For years, pension products have been about saving for retirement, with a 1,001 different varieties of tax-advantaged savings vehicles.
In contrast, the purpose of all that saving – the deaccumulation phase of our lives — was not much catered for at all.
With a Stalinist lack of choice that would have made Henry Ford blush, pensioners were largely restricted to purchasing an annuity.
Income drawdown came on the scene in 1995, but only in a form that restricted drawdown amounts to limits set by the Government Actuary’s Department (GAD), in order to prevent retirees from running out of money before they died.
And while annuities and drawdown plans do admittedly come in slightly different flavours from provider to provider, by my count that still adds up to a magnificent total of, er, two distinct pension products.
But after years of minimal innovation in the world of deaccumulation products, I think we’re set to see that number of products increase.
How come? Read on.
Brave new world of pension planning
While you probably don’t need reminding of this, the UK’s liberal new pensions regime comes into force next April.
From then, retirees will be able to access their pension pots more or less at will.
Withdraw the lot, and blow it on a Lamborghini, to quote the infamous words of pensions minister Steve Webb? Certainly, Sir. Or Madam. What colour of Lamborghini?
GAD limits? Forget ‘em. At long last, your pension pot is yours to do with as you wish.
Subject to paying tax on the amount withdrawn – which can quickly tot up to a hefty amount if such withdrawals take you into higher-rate tax bands – there’s more or less total freedom.
Spend, spend, spend your pension
So what will people do with this freedom?
One option, of course, is indeed the Lamborghini (although personally, I’d sooner have a Cessna 172).
The usual suspects in the financial services industry have whipped up the usual froth with a slew of ‘surveys’ showing that people will be tempted to splash out on foreign holidays, pay off the kids’ university fees, and build a conservatory.
Personally, I’m dubious. Having saved all their lives, will people really splurge the lot on a trip to Thailand and a new kitchen?
The more sensible commentators, however, have added another option: still withdrawing the lot, but buying rental property with it.
In property-obsessed Britain, that’s an option with widespread appeal.
Denied the opportunity to be a BTL landlord during their working careers, some pensioners will see retirement as the ideal time to deal with dodgy builders, handle ungrateful tenants, and suffer prolonged income-sapping rental voids.
I jest. At least in part. But I don’t really think that the property option has legs.
Tax take on converting your pension into property
Because however alluring the property dream, there’s that tax hit to consider.
This will see the government claw back 40% of any pension withdrawal (after the 25% tax-free allowance) that takes an individual’s total income above £42,3661 —and 45% of any pension withdrawal that takes it above £150,000.
Yikes! As Hargreaves Lansdown’s Tom McPhail has pointed out, this would see an individual earning £40,000 a year paying a top rate of tax of 45% to withdraw in its entirety a pension pot of £300,000. (Worse, the effective tax charge would be 60%, due to the loss of the personal allowance affecting individuals with annual incomes of over £100,000).
Overall, the effective tax rate on that pension pot as a whole would be 32%.
Of that £300,000 pension, £95,750 would promptly go to the Chancellor, in tax.
A castle, not a pension
After that tax hit, the effectiveness of a property investment as an income-generating solution pales into inconsequence.
To prove the point, the ever-helpful Hargreaves Lansdown (who admittedly isn’t a disinterested bystander in all this) has produced a chart comparing the income from a £300,000 pension pot under three different scenarios:
- #1 – ISA and Drawdown: Take the tax free lump sum, invest it progressively in an ISA, leave the balance in drawdown, take an income from both the ISA and the drawdown.
- #2 – Property: Take all the money in one go, paying tax on 75% of it, reinvest in a property, live off the rental income.
- #3 – ISAs: Take all the money in one go, invest in funds and progressively reinvest it in ISAs, taking an income from the funds (taxed) and the ISAs (tax free).
Here’s what happens over a 20-year period:
Source: Hargreaves Lansdown
Interesting, isn’t it?
For me, the two key takeaways are that the property income never really recovers from that initial tax hit, and that the ISA income – thanks to its tax-free status – progressively catches up with the drawdown option.
Desiderata
So where does that leave us?
In short, desperately hunting for some other sort of pension product – some way of getting an income, in my case while retaining my capital (so no annuities here, thank you) and not suffering an initial tax hit by withdrawing.
- Equities? Fine in theory, but subject to periodic worrying falls in capital value (45% in the 2008-2009 downturn, for instance), and periodic downturns in income flow.
- Fixed-income bonds and gilts? Much depends on the entry point.
- Some judicious mix of the two? Well, yes — but what about other asset classes, such as property? Some bricks and mortar might be good. And so on.
Funds can be dreamt up to do all that, of course. But how much will it cost to manage the resulting mix?
A charge of 1.75% per year, for instance, is about half the market’s present yield.
Not to mention the further income-sapping double-whammy of platform charges levied by some of the major fund supermarkets.
Shares in your pension: British Assets Trust
I was heartened then to read of the proposed changes to British Assets Trust, a venerable investment trust dating from 1898.
The changes in question directly stem from the new pensions regime we’re entering.
Simply put, British Assets Trust proposes to switch fund managers and reposition itself with a multi-asset portfolio, to deliver a pensioner-friendly quarterly stream of dividends that will (it hopes) grow over time.
To quote from the document that the Trust is putting to shareholders:
“The Board believes that [the] proposed strategy for the Company… represents an innovative way to capitalise on the very attractive opportunities presented by recent legislative changes relating to UK pensions, and … is well designed to address the issue of relevance and relative awareness in the post-RDR investment world. The Board believes that… the Company will attract a new investor base, and that the Company will grow, as well as deliver shareholder value.”
As an investment trust, British Assets can be held quite cheaply on most investment platforms and brokerage accounts, and fee-wise isn’t too expensive.
Inside a SIPP, it could throw off a reasonable income. One that is actually geared to the needs of retirees – unlike all those supposedly income-centric funds that investors perversely pile into looking for growth. (That’s you that I’m looking at, Mr Woodford.)
But what is especially noteworthy is that here we have a long-established investment trust – albeit one that is very much on the staid and steady side of the road – explicitly re-purposing itself to attract retirees after next April’s reforms.
Somehow, I don’t think that it will be the only one.
Also, if investment trusts can do it, then I’d hope products such as ETFs can’t be far behind.
And that’ll all be great news for DIY pension planners.
- Note: For the sake of simplicity, calculated as £10,500 personal allowance for individuals over 65, plus applicable earnings band. Note for pedants: you mileage may vary. [↩]
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British Assets Trust isn’t the first – Alliance Trust has been paying quartlerly dividends for as long as I can remember
However with this kind of investment costs are key: BAT has a disclosed “ongoing charge” of 0.7% pa
Vanguard’s UK FTSE100 etf has a TER of 0.09% and its developed world etf has a TER of 0.18%
With the same asset mix as BAT its blended TER is 0.11%
Why pay 5.5x as much for the convenience of quarterly dividends?
@Neverland — It’s not just the dividend schedule, the trust is also proposing to change the asset mix to suit the new objective.
Your points about charges are of course well made.
I personally believe quarterly income alone is a bad reason to plump for any dividend stock or trust, as I’ve discussed before:
http://monevator.com/how-to-live-off-investment-income/
Nobody should be living literally from quarter to quarter on any income that’s generated from risky assets, unless they have to. But as I discuss in the link just given, smoothing the payments via a self-administered cash buffer is one simple solution. 🙂
Our rough plan is the draw max from wife’s SIPP that we can without paying tax, max from mine to avoid paying 40% tax, keep doing full ISAs every year, and to use our unwrapped assets (current and those from using max 25% tax free) for dividend income in wife’s name (no more tax to pay) and to fund those ISAs.
Once state pension kicks in (over a decade after retiring) my wife’s SIPP will be empty, unwrapped assets will nearly all be wrapped in ISAs, and I can back off my pension drawdown to something more sustainable.
@Neverland: I think the key phrase is “multi-asset”, not “quarterly dividends”.
@Greybeard: of course we have yet to see what the various charges for these new drawdown products post-April 2015 is going to be. Such hints as I’ve gleaned from press comment so far is that we are in for more rip-offs. I note that Standard Life has recently re-vamped its webpages to tell us all the basics about the changes (yes, all that info which has been filling the press since the budget statement), while not giving information anywhere on their website* about what their charges are actually going to be. It seems that in order to get the nitty-gritty you have to go through the motions of getting a personalised quote. Not a good sign. I suspect it might be sensible to defer drawing down for 4/5 years until the FCA has weighed in against the more egregious practices and the market has settled down a bit.
Tyro
* searches eventually direct one to a document that merely describes the kind of charges that might be applied, without mentioning any actual £, s and d.
Drawdown charges can be high for small pots, but at least those with smaller pots will in future be able to empty them quickly (while still likely being tax efficient, and ideally moving surplus to ISAs) and then see the charges drop to zero.
The annual drawdown fees would previously go on until death as the amount you could take out was a capped percentage.
@Tyro
The key phrase is 0.7% ongoing charge
So lets see…on a £500m trust thats £3.5m plus what ever other charges they can sneak on besides
Where are the customers’ yatchts?
@ Neverland: moored up next to their Lamborghinis maybe ….
“But what is especially noteworthy is that here we have a long-established investment trust – albeit one that is very much on the staid and steady side of the road – explicitly re-purposing itself to attract retirees after next April’s reforms.”
So we have here with British Assets, an IT with a so-so past (albeit long) performance, medium size, unknown future charges, which is about to change fund managers and all of its’ asset allocations.
Note : Current benchmark is 80% All Share Stocks; 20% Int’l Stocks.
This is probably a welcome change of heart, but maybe one to watch for a while to see how the assets are allocated before rushing in?
Presumably real estate will feature as an ‘attractive’ addition?
Get this nagging feeling about opportunistic marketing?
Nevertheless step in right direction for the retired income seeeker.
With British Assets (BSET) : looking at the link, curious that F&C are appointing Blackrock to manage!
See that the proposed allocation is :-
40% UK Equity Income, 60% Tactical.
That’s a lot of tactical! What could it comprise?
Over the last three years ignoring dividends (which are above avg with BSET and make up much ground), share price growth comparisons :-
Global IWRD +44%
UK All Share +24%
BSET +17%
All this now irrelevant with new managers and new portfolio. It is essentially a new IT. Out with the old, in with the new!
The good news is that as Greybeard notes where F&C lead today, others may well follow.
But where in today’s investing environment are the managers going to find undervalued asset classes to provide a reasonable positive real yield, without taking undue risk?
Where would be put equity release mortgages? They seem pretty expensive but could be a way to release to equity if your capital starts running dry. ..
No other retirement products? What about fixed term annuities, investment backed annuities and other third way products?
Maybe I’ve missed the jist of the article, but it reads to me as if pensions = bad. Surely with all the new flexibility, improved death benefits etc, people should be leaving their money in pension?
Add to that the potential issue of moving something that currently sits outside your estate (pension) into your estate (ISA/property) in terms of IHT, benefits/long term care implications, protection from bankruptcy etc.
We are going to see quite a bit of innovation in the retirement income space over the next 6 to 12 months in terms of product solutions that sit between full annuitisation and full drawdown. The majority of the offerings providers are currently working on is in the ‘guaranteed’ drawdown space to solve the “drawdown for the masses” issue. I also understand there will be a number of low cost drawdown launches (to rival HL et al) and annuity ‘shape’ innovation.
All in all a lot of change, but I don’t agree simple looking to take all money out of pension (in one go or over time) should/will be the default solution.
The problem with leaving money in a pension is that you’ve got a regulatory noose around your neck, and HMG have shown time and again that they are more than happy to kick away the stool.
If you can extract the money in a tax efficient way, and invest it to generate the same (or even more) post-tax income with a greatly reduced risk of government meddling, then why wouldn’t you?
I’ll admit to be confused by option 3 on the HL chart. Surely taking all the money at once and investing in funds (taxed) and ISAs as you can should see almost as large a drop in value as the property option due to the tax levied for taking the whole pot?
@Mikkamakkamoo — I think you missed the gist of the article. There’s a whole chunk about the tax hit on withdrawing the lot, and why it is bad, and of the three options listed and graphed, the one that involves leaving a tax-efficient major portion in the pension is shown as the optimal strategy.
So:
Nor does the article! 🙂
Hello Luke,
You may be misinterpreting the chart. As the labels state, the values shown are INCOME, not CAPITAL. The chart and accompanying text relate to INCOME.
Two further pieces of information may be helpful. First, HL have assumed that all investments grow at 3% a year and yield 4% net income, and second, they have assumed 1% stamp duty, £1500 property purchase costs and no other deductions.
I can post their calculations re: capital values (and a chart) if that would be helpful, but my primary focus is on income, not capital value.
FWIW, the starting points for ISA and property CAPITAL values on the value chart ARE almost identical, but not quite. I assume that this is because they take advantage of the ISA allowance in the every first year, ie right at the start. But given the scale (in the hundreds of thousands) it’s slightly difficult to make out.
The Greybeard
@Mikkamakkamoo — yes, I think you may have missed the gist of the article.
I’m NOT arguing that 100% withdrawal will be the default at all. Indeed, the purpose of the tax calculations was to show the inadvisability of this course of action.
The Greybeard
@Neverland — As others have pointed out, it’s about the asset mix, not the quarterly dividends. But your point about ATST is well made: ATST has also experimented with diverse asset mixes, and is generally regarded as a somewhat lackluster performer, at least in capital terms.
I imagine that British Assets Trust will be wanting to avoid an ATST-like performance (or at least, reputation).
The Greybeard
Personally, I’d rather use a balanced portfolio of low cost trackers, and distrust the scramble for yield/income above all else.
However, in my dotage, switching to something like the Basket of Eight described here could be tempting.
http://boards.fool.co.uk/basket-of-eight-annual-review-2014-13094733.aspx?sort=whole#13094733
Hello gadgetmind,
Re: Baskets, I quite agree. However, my own preference is for the same Fool contributor’s Basket of Seven, not Basket of Eight. Loosely speaking, there’s a lower starting income, but better income growth. However, in either of the baskets, one would need to carefully consider the question of hindsight bias.
The Greybeard
Youngsters like us clearly take a longer term view rather than the “front loading” of the likes of the B8.
However, some funds and ITs are doing silly things to boost yield. HFEL did a dodgy dividend share deal that turned into a total loss for a decent chunk of the portfolio, and they also buy shares just before they go ex divi and then sell afterwards. The latter basically turns your capital into dividends (with costs along the way) which is a bit of a turn off for me!
So, on balance, I agree with you!
Invest in IT’s in my dotage? No chance. If I get too senile to manage my portfolio I would go for one third each in a gilts tracker, an investment grade GBP corporate bond tracker and a world equity tracker. Skim off the distributions and instruct whoever is managing the my pension to sell 2% of whatever fund has the highest value each quarter, or whatever percentage is required to meet my annual income needs. In addition, keep 2 years income requirements in short term deposit accounts.
Job done and no cash funding overpaid IT managers’ yachts.
We have an ISA pot and a SIPP pot.
Currently for income needs I take from the ISA pot first taxfree.
Eventually I will take from the SIPP pot. Any left can pass free of IHT to beneficiaries?
@ The Greybeard –
Thanks for that, this is what happens when you read things too fast! 🙂
@naeclue
“If I get too senile to manage my portfolio I would go for one third each in a gilts tracker, an investment grade GBP corporate bond tracker and a world equity tracker.”
Thought provoking!
Assuming low cost ETFs which ones would be favoured?
All Best
Our ISAs won’t be touched until our unwrapped holdings (other than 3 year cash buffer) have been depleted. Even then, we’ll only take out what’s needed to cover any shortfall after my SIPP (wife’s will be gone by then) has had everything we can get out at 0%/20% removed.
Note that there is very little IHT planning being done in the Gadget household!
@magneto “Assuming low cost ETFs which ones would be favoured?”
The ones that are best value at the time. Value to be judged by considering current TERs and long term tracking difference. At the moment I would go for the Vanguard World tracker ETF VWRL, the UK Government bond ETF VGOV and probably the iShares GBP corporate bond ETF SLXX.