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Decumulation strategy: first withdrawal, tax-free cash and drawdown antics [Members]
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Holy Uzi Batman… somebody must have shot the sub-editor to let that past.
Thanks for the article. I would rate that portfolio 75:25 in risk on/off terms but I guess your fictional 55 year old can stand it. This 70 year old might struggle :).
Thanks for this, lots to think about, especially as I’m probably going to have to start operating something like this in the next year or so.
There’s quite a lot to do here for our fictional couple, I suspect in reality it will be one half of the couple who ends up having to look after it. I can see the 50/50 split in assets is desirable for tax efficiency though.
Going to have to read this slowly with a cuppa over the weekend, rather than skim reading during work lunch hour! Been thinking more of what my own drawdown will look like, so this should help with my modelling – thanks, TA!
Excellent piece @TA. To circumnavigate the ‘first payment’ tax coding ‘trap’ here; could one sell up £32,570 worth of the defensive allocation within the SIPP at the end of one tax year, move it to say Lyxor Smart Cash UCITS ETF C GBP (ticker CSH2, OCF 0.07%) within the SIPP and then sell/encash and withdraw £1,047.50p per month each month of the first 11 months of new tax year to get the full Personal Allowance of £12,570 in that tax year, with then £21,047.50p withdrawn from the SIPP in the final month of the tax year of which £20,000 was a crystallised tax free lump sum with £60,000 crystallised and remaining in the SIPP (the £20,000 tax free lump sum to go into a S&S ISA before end 5th April)?
Thanks for this.
I guess in an average year you’re effectively drawing natural yield, and the potential for growth outstripping demand in a good year may be better, but it still FEELS counter intuitive to be encashing capital, rather than tilting towards income?
Great article but way too complex for me to understand and handle especially as I age
Now 77 retired 20+ years
A portfolio of SIPPs and ISAs plus Easy Access Cash ISAs and a high interest bank account
Asset Allocation 34/60/6 -equities/bonds/cash.Cash = 2 years living expenses
Run on a total return basis.25% Tax free cash taken from SIPPs and used for living expenses at retirement-allowed remaining funds to grow in peace
3 index funds only-simple cheap and easy to understand
Fund units sold once a year to top up cash living expenses account
Using ISAs mostly so income tax free-reduces IHT possibilities
Mostly equities that get sold as you would expect-keeping equities in ISAs and Bonds in SIPPs
Portfolio continues to grow-3%+ withdrawal rate sustained
Worked so far!
xxd09
Great article. Well explained. Thanks.
@xxd09 (#6) “Mostly equities get sold as you expect-keeping equities is ISAs and Bonds in SIPPs”.
Would you be able to expand on your thinking? What is the advantage in splitting your equity and bond holdings this way? Also if you are selling mostly equities doesn’t that mean that they become a smaller percentage of your portfolio each year? Many thanks.
Good article and I’ve sort of been following this strategy for some time albeit with a riskier portfolio!
One small thing basic tax payers can do you can do to increase income is pay in £2880 into your SIPP annually. You get £720 from HRMC taking it up to £3600. Take the extra £3600 with £900 as tax free as cash and you then you pay £540 income tax on the remaining £2700 giving you £180 extra. For two people that gives £360. I’m not sure how it works for Higher tax payers.
Taking returns from an ISA is tax free-ie my income is therefore tax free
Equities are the growth engines of a portfolio-usually not always
They are therefore the most likely asset get sold in a Total Return portfolio to generate income
However as the equity remnant continues to grow in value in the ISA the income that has been taken is soon made up -often more so by the time next years income requirements are needed-shares tend go up in value over time
This is a practical finding by me over 20+ years retirement (monies from bond sales and use of SIPPs is not precluded if required )
2+ years of living expenses in cash helps bridge downturns like 2022 when equities and bonds both went down
The IHT outcome is that SIPPs ( in my case mostly bonds) are outwith my estate re IHT .ISAs on the other hand will be liable to IHT if over IHT limits
An interesting fact- it is relatively easy to rearrange your bond equity balance within your SIPPs and ISAs to suit this type of de accumulation plan especially if you are running a simple portfolio of 3 funds only
This is only one personal way of decumulating and obviously depends on a number of personal factors ie size of ISA funds available etc etc
xxd09
@ Delta Hedge – if you set up a monthly drawdown then your ’emergency tax code’ hit will be lower for the first payment than if you withdrew an annual amount. So you’re right to think that mitigates the problem. HMRC will then refund the tax overpayment over the course of the year via the PAYE system. So you’ll get a bump in monthly income at some point. You’ll probably be filling in tax refund claims if you utilise an annual withdrawal – though plenty of Monevator readers said that was absolutely fine in their experience.
You don’t need to hang on to the tax-free cash until March or anything like that. It’s not subject to income tax so doesn’t trip any HMRC alarms.
@ Martin T – I’ve been thinking in terms of total returns for years. It doesn’t feel bad to me to sell units as opposed to living on dividends, though I appreciate a significant chunk of people don’t like to sell. To me, it’s mental accounting. Companies that practice share buybacks are effectively paying you a dividend but you can only realise it by selling shares. It’s all the same cake, it’s just a question of whether you’re just eating the icing or taking some sponge too.
Re the “emergency tax code hit” … I’ve managed to avoid it and have been taxed on my first SIPP withdrawal this month with the same tax code as when I was a wage slave ie 1257L. As I’ve scheduled a monthly withdrawal of £1047, my tax was nil. I did plan for my first withdrawal to be at the start of a new tax year which possibly helped.
It could be I’ve been lucky. However, when I FIRE’d last month (yippee !) I made sure my employer promptly informed HMRC and I received my P45 showing the 1257L code. I received the SIPP withdrawal transaction doc from Vanguard last week (they call it a pay slip !) showing 1257L and no tax withholding & it popped into my bank account this week.
@TA. When I took my first taxable withdrawal from my SIPP I did it in March of that year thinking this would negate the ‘year 1’ tax issue. For some reason that didn’t work and I was overcharged tax. However getting the surplus refunded was easy enough, all online. The hardest part was finding the code for the appropriate tax office.
@TA — are you going to use the “smooth” version of prime harvesting that ERN devised? It seems to solve some problems with McClung’s original implementation. Also, regarding the variable withdrawal strategy, would it make sense to park the excess cash from bumper years in a high-interest savings account if not needed immediately, and to draw on this cash buffer in down years?
Thank you TA for a great article and series, I must take time to read McClung more thoroughly. I realise that I have currently drifted away from static allocation to my own ‘active’ version of dynamic asset allocation. Recent examples would include some very recent opportunistic selling of my gold and staying overweight in global small/mid to mitigate the Magnificent 7 weighting discussed recently. For me active asset allocation via withdrawals allows me to scratch that ‘active itch’ whilst staying passively invested, in the main. For me, waiting for a 20% run up in equities is too testing and you miss out on opportunities to withdraw when equities are doing well. Market correction anyone?
@ Brooksy – thank you for sharing. I had read that supplying your employer’s taxcode could help but you’re the first person to confirm.
@ Paul a38 – it seems that the magical tax balancing powers of March are just a myth. But good to know you found it easy to reclaim. A fair few readers have also reported an efficient experience, so seems like this isn’t too much of a nightmare as long as you don’t need the cash urgently to pay off the bailiffs or what have you.
@ Wodger – yes, gonna use McClung Smooth. I like your idea about setting aside some savings for a rainy day. I’ve read papers that suggest there’s a tendency for retirees at all income levels to do this. It makes sense for people to hedge against the unknown rather than put their faith entirely in some spending rule. As an aside, both my parents still save so it’s probably in the genes for me 🙂
@ Nearlyrich – I think you’re smart to allow yourself some limited tinkering room in order to hold yourself in check. Like say the 80/20 rule of dieting – where a practitioner eats well 80% of the time but mainlines greasy sausages the other 20%. Good self-knowledge!
Thanks for the detailed article.
I may have missed something here; why take a tax free element from your SIPP and put it into an ISA? Can’t this be taken annually from the SIPP as cash And accrue within the SIPP whilst not taken.
@Tom — It’s not vital but it’s a tax change risk mitigation strategy. See this longer explanation from @TA in the comments (comment #92, addressing @john) on this post from February:
https://monevator.com/pension-drawdown-rules/#comment-1750085
Excellent thanks TI that makes sense. Still haven’t got through all those comments on that post.