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Retiring abroad with young kids

Our experts say our expatriate reader needs to keep an eye on costs and currency risk.
November 2, 2012 and Cazenove Capital Management

Jonathan is 55 and has been investing for 20 years. He wants to provide for his children's future and retire in five years' time. "I am currently an expat and suspect that I will have to stay this way in view of UK taxes. I am 55, but with young children - one 3-year-old and eight-month-old twins - this is why I have moved from a final-salary scheme to a self-invested personal pension (Sipp) and am not looking at annuities."

He describes his risk appetite as low to medium risk. His newly created Sipp is worth £1.2m, but he has only allocated 30 per cent to the funds marked with a star in the table. He has £130,000 in a Royal Skandia Managed Pension Account set up in 1991, to which he is no longer contributing. He also holds unmortgaged property in the UK and Poland - his wife is Polish.

Reader Portfolio
Jonathan 55
Description

Objectives

Retirement funding and kids

Jonathan's portfolio
Name of share or fundValue
HSBC GIF Euro High Yield Bond A AccE34,551
Sipp funds*£1.2m
*Schroder ISF Emerging Markets I Acc  
*Fidelity Sterling Bond - A GBP 
*Collins Stewart Select Income B Inc 
*Aberdeen Asian Local Currency Short Duration Bond GBP 
*Schroder Monthly High Income Acc 
*CF Miton Special Solutions Portfolio A Acc 
*Iveagh Wealth GBP Acc 
Royal Skandia Managed Pension Account£130,000
Cash held with HSBC£50,000
Santander fixed-rate bonds£112,000
UK property£350,000
Polish property£100,000

Price and value as at 26 October 2012. *Held in Sipp

 

Chris Dillow, Investors Chronicle's economist, says:

You say you have both a short-term investment objective (to retire in five years) and a long-term one, to provide for your children’s future. However, this portfolio seems better aimed at the short-term objective than the long-term one.

I say this because of its high bond exposure; even your balanced funds, such as Iveagh Wealth and Royal Skandia’s, have quite high bond holdings, on top of your own bond funds. Such funds are risky. There is a danger (quite large in my view) that bond prices around the world could fall in the next few years as the savings glut and pessimism about global growth diminish. Bond funds - as distinct from direct bond holdings - don't protect you from this risk.

For people approaching retirement, however, this risk isn't catastrophic. This is because what you lose from lower bond prices you gain in higher yields and therefore annuity rates. I know you say you're not looking at annuities. But bond yields affect your retirement income even if you don't hold annuities, because they set the risk-free return and thus determine the rate at which you can safely live off your wealth without eating into your capital.

In this sense, your portfolio isn't too badly set up for someone approaching retirement - although you might want to consider some better cash funds rather than bonds.

What does worry me is how well it is set up to provide for your children. There are two issues here. One is that they have longer time horizons than you; it'll be 18 years until your twins have to pay their way through university.

One solution here might be to have more equity exposure. Let's do the maths. If we assume equities' real return is 5 per cent a year with a standard deviation of 20 percentage points - which are reasonable round numbers as a starting point - then the chance of a real loss over 12 months is around 40 per cent. But the chance of a real loss over 18 years is less than 5 per cent; equity risk rises with the square root of time.

Granted, a real loss over a long time is worse than one over a short period, so we are comparing a large chance of a small problem to the small chance of a large problem. But this calculation shows why many people think equities are more suited to long-term investors. If you and your family share that opinion, there's a case for more equity exposure. I don't see what’s wrong with having a low-cost global equity market tracker fund somewhere in your portfolio, especially as it is otherwise quite equity-light.

The second issue concerns school fees. If you want to educate your children in England, you face an especial risk as an expat - that the cost of doing so might rise not just because of the high inflation in school fees, but because sterling might rise too (this possibility looks more plausible the less you look at the UK and more you look at other economies). The natural way to insure yourself against this risk would be to hold index-linked gilts (not a gilt fund) which mature around the time fees become payable. Yes, these offer negligible real returns. But nobody buys them for their returns, but for their insurance value - which might be especially useful for you.

Which brings me to another point. Most investors can safely ignore currency risk, because their wealth is held in the same currency as their outgoings. But is this true for you? If your assets are in a currency different from where you want to live in retirement, you are exposing yourself to currency risk - the danger that the currency of the place you want to retire to might rise, relative to the currencies in which you hold your wealth, thus raising your cost of living. I would advise you to look to reduce this risk by holding more of your wealth in the currency you intend to use in retirement.

 

John Hanna, fund director, and Michael Martin, financial planner, at Cazenove Capital Management, say:

Being an expat highlights a number of important issues that need consideration. While further clarification around your existing state of affairs and future intentions would be preferable, we can still explore some of the more obvious points.

Of primary consideration is the likelihood of you returning to the United Kingdom.

If you intend to remain non-resident for the rest of your life then your self-invested personal pension (Sipp) could attract more favourable treatment by transferring from the UK to another jurisdiction using a Qualifying Recognised Overseas Pension Scheme (Qrops). This would mirror the favourable UK tax advantages but give greater flexibility in terms of investments, including a wider choice of base currency. The Qrops should also remove the Sipp from the 55 per cent recovery charge on funds remaining post death.

However, if you are likely to return to the UK then the Qrops would revert to UK rules, hence nothing would have been achieved. You do face a potential problem if your Sipp remains in the UK as the combined fund of £1.33m is close to the lifetime allowance (LTA) of £1.5m. If you have no protection in place then the fund only needs to grow by 13 per cent before taking benefits to breach the lifetime limit and be subject to a charge on the amount in excess of the LTA.

In any event, you should consider consolidating your existing Skandia Managed Pension into the Sipp, subject to confirmation of there being no penalties or loss of contractual guarantees.

You wish to retire in five years' time when you are 60 and, based on the schedule given, will thereafter rely primarily on the pension to support you and your family in the many years ahead. This longevity will require you to strike an appropriate balance between security of capital and growth in order to counter the effect of inflation on the value of your assets over the long term. There will be many ways to achieve this, but a balanced portfolio with government bonds, corporate bonds and high-quality income-paying equities at the centre should suffice in the long run.

On a look-through basis, the asset allocation of your current (and potential) investments offers a good level of diversification, albeit with a couple of observations. Firstly, where using funds of funds it pays to keep a close eye on the costs. Looking at your investments, the headline charges are typically 1.5 per cent, however these can actually rise to 3.25 per cent when all the underlying costs are added in! The other point would be to watch your overall exposure to high-yield bonds. The last year has provided strong returns for the asset class; however, you only need look back to last summer in order to see what can happen during periods of market stress.

You currently hold £162,000 in cash in the Isle of Man and benefit from the interest, what little there is, being paid gross. It is always prudent to keep an amount of cash readily accessible, although in your situation the question is not simply how much to set aside, but also which currency to hold. For example, should your intention be to retire overseas then it makes sense to start transitioning the cash into the currency where your liabilities will be for the longer term.

Other issues that need consideration include the impact of inheritance tax on your worldwide assets, ensuring wills are in place and up to date and quantifying income needs post retirement. Your non-resident investments should continue to be held offshore to avoid UK tax and to help planning in advance of any return to the UK.

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