accept that the decision to buy a house then was the dumbest financial thing I have ever done, the amplification of that cock-up through what was basically self-serving and wrong financial advice against my interests makes me leery of the whole financial advice scene. It’s not an experience I feel I want to repeat at a gut level, and it’s not an experience I want to pay for. I guess I can jump over that by reminding myself this was money the taxman would have stolen 40% of, and indeed money that inflation has bitten 8% out of since 2012.
I shouldn’t think there’s anyone reading this who doesn’t read Monevator, but there’s apparently a consultation on about UK pensions. Props to The Accumulator for trying to sift the mutually contradictory desiderata in the comments thread into a narrative suitable for Her Majesty’s Government, who will probably file the results in the round filing cabinet on the floor.
Nobody actually does a consultation to find anything out, they do it to put a veneer of faux democracy on the decision they are going to take anyway. Most of the motivated commenters are richer though not necessarily wealthier than I am[ref]you are rich by the size of your wad and/or income. You are wealthy by how much of your income is committed/how many years your wad will maintain your lifestyle – open-ended for the financially independent. There is correlation but not necessarily causation between the two, because of the astronomical variation in lifestyle costs[/ref], so the issue of the life time average and the annual contribution limits exercise many. I would have been sore about the annual limits as set now but I didn’t have £225,000 handy to put into a pension when I was going for it so I was okay. This isn’t my problem any more, because once I am 55 I won’t have space to avoid paying tax on pensions, so more pension saving isn’t useful to me. In the unlikely event that I decide to become a wage slave/productive member of society again I’ll just have to suck it up and pay tax, as my personal allowance will already be eaten up by existing income. Which is obviously a disincentive to putting my shoulder to the wheel of raising Britain’s dreadful productivity, though I will show later that it appears the Government has already decided I am over the hill in contributing to STEM activities, so it’ll be making knick-knacks on Etsy for me then. Bollocks to that, Iain Duncan-Smith. That’s the joy of financial independence – being able to issue that command.
I paid less tax in my last three years by using pension saving than probably at any time throughout my working life even though I was in theory a 40% taxpayer. Yes it would be nice if I could save more than £3600 p.a. into a pension now and get back the tax, but so what.
The straws in the wind are that the Government want to do for the 40% and up tax relief on pensions, perhaps making it about 33% for everyone, because the people they want to incentivise are basic rate taxpayers, higher rate taxpayers are rich enough to sort themselves out. It’s worth observing that a basic rate taxpayer can get 32% tax beneift if you can save into a pension by salary sacrifice, because the contribution comes off your pay before NI and tax are charged. But that’s for some future budget. Let’s just say that I am not yet putting my £3600 into a pension because if I can get 33% rather than 20% relief it will cost me £2400 rather than £2880. It’s not a huge amount of difference but it’s worth waiting till March 2016 for.
The overall feeling seem to be that the well off and the rich have been making hay on the pensions front and this will get screwed down. In some ways pensions are an odd incentive – the government is encouraging people like me to leave the workforce early, some 8 years (relative to The Firm’s NRA) to 15 years (relative to my State Pension Age), while at the same time hollering that the country is short of scientists and engineers. I am tickled by the casual ageism of the Government’s report on High Level STEM Skills – supply and demand –
However, it is the inflow of new STEM graduates that is more likely to help ensure workers have knowledge of the latest science and technology – retaining older individuals does not do this.
That’s the trouble with those old dogs – you just can’t teach ’em new tricks 😉 Bless. What they are saying is that we need young scientists and engineers – the Zuckerberg doctrine at work.
I have heard the theory that while the artistic side of CP Snow’s Two Cultures deepens and matures with age Zuckerberg may have a point in technology that young people are just smarter – it seems echoed at GOV.UK 😉 I also observe that companies can’t be bothered to train young people in their specialisms these days – to wit:
A representative of one of the major engineering companies noted, “For mechanical engineering, I would agree [there is no shortage]. However, for electrical / electronics, there are simply not enough graduates with the right degree and employers are trying to recruit from a small pool of those with the right degree content (i.e. higher-voltage direct current is a pre-requisite for the transmission and distribution industry: there the supply of graduates is inadequate)”.
You, Mr Representative, are the problem, because of the fecklessness of your company. When I joined the BBC, with their specialism of colour TV, they damn well trained their graduate entry for a few weeks into the intricacies of the subject at their training facility in Wood Norton. You go to university to learn how to learn, and grasp the high-level aspects of your chosen field. Exactly what part of investing in people does this damn company not understand?
The upshot seems to be that the Government wants to spend less on pensions tax relief, and in particular less on pensions tax relief for the well-heeled. This was also a theme of the Coalition government before this one. The Tories clearly have the interests of old money at heart with their fondness for inherited wealth and the iniquity that goes with that encouraged in the Summer Budget, but they are perhaps less fond of the nouveaux riche and their tax avoidance through the pension system. Hence the double targeting of the lifetime allowance, aiming to limit tax-advantaged pension income to about £40k (SWR of 4% on a lifetime allowance that seems to be trending towards £1,000,000, currently £1,250,000) and limiting the annual contribution rate to £40,000. The combination seems a bit rough – elementary arithmetic shows a young pup in the finance industry could just about make it, if he gets his running shoes on and saves the full £40k every year from graduating at 21 to becoming a greybeard at 52 (how many 52-year olds are there in finance?) but he better not want to buy a house, he needs to be prepared to eat ramen in those first few years and not inflate his lifestyle. In practice it’s not quite as bad as that, compound interest typically doubles the real value of savings over a 40-year working life, but it’s not going to be easy to reach the lifetime allowance with the annual allowance.
I don’t understand the double whammy. There’s a case to be made for the lifetime allowance – there’s no need to tax-favour pension incomes of more than twice the median wage, but I don’t really see the point of the annual allowance limitation. And I certainly don’t agree with having both limits in place – one of the other seems okay. People’s careers vary much more than they used to, and the lifetime allowance sets a target of saying ‘this much income can be saved tax-advantaged, no more’. The annual allowance arbitrarily limits the capacity of the feckless Johnny-come-latelys to fix their pension savings in their forties and fifties – not everybody is a Steady Eddie on this.
When I was working, I got a steady income. As two decades rolled by The Firm shifted about 10% of pay towards an annual bonus predicated on a stupid bunch of metrics to reduce pensionable pay, I always treated such bonuses as windfalls for investment – primarily in reducing the mortgage or as ISA feed later on. So I lived off a steady income.
Reading Monevator’s post on investment trusts there is an assumption that retirees need a steady income flow. I’ve always made the same assumption, but on reflection I think this assumption should be challenged, because a retiree’s life is different to their working predecessor. Two things change in a big way:
No dependent children
Retirees don’t usually have dependent children under 18, though this assumption is probably more true for people coming up to retirement now that those planning it in 20 years time. In this country people tend to have children between 20 and 35, with a peak at 30 according to the ONS. People[ref]these people are women, the stats don’t track the guys[/ref] had children earlier in the past, often in their 20s in the 1960s and 70s. It surprises me quite how nonchalant some people aiming for FI are about phasing this. For all the joyful Kodak moments etc, most people don’t deny that children are a big financial cost, and the sooner you get started the sooner you’re done with it – and indeed you will enjoy their company for longer too. A 25-year old having children will be 43 when the child reaches 18, a 35-year old will be 53. For the common two kids with two or three years gap that spans 46 to 56.
There seems to be a recent tendency for children to remain financially dependent beyond 18[ref]The torygraph is pumping this up a little bit. In the 1970s many more children left school at 16 and could find decent jobs, it isn’t so surprising that more children were financially independent when they start earning at 16 rather than at 21 – 11% of school leavers went to university when I was 21 compared to about half now. It isn’t so much the dependent children at 25 that flabbergasts me, it is the late twenties to early thirties crowd[/ref]- if they are dependent through university these ages move to 46/49 and 56/59. The early starter will be more employable, while the late starter could be well finished at fifty and in trouble financially if they want to retire early. They will need more money compared to the early starters just at the start of early retirement, at a time when money is particularly short because they can’t use pension savings – the earliest call on a SIPP is drifting up to 57 from 55 now. There is of course the opposing case to be made that having children impacts one’s career early on so you might accumulate more by delaying. If you’re okay with slightly early retirement (60 and up) then this may work out well, as you are into SIPP territory then.
Lower general running costs including housing
One of the things that clobbered me in my twenties was moving so often from one rented place to another – the Guardian’s Jenn Ashworth griped about this but I also had 14 addresses between leaving home and this house. I preferred flat/house-sharing, but that gets less possible as time goes by, because your pals tend to pair up, work elsewhere and so on. The instability of young life is expensive – you can’t accumulate tools and kit and you are always having to adapt – one place has enough kitchen paraphernalia, another doesn’t, all this incidental Stuff adds up.
Then acquiring the first house – you need tools, you need to learn a modicum of DIY, everything is dear. I have all this stuff now – I don’t need new lawnmowers and saws and shit except to replace what’s worn out. With housing I’ve paid down my mortgage. The costs of running Ermine Towers is so much less than it used to be, because there’s little capital spend. Depreciation on a house is about 1% of the capital value or a bit more – if I factor in that about £2000 of utility falls off the house every year in terms of Stuff that Wants Fixing or upgrading it is about right, whereas renting it would cost £7000, though obviously the landlord would get to eat the £2000 operation and maintenance costs[ref]These costs are shockingly lumpy – you need about five years of savings to smooth the costs. Presumably this afflicts BTL landlords too, particularly amateur landlords with just one BTL property – the statistics improve as the number of owned houses rises[/ref]
When I left early I looked at what my pension was going to pay after working for 30 years for The Firm (I made nearly 24) which was half final salary and targeted that as The Number I had to make up. Half to 2/3 of salary was a typical assumption of DB pensions and presumably this came from some acknowledgement that retirees would not have some of the big costs of their working selves. Often the pension commencement lump sum was there to clear the mortgage, though along with the kids dragging on their coat-tails into what used to be considered adulthood is a knock-on trend for people to have bigger mortgages later in life.
Up until very recently there was a big assumption built into the UK pension system that a pension needed to be steady – hence you had to buy an annuity on retirement. In Broke, I read that this was the historical way the middle classes dealt with the income on retirement problem – the destitute poor ended up in the poorhouse.
Of my pension income I’ve lost about 25% by leaving work 8 years early. Unthinkingly, I fixated on a target income set by other people a long time ago. I lost my way in the details, and accepted two hidden assumptions, simply because that was how retirement was meant to look. One was that the amount needed to be half my final salary, and the other was that this needed to be a steady income.
And then I went on a crash course on how to eliminate unnecessary spending between 2009 and 2012 because I wanted to get out and never have to work again. Freedom was that much more valuable to me than consumer doodads and rushed experiences. It was tough, but in that experience I learned what mattered to me and what didn’t.
I used the experience to drive waste out of my non-discretionary spending[ref]non-discretionary spending is on Needs, discretionary is on Wants[/ref], but there has been a corollary – it skews the ratio of discretionary vs non-discretionary spending upwards. The former is more than half of the total. I have no income, so I am running down some cash savings. If I knocked out some of the discretionary spend I can easily meet TFS’s £10,000 a year target – this is largely because of the reasons given earlier – my running costs are lowered by fossil savings from my working life, particularly in terms of housing. I don’t have to pay rent and I don’t have to pay 32% tax and NI on earning the money to pay for the rent.
Despite this I am going to invest in delaying my pension to secure a more fixed income, front-running it with a 5 year SIPP. The 5 year term means I can use cash for that rather than equities, which then takes me to the thorny question of my equity investments. They were designed to make up the difference, but my HYP has already reached the target amount thrown off as dividends[ref]This is because I won’t draw the pension early, so the difference to make up is less[/ref]. The surrounding globally diversified passive index shell I can’t qualify in terms of productivity – it increases my networth but it contributes little to my investment income. Theoretically you can take income either by natural yield (the principle behind a HYP) or by selling off units from a fund that is giving capgain, but the problem is ‘how much of this damned volatile capgain may I spend this year’ which is a tough call to make.
Greybeard describes one way of smoothing the income across the business cycle. This is attractive to me, but since it turns out my equity holdings are entirely aimed at the Wants and not the Needs I wonder if I need the stability. Because I am child-free I have an option not open to those who want to leave money to their children, and that is of taking a joint annuity in 20 years time. Annuities get better value when you take them older because they’ll be paid for less time. This would address the stability problem, I would be in my seventies.
On the other hand, I might want to leave money I haven’t consumed to better the world somehow. There shifting to investment trusts in 15 to 20 years may make sense – it is a low-maintenance approach, something like luniversal’s basket of eight would work. Yes, I would be paying something for the management and the income smoothing across the business cycle. But not paying as much as for an annuity, which destroys all the capital in the interests of a steady income.
These are not decisions I have to take now. In general, in finance, I’ve come to the conclusion that it’s best to keep options open. Things change over time, unforeseen shit happens.
After all, I wrote this before wandering through the park to go to the library to pick up a copy of Nate Silver’s the Signal and the Noise precisely because shit happened but it broke me out of a rut where I could have been spending the next six years at The Firm staring at screens and every quarter having to dream up meaningless crap and lies to keep the performance management system happy because the top brass decided to manage by numbers and wouldn’t trust my boss to know if I am doing a good job or not. After leaving, had I closed off other options drawing my pension early, I would have been sore when Osborne’s changes altered the landscape giving me the front-running opportunities I can take now. Options are good, as long as they don’t depreciate the asset too much.
Or split stable and volatile incomes – and spend electively going with the flow
There’s a case to be made that a retiree should look for lower volatility income for their needs, and let the wants go with the flow. On a 100% DC pension that might favour investment trusts (and later on an annuity) for the needs part of the portfolio, with a decent amount of headroom for the unforeseen rises – after all any retiree quitting now really ought to allow for an increase of about 10 times in the real cost of the oil price across a 30-year retirement, with a corresponding knock on cost in domestic fuel.
The wants part of your income could be invested with a higher equity exposure – anything from stockpicking to a world index tracker, and here you sell off units/shares each year to cover your next year’s elective spend. If the stock market goes through a rough patch then go on fewer holidays and more staycations, if it does well then salt away a bit to live larger in future and take more exotic holidays and eat out more. A retiree is in a great position to vary their wants spending according the the volatility of the stock market – to some extent you can also manage needs by shifting running costs along the Châteauneuf-du-Pape with caviar [ref]yeah, I know you’re a barbarian if you have Châteauneuf-du-Pape with caviar, but sod it, being your own person is one of the joys of getting older – if Jenny Joseph can wear purple and red then if you want to drink red wine with caviar just do it[/ref] <-> tap water and ramen axis.
This sort of thinking probably benefits the extreme early retiree – quitting the rat-race at 40 or mid-forties. If you can live with the volatility, and let’s face it most UK extreme early retirees had some connection with the finance industry so are probably better qualified for this than the likes of me, you can probably do better spending electively with the ebb and flow of the market than going for stability across the whole income stream.
Smooth the volatility with a 3 year cash pipeline
If you don’t like the investment trust option you can soften the ‘how much of this damned volatile capgain may I spend this year’ question by pipelining it through a multi-year cash buffer. The only indicator you have is the market value – tie your elective spend to x% of that[ref]where x is your SWR of choice – typically 4 to 5%[/ref] and one year you are partying in Sydney, the next you are in a tent in North Wales.
I could use a three-year cash buffer and drip x% of the market value in at one end and spend a third of the buffer each year – that would make a three-year boxcar average which would probably soften the worst hits (bear markets tend to fall faster than bull markets crawl out from the wreckage, but three years is a long bear market. Just don’t mention Japan, okay?). That would be a lot of dead money if this were three years of my entire income but if it’s a part of it that’s not so bad.
Does the three-year pipeline being in cash cost on average more than the investment trust premium? Say you start with £1,000,000[ref]to make the numbers easier, for illustration. Consider paying an IFA if you start with that much – your time is worth more than mine[/ref] Your cash buffer, at three years of 4% SWR is £120,000
After all, let’s say on average equities give a real return of 5% and you lose 1% to the extra IT costs giving you a 4% p.a. real return with no cash buffer, or a 5% return on 88% of your capital, let’s be charitable to the Bank of England and say inflation is 2%, so you eat a 6% loss on the 4% going through your three-year buffer as it falls out the end. You therefore have to put 12.7% into that buffer, so in reality you’re getting 15% return on 87.3% of your capital.
Each year on average the ITs turn your £1M into 1,040,000 and you get to spend the 40,000. With the buffer, each year your index funds returning 5% p.a turn your £878,000 into £921,900, of which you now take 4.2% to top up your buffer, leaving you with £885,000. Although I confess it wasn’t the answer I expected, you’re better off using the cash buffer and keeping fees lower, as your capital slowly creeps up in real terms or you could spend a little more. Over two decades this ends up in a doubling of capital reserves taking the buffer route as opposed to the IT route.
Of course you can spend your retirement opening a bazillion current accounts and yomp the cash through the latest best paying account du jour to improve the return/lose less to inflation. Or pass the cash buffer through Zopa and a couple other P2P joints – don’t reinvest what your borrowers pay back but keep adding every year – this makes a pipeline well suited to the 3 year term and you will get your money from 3 years ago back, with interest.
Decumulation is a bastard to get my head round. Initially I am going to decumulate cash, and that isn’t particularly challenging. In the equity part I can take the natural yield of the HYP section easy enough. But working out what to do with the foreign index stuff I’ve used to diversify the HYP isn’t clear to me at all, so far the 3 year pipeline through 1/3 Zopa 1/3 some other P2P operation and 1/3 cash 3year term account is the best I can come up with for that. Fortunately I don’t have to start doing this on equity savings for another 5 years, some clarity may come out of the murk by then.
I’ve written about this before, but it is getting close to doing it for me, hence a worked example. This is particularly useful for people with a legacy DB pension although the technique also works to smooth your income between retiring and getting the State pension, which is another defined benefit pension [ref]a company DB pension is defined after each year you work for the company – they can change the terms for future accrual but not retrospectively for defined benefits already accrued. Whereas the State pension is defined by government and can be redefined – as has been the case recently[/ref].
A DB pension is defined only at a particular retirement age, usually 60 or 65, or use this calculator in the case of the State Pension. With a company DB pension you can often retire earlier, but you will take an income hit called an actuarial reduction if you retire earlier than the scheme NRA. In my case the NRA for most of my DB pension is 60, I will eat the loss from ‘retiring five years early’ for the last three years accrued when it was shifted to 65.
When these schemes were designed in the 1970s and early 1980s there was more goodwill between companies and their workforce which was seen as more of an asset than now, the pension was part of aiming at staff retention, which is largely gone in a faster-moving, possibly more efficient and definitely more dog-eat-dog employer/employee relationship now[ref]until you get to the parasitic executive level, which seems to featherbed a ‘because we’re worth it’ layer of scum to loot shareholders more and more, because of course you have ‘pay the going rate’ to recruit top talent despite the fact that CEO pay used to be about 40 times that of the grunts (US study, Table 6), compared to over 200 times now and there’s been no notable increase in company profitability since then[/ref]. The actuarial reduction is rarely defined, and gives companies wiggle room to reduce their costs. As a result it’s usually best to take a DB pension at NRA, because it’s nailed down what you get. Individual circumstances can sometimes mean you’re better off to take it earlier, but that’s usually more to do with paying off debts with any tax-free lump sum.
What to do if you want to retire before NRA?
What you ideally want is a short pension to front-run the main pension until its NRA. This pays out between the date of your early retirement and the DB pension NRA. If you want to retire before 55 you also need to save enough money in an ISA or unwrapped to pay your way to the earliest date you can draw pension savings, currently 55 but scheduled to rise to 57 and further – a gotcha to watch.
When I retired in 2012 a short pension wasn’t an option – if I had used a SIPP I wouldn’t have been able to draw it down, but all this has changed now. So the question is now how much can I save into a SIPP such that I can run the SIPP flat in the (for me) 5 years between getting hold of it and the pension NRA, without paying any tax. There’s not much mileage[ref]but there is some – even if you pay 20% tax on all of your SIPP income the 25% pension commencement lump sum saves you a quarter of the BR tax you’d otherwise have paid[/ref] in a basic rate taxpayer saving tax on the way into a SIPP only to pay tax on the way out, although any sort of higher rate taxpayer will gain a useful amount drawing down a SIPP even above the tax-free personal allowance up to the 40% tax threshold.
Put another way, I want to know how much can I put into a SIPP, such that I can withdraw the 25% tax-free lump sum up front and then a personal allowance worth each year, for (in my case) five years, from 55 to 60. With a NRA of 65 that would be 10 years. It’s reasonable to hold a five-year amount in cash, a ten-year amount would need to have some investment component for inflation protection – either some exposure to equities or some fixed interest bond-like stuff.
By his pension changes, that is. Sadly the exact mechanics wont be of much use to young’uns but for for some modestly old gits (45 plus) who have accrued a defined-benefit (DB) pension where you can buy additional voluntary contributions (AVCs). Since there are a number of readers who work(ed) for The Firm that employed me for many years I’m throwing it out there.
The philosophy of how difficult it is to qualify living off savings may be of more general interest. It’s heavy on pensions, which seem to be the Cinderella of the PF world, because most PF bloggers are younger than me and Monevator’s Greybeard seems to be off on a cruise. However, hopefully you’ll all get old enough to be interested in pensions one day, and if you can learn from my mortgage screw-up then so be it 😉
Some pension and early retirement orientation
One of the big challenges facing early retirees is how to fund the pre 55 early part of their early retirement. The part before 55 has to be something other than pensions because you can’t get hold of pensions before getting to 55. The goto place for this is ISA income and cash savings, though not paying your mortgage off early is a great way to have more cash savings in the pre-55 period, because you can use the pension commencement lump sum to save to pay off your mortgage from pre-tax income.
I didn’t get the mortgage wheeze right. In threading your way through the myriad paths to early retirement you are always going to get something or other wrong, that was my big mistake. I don’t have housing costs other than council tax and the 1% or so house purchase price depreciation fund, but having the borrowed capital to run down now would be useful. I could then use my AVC fund to pay off the mortgage tax-free at 60. Pretty much any time I go anywhere near anything to do with housing I screw it up royally. Why break the habit, eh?
Because I drove my spending down to be able to quit early I have been able to string out my savings for twice the amount of time I anticipated. But it’s probably fair to say I haven’t lived large like like mistersquirrel and theFIREstarter 😉 I don’t have any complaints – freedom from The Man and being able to pursue my own interests is more than adequate compensation. For much of the first couple of years it was a process of recovery from the experience – and it’s respite that matters, not consumer goods and services. But I am also mindful that time is also ticking away, so if I could smooth my income I could do more in the near future rather than back-loading it. I’ve noticed the birds are starting to sing and maybe they call to me, get out there, travel more.
I have no income – one of the primary navigational aids of personal finance spins and knows no North
Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness.
Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
I never understood how to manage finances without having a number I could allocate on the Annual Income side. Without a figure for income, I could never qualify the Micawber question. It has made me fearful and over-conservative in spending. This has worked out okay for me till now – it is how I got to this point and having the choice to take Osborne up on his alternative offer of getting my AVC out tax-free but earlier. If I had favoured spending I would have drawn my pension short by now.
Some readers will wonder WTF? The income computation is easy. Take current age of Ermine, subtract from 60 which is how long it needs to last till a good alternative, then divide total amount of cash savings by years and you have the income level. Maybe knock off about a year’s savings to cover emergencies then run the calculation.
The logical thing to to with a cash ISA these days is to switch the damn thing into S&S ISA but I can’t bring myself to do that, because of the fears of some of Lucy Mangan’s demons catching up with me, or needing to pay for an operation[ref]the NHS does fine with big stuff and with chronic stuff, but elective quality of life interventions it does poorly now the Tories have been at it.[/ref], or something like that. And as a result, the fearful me jams my spending. I err in the opposite way to mistersquirrel and theFIREstarter but error it still is.
If you are one of those people and you carry on working in your all consuming City or Corporate job, then you are wasting your life.
This is more frequent than you might think. The most common motivation for this behaviour is fear – fear of change, (irrational) fear of poverty, fear of loss of status, fear of their spouse’s reaction etc. Its not enough just to make a life-changing amount of money, you still have to change your life. Don’t just load the gun, pull the trigger.
Apply own mask first… We owe it to ourselves and our families and friends to start by getting our own shit together. Think about the airline safety briefing : always apply your own oxygen mask before helping others. This initially sounds a bit counter-intuitive and even selfish to some people.
I have overcome most of that. I changed my life, and I qualified what Enough looked like to me. But I am still on his Level 2.
These people understand the power of money and have mastered some of their emotional weaknesses re money. Paradoxically, they are seeking to get to a point (see level 1 below) where they think much less about money.
I am not sure I can do that until Mr Micawber’s compass begins to respond and the questing needle shows which way is North. After a certain level personal finance is much more about the personal than it is about the finance. My fears of Lucy Mangan’s demons are part of the emotional weaknesses re money. Possibly I have some of the elements of her sociopath. I just didn’t want to depend on other people’s grace for dealing with the demons and so I spent less so I could buy my way out of certain kinds of misfortune. But I take TEA’s point. This is a question of balance and I haven’t got that right. A clawed hand remains frozen on the controls set to dead slow because the broken compass shows no signal I feel I can trust. There is still work to do on that intentional living thing.
It has been five, getting on for six years since that fateful day in February 2009 when a jumped up punk of a manager squeezed an Ermine, intimated TINA and I realised I was all out of options and didn’t want to kiss The Man’s ass, and I locked down spending and took a three-year holiday from the middle class in the name of Freedom. I would do the same again. I have become even more ornery, awkward and unemployable since then. Work is not the point of Life[ref]with the obvious rider ‘for me’. If Work is the point of Life for you then knock yourself out[/ref]. This much I know.
I would soon have access to a DC pension
Now if I had a DC pension I would soon be able to draw it. As a brutal simplification that everyone should qualify for their own circumstances, it makes sense to draw a DC pension as soon as possible, all other things being equal. By drawing it early, you stretch out the time over which the money is extracted, and you get a personal allowance for each of the years over which you take it. If you don’t need all the money that year , reinvest it in an ISA in the same sort of thing the pension was invested, and you shift the pension capital from being taxable to being sheltered from tax. If you still have more than 15k left over each year I suggest you need to spend more, unless you are looking to mollycoddle your kids in which case leave it in the pension since they can inherit that at their marginal tax rate it seems. The converse is that if you are so bloody stupid as to take your DC pension out in one lump then you deserve to pay a shitload of tax because such arrant stupidity should be taxed out of existence.
But I don’t have a DC pension. So I can’t do that. Don’t get me wrong – I am deeply grateful that I started work at a time when there was a better balance between labour and capital and The Firm actually wanted people to work for them so they offered good benefits, the original DB pension being one of them. However, a DB pension is less flexible than a DC about the retirement date – draw it earlier than normal retirement age (60 in my case) and it is reduced by roughly 5% per year drawn short. If you are in decent health you really don’t want to do that. The actuarial reductions usually favour those who follow the norm rather than the early retirees. In itself that’s not a big deal, because I saved a quarter of my DB pension capital[ref]computed by taking the gross paid at NRA and multiplying by 20[/ref] in AVCs.
the original plan – invest the 25% tax-free PCLS in the market in a couple of years time
The original plan was to run off the SIPP I took out earlier this year when Osborne changed things, after another two years worth of contributions which I can get in by May 2015 (this year and next tax year), and then to draw my main pension a bit early and eat the actuarial reduction. I would then get the AVC tax free, which I would then shovel into ISAs over a few years, getting more ISA income to top up the actuarially reduced pension.
Note the correct way to have done this job would have been to keep my mortgage at the level of the PCLS and live off the money I paid my mortgage off with until at 60 I take the PCLS tax-free and pay off the mortgage. The general cocked up the tactics there, even before the battle plan made contact with the enemy.
the new plan – invest the AVC in deferring my main pension
It appears I can shift the AVC into a SIPP without taking the main pension, as it is considered a DC independent saving. All of a sudden I lose the whole point of the AVC, which is to get 25% of my DB pension capital free of tax. I now only get 25% of 25% or a sixteenth of the capital tax free. However, I have discharged my mortgage and don’t have a particular need for a shedload of cash, other than as investment capital to make up for the actuarial reduction.
From some time after this April, I can draw down the SIPP tax-free, as long as I stay below the income tax threshold. There is also some hazard of work income over the coming years[ref]there is some research work I want to do. In the end even an ermine can’t outrun the W word forever…[/ref]. Indeed, it seems I can contribute to a SIPP up to £10k p.a. while drawing from it, so I can lose any earned income into the SIPP, which is a good way of spreading out earnings to minimise tax – I don’t aim to give up much time to the filthy W word, so 10k will probably do 🙂
Each year I live off the AVC fuelled SIPP and the dividend income of my ISA, my deferred DB pension increases by roughly 5%. Effectively I get a return on my AVC funds in terms of that permanently increased DB pension, and at current stock market valuations that looks a higher return and lower risk than I could win from adding to my ISA. Of course that is a return on capital, the return of capital is consumed as income. Normally if you want a return on capital you need to retain the capital and not spend it, this is one of the few exceptions[ref]it isn’t a true exception, it is the interaction with life-expectancy figures that gives an appearance of a return on capital.[/ref]. When I get to 60 I will probably stop drawing down the divi from my ISA unless I think of something to spend it on. Running down the AVC + ISA income is roughly equal to the value of the DB pension at NRA, so I smooth my income. I will get two smaller bump-ups, one at 60 when the ISA dividend income becomes superfluous to requirements, and one in the distant time at 67 when and if I get the State pension.
I get the same general effect as if I hadn’t made a cod’s of the mortgage/PCLS thing, subject to the limitation of being limited to the tax threshold + the income from my ISA each year. I’m easy with that, big spenders may not be.
An annual income, and an answer to the Micawber question
Obviously there’s the benefit of getting this AVC cash into use rather than depreciating for another six years. More importantly, however, I get an income for the first time in about three years. So I could return to that middle-class sort of spending if I wanted to. They say that it takes a month to break a habit, so six years should be plenty. I can’t unsee the wanton waste I discovered in some of the empty dreams of the middle class cubicle slave I was. I am no longer a cubicle slave, but some of the dreams still seem empty. I found freedom in the open spaces, in the sound of birdsong, in places like this
rather than places like this
I am in no hurry to spend more, but I do need to release the dead hand of the fearful non-spender who felt adrift in a pathless land without the compass of Wilkins Micawber to guide the way. Unusually among consumers, possibly I am consuming at too low a rate. I can easily live well on the personal allowance plus £5000 tax-free from my ISA, maybe I will have to consult with good people like mistersquirrel and theFIREstarter as to how to inflate my outgoings on fine living. On the other hand I don’t have to spend all of it every year. My ISA will thank me for continued reinvestment. I now have a high-water-mark for annual spending, which I can exchange for the dead-hand’s ‘as little as possible’. The tide is a long, long, way out.
There’s no rush – one of the arts of pension planning seems to be keep as many options open, and then opportunistically close them off at the eleventh hour in whatever way is most advantageous at the time.
Ed Miliband could destroy this plan
…in May. In which case it’s back to plan A. There’s nothing I can do about that, it’s the usual mantra – coffee for the things I can do something about, red wine for what I can’t change. It’s the problem with pension savings all round – government meddling can screw up the best laid plans. In fairness to governments, it is only government meddling that has made this alternative a possibility. It wasn’t a possibility when I left work in 2012.
of market crashes, and excitement, and foolishness
All this will take a few years, should there be a market crash I can rethink, draw my DB pension a little earlier, eat some actuarial reduction and seize the opportunity to invest the SIPP. Assuming, that is, I have the cojones to do that – such a market crash could be the trumpet at dawn of the great unwinding. Or maybe I lack the taste for the ride. Finding myself unable to to determine a reasonable spending rate without having an annual income shows that perhaps I am not the Wolf of Wall Street. I should heed the words of Warren Buffett…
To make the money they didn’t have and they didn’t need, they risked what they did have and did need–that’s foolish, that’s just plain foolish.
…and at most half-split this if the denouement comes this year. At the moment an increase in DB pension looks lower risk than the known risk of the market[ref]I am casually interchanging risk and volatility of the short-term price levels which I really shouldn’t do[/ref]. It’s taken me a long time to realise that I had this opportunity, because my original plan was built when Osborne’s changes hadn’t happened. However, the job of any chief executive is to adapt to changing circumstances
Pension planning is a bastard for complexity and counterintuitive wrinkles and changing rules. I’m generally of Monevator’s opinion when it comes to financial advisers, but I wonder if pension planning might not be an exception. Certainly for those working at The Firm, take up the offer of the Wealth at Work seminars, since you don’t pay for the advice and they have knowledge of your specific environment. Just don’t hire W@W to run your investment portfolio, which is what they’d like you to do afterwards 😉
My pension will eventually be a combination of the DB pension with about 2/3 of the target time accrued, and my ISA to make up the difference, tax-free. But as an early retiree I could have 30 years ahead – possibly more. It would be unwise to ignore the tail risks that affect both types of pension, though differently. The world will change over that sort of timescale. Just to remind ourselves of the scale of those sorts of changes, we were listening to this on the radio 30 years ago
Only one guy in Britain had a mobile phone, though the first had been demonstrated in 1973 in the US. Those 1970s analogue devices were not cellular like TACS was, so the number of channels was very low and prices were astronomical.
Nobody much had the Internet. I was using a VAX with green-screen text terminal and 9600 baud serial connectors to do circuit simulation. 30 years is one hell of a long time for things to change. It’s plenty of time for tail risks to show up. But it’s also plenty of time for nimbler, younger minds to invent good stuff that people want to pay for. Assuming, of course, that the work of humans is not done here – in which case the spoils will accrue to patrimonial capital as Piketty told us it would.