Welcome to the second part of our new series, How to Invest Your Pension For Income. It's a daunting and complex business but here we walk you through which investments to choose, how much income to take, and show you how to avoid paying too much tax on your income.
Here we explore how someone can turn a £300,000 pension pot into a steady income stream for the rest of their life.
What assets should you invest in?
Above the issues discussed in last week's article on how to invest a £100,000 pension, if you have a bigger pension to invest, you need to decide how much risk you want to take in your portfolio, as this will dictate how much income you can take from your pot without spending it too quickly. The biggest key to risk is how much equity you have in your portfolio.
The examples below from Sanlam UK show how different levels of equities are likely to have different outcomes for a portfolio initially worth £300,000. The calculations are based on someone taking the UK minimum wage (currently £13,520 for a 40-hour week), which is a monthly income of £1,127. Including a full state pension of £5,881 a year, this would equate to a total income of £19,405 a year.
Rick Eling, head of investment solutions at Sanlam, recommends a retiree with a pot of £300,000 should increase payouts by 4 per cent a year - 2 per cent over The Bank of England's Consumer Prices Index inflation (CPI) target - if they want to be comfortable. This is to provide some headroom during periods of higher inflation, and also to reflect the fact that elderly people often have higher personal inflation rates than the CPI average.
A portfolio with 30 per cent equity exposure
This pot is expected to be exhausted after an average of 19 years. The worst case scenario (spending maintained in poor markets delivering 2.2 per cent a year) is that the pot would only last 17 years, and the best case (if markets do well, delivering 5.9 per cent annual returns) is 21 years. The odds of having some money left at the 20 year point are estimated at 30.51 per cent.
A portfolio with 50 per cent equity exposure
This pot is expected to be exhausted after an average of 25 years. Worst case (spending maintained in poor markets deivering 2.4 per cent a year) is 22 years, and the best case (if markets do well, delivering 8.3 per cent annual returns) is 28 years. The odds of having some money left after 20 years of retirement is 95 per cent.
Charges of 2 per cent a year have also been included in this modelling.
Consider taking more income in the early years
The bigger a retiree's pension pot, the more flexibility they have when it comes to deciding how much income to take. A strategy favoured by many retirees with a pension pot of around £300,000, according to James Baxter, director at Tideway Wealth, is to take a higher income in the first 10 years of retirement, leaving them with less in the later years. Someone who retires at 65 and takes income of £20,000 a year (plus the state pension) until they are 74 (assuming 6.5 per cent a year gross return) will have around £180,000 left in their pension at this point. They could then continue to take a more modest £5,000 a year on top of their state pension for their remaining years.
Move your pension into Isas and personal accounts
Self invested personal pensions (Sipps) are the traditional home for a pension you're investing yourself.
It makes sense to move money you want to invest in dividend-paying funds into your Isa, because you’ll be taxed less. Happily, the new rules on Sipp withdrawals and increased £15,000 Isa limit make it much easier to steadily move money from Sipps into Isas.
Another big reason to move money out of your Sipp is the amount of money you could access in an emergency without suffering a 40 per cent tax bill. Someone with a £300,000 pension, taking £20,000 income a year from a Sipp, will only be able to take £14,440 a year extra between the ages of 69 and 74 without paying 40 per cent tax, according to Tideway Wealth calculations.
However, if they use their maximum annual Isa limit from July (£15,000 a year), to move money from their pension into Isas, and move their 25 per cent tax-free cash into a taxable account, by age 71 they would have £150,000 available to spend in any given year without paying 40 per cent tax.
Mr Baxter said: "This tax trick will alow you to take lump sums from your portfolio without having the worry of a huge tax bill that could seriously dent your pension. For anyone who wants to help their children or grandchildren, pay for emergency care, or for pay any other big expense, it will leave them with much more pension to live off afterwards."
When you pass away it also pays not to have your money in a Sipp, because any money left over will be charged at 55 per cent tax. However, if you hold the money in an Isa or a general account, you will only suffer tax at 40 per cent on amounts above the £325,000 inheritance tax threshold.
Safety checklist
■ Before anything else, think carefully about your financial goals and how you want to strike a balance between enjoying your money while you still can and having enough to last until you die.
■ Plan ahead so you don't end up paying 40 per cent tax on big withdrawals.
■ Use your £15,000 a year Isa limit (from July) to move your money away from your Sipp, and use it to hold dividend paying equities so you can receive income from them without paying too much tax.
