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TV execs in 50s aim for £150k income

This couple can achieve their goal more tax-efficiently and need to tidy their portfolio holdings
February 27, 2015

Dan is in his 50s and works as a television executive. He is married to Henrietta, also in her 50s, who works as a media consultant.

The couple have substantial assets in the form of pensions, individual savings accounts, equities, cash and buy-to-let investments that they hope will give them a combined retirement income of £150,000. They say: "In seven years time we hope that Henrietta's self-invested personal pension (Sipp) might be worth £250,000 and Dan's pension £600,000. We are planning to put both of these in drawdown at this stage and take 4 per cent a year. With our current pensions, this would give us an annual income of nearly £100,000. We would then look to supplement this with property and investment income and possibly part time income for a while, giving us another £50,000 a year.

"We want to review our investments and pension planning to ensure we maximise growth of these over the next 10 years. "

Reader Portfolio
Dan and Henrietta 50s
Description

Pensions, Isas and buy-to-let

Objectives

£150k retirement income in 7 years

DAN AND HENRIETTA'S EQUITY PORTFOLIO

DanHenrietta
BBC pension at age 65: £19,000 a yearBBC pension in payment: £43,000 a year
Aegon Company Pension: £260,026Alliance Trust Isa: £38,239
Fund (% of pension)Fund (% of Isa)
UK Smaller companies (28)Henderson UK Smaller Companies Fund I (15)
European (11)F&C US Smaller Companies C In (11)
Global equity tracker (18)HSBC FTSE 250 C Acc (15)
Pacific (12)BlackRock Emerging Markets Equity Tracker D Acc (11)
Overseas Equity Tracker (20)Jupiter UK Special Siuations I (15)
SE BAQ US (7)Schroder European Smaller Companies Z Acc (19)
European tactical (1)Unicorn UK Income Fund B Inc (5)
UK equity tactical (3)Unicorn UK Income Fund I Acc (9)
Fidelity Isa: £24,082Alliance Trust Sipp: £161,574
Fund (% of Isa)Fund (% of Sipp)
BlackRock Emerging Markets Equity Tracker (11)Henderson European Focus I Acc (2)
BlackRock UK Smaller Companies (23)JPMorgan Emerging Markets (5)
HSBC American Index (12)First State Asia Pacific B Acc (3)

HSBC FTSE 100 Index (10)

First State Asia Pacific Leaders B (1)

Old Mutual UK Equity Income (25)

Henderson UK Smaller Companies CL (19)

Schroder European Smaller Companies (19)

Henderson European Focus (8)

Fidelity Pension: £37,761

F&C US Smaller Companies C Inc (11)

Fid BlackRock Global Eqty 50/50 Fnd

HSBC FTSE 250 C Acc (15)

Fid BlackRock UK Equity Index Fund

HSBC American Index C Acc (12)

Fid BlackRock World (ex UK) Fund

Artemis Global Growth I Acc (5)

Fid F&C Responsible UK Eq Growth Fd

Jupiter UK Special Situations I (4)

Fidelity Henderson Hi Alpha UK Eqty

Unicorn UK Income I Inc B (10)

HSBC ISA: £6,266

Vanguard FTSE Developed World E (5)

FTSE250 Index Fund

Joint share portfolio: £20,408National Grid (4)
Holding (% of portfolio)Royal Mail (5)
Dunedin Income Growth Inv Trust (27)BT (10)                                  
Lloyds Bank (1)3i (7)                                           
Aviva (14)Banco Santander (32)

TOTAL EQUITY FUNDS: £548,356

 

OUR EXPERTS' VERDICT

Chris Dillow, the Investors Chronicle's economist, says:

You say you want to "ensure we maximise growth." In truth, though, you neither want to do this, nor need to.

If you really wanted to maximise growth, you'd invest everything in the single stock which you thought would offer the highest returns. But of course you're not doing this. In spreading your investments across funds you are diversifying. Diversifying, though, is just another word for diluting returns; good diversification dilutes bad returns, but the price we pay for doing so is that good returns get diluted too.

And in truth, you don't need to maximise returns. With average luck, equities should give a return of 5 per cent per year after inflation. If Dan continues to pay in £27,000 per year, this should get you both to your target pension wealth. And with total returns of 5 per cent per year, a 4 per cent drawdown rate means you should - on average - be able to preserve your wealth in retirement.

But of course, there's only a 50-50 chance of getting average luck or better. You should therefore consider what you'd do if returns fall short of expectations.

One possibility could be to postpone Dan's retirement. Another is that you could release the capital in your house by trading down; unless relative prices change a lot in the next seven years, you can raise hundreds of thousands simply by moving from London to somewhere cheaper.

I assume that these options aren't too unattractive for you. If so, they justify what many readers would otherwise find odd about this portfolio: the absence of safer assets such as cash or bonds. In effect, you're using your background assets (human capital and ability to trade down your house) as a hedge against equity risk, rather than financial assets.

 

Steve Wilson, investment director at Alan Steel Asset Management, says:

Your goals are achievable but there are probably more tax efficient ways to achieve them, while providing flexibility and tidying up a few of your portfolio holdings.

Your target income of £150,000 in seven years' time looks achievable but you don't say whether the income you want is to be gross or net. If gross, then I do not see any major issue achieving this.

You both have defined-benefit pensions, of which Henrietta's BBC Pension is £43,000 a year, with Dan's kicking in at age 65. On top of this the rental income you receive is £15,000 a year, giving a total income of around £77,000 pa from 2025 when Dan is 65. You want to retire when Dan is 62, therefore there would be a three-year shortfall before Dan's defined benefit pension kicked in from the BBC.

Henrietta may also have a year to wait before her BBC pension kicks in, as I've assumed it is the same scheme retirement age of 65 for her.

In total, your current pensions of £298,000 (Dan), including his Fidelity Plan, and £174,000 (Henrietta) including her L&G Pension would reach your target values of £600k and £250k respectively, assuming around a 6 per cent growth rate which I think is reasonable if you are prepared to take some risk. This assumes the further contributions of £27,000 per year are added to Dan's pension.

This gives joint pension pot of £850,000 and, given the new flexible drawdown rules, a tax free cash entitlement of 25 per cent of the fund which they could draw down on a gradual basis to create some tax efficient income before the final salary pension plan kicked in for Dan.

I would try to aim for less pension income and perhaps keep that within the basic-rate tax band and try to create more tax efficient income from investments. At the moment their intention is to create pension income which is fully liable to income tax. Your rental income from your properties is also taxable and therefore you would be well into the 40 per cent tax rate in retirement.

State Pension would kick in from age 66 onwards which would mean a one-year gap for Dan and a two-year gap for Henrietta before those kicked in, but again would go some way towards your target income needs.

It looks as though Dan is not contributing to his pension plan but his employer is. As Dan is earning £182,000 he is into the Super Rate Tax of 45 per cent. While being mindful of the annual allowance for pension contributions, Dan could make use of unused relief from previous years and carry this forward to make a pension contribution this year of £33,000, to bring him back down below the 45 per cent tax rate. Dan would also receive 45 per cent tax relief on the contribution, meaning a net cost to him of only £18,000 or thereabouts for a £33,000 contribution.

When you come to take benefits, you may be close to the Lifetime Allowance limit of £1.25m. We have seen the government tinker with pension rules so often over the past decade that we do not know what the Lifetime Allowance will be when they come to take benefits, but the defined benefit pensions will be taken into account at 20 times the annual pension, plus any tax free lump sum, which means they will be close to the £1.25m limit when you add in their Money Purchase pots (ie £43,000 x 20 for Henrietta).

 

LIFETIME ALLOWANCE HISTORY

The lifetime allowance was introduced on 6 April 2006 but has not remained at the same level and has even reduced in recent years.

Tax yearLifetime allowance
2006/07£1,500,000
2007/08£1,600,000
2008/09£1,650,000
2009/10£1,750,000
2010/11£1,800,000
2011/12£1,800,000
2012/13£1,500,000
2013/14£1,500,000
2014/15£1,250,000

Your plan to fund individual savings accounts (Isas) is a wise move as, other than the £60,000 you have in Isas, plus £20,000 in stocks and shares, the bulk of your assets are non-liquid in pensions and property. The Isas, of course, would grow virtually tax free and, in seven years' time, assuming they had funded £30,000 each year, even assuming no growth would be worth around £270,000. This means you could create around £13,000 per annum in tax free income if you assume a 5 per cent withdrawal rate. This would give a chance for the capital to be maintained and, hopefully, a bit of capital growth on top.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

First, keep an eye on charges. Henrietta's Sipp has quite a few actively managed funds. While there might be a case for holding one or two such funds, there isn't a case for many. Remember that a tracker fund is, in effect, a fund of funds - and one that has lower charges.

Secondly, there might come a time when you'll want to reconsider your massive equity weighting. If shares rise sharply in the next year or so while interest rates rise, a partial shift from equities into cash might be a useful way of reducing risk whilst still leaving you a good chance of hitting your wealth target.

 

Steve Wilson says:

Thirty per cent of your overall investment and pension portfolio is invested in smaller companies, which, while having struggled in the past 12 months, have performed extremely well over three years. You are light on US exposure and we believe the US is still going to lead the way. Of course, the US has had a good run over recent years, but their economy is in much better shape than most.

You do have exposure to Europe and, we do think the EU will survive, despite the political problems over there. Perhaps think about a fund manager who hedges the currency.

While you have picked some good funds within your Isas and Henrietta's Sipp, Dan's pension unfortunately is fully invested in Aegon's own funds. It would be worth checking to see whether there are external fund managers available to get the money working better for him over the coming years.

You have no exposure to UK equity income or global income funds and they have been the stalwart of investment returns for many years. The only exposure I can see is Old Mutual UK Equity Income Fund (GB00B1XG7551). I would look to include someone like Neil Woodford at CF Woodford Equity Income (GB00BLRZQC88) or Jacob De Touchelac at Artemis Global Income (GB00B5ZX1M70) to name but two within that space.

BUY-TO-LET TIPS

Dan and Henrietta have a buy-to-let portfolio of five properties located in London and Bristol. The total value is £1.25mn and the total mortagage liability is £600,000. The net income from the portfolio is £15,000 a year.

Chris Dillow says:

I'm not sure your buy-to-let (BTL) investments are a great hedge against your pensions. For one thing, in the longer-run, house prices and share prices are both plays upon economic growth: were we to fall into another recession - which is a highish probability on a seven-year view - shares and house prices would probably both fall.

And for another, BTL investments carry some risks. Some of these are idiosyncratic and so uncorrelated with your pension; the risk of voids or high repair bills, or of a downturn in the local market. Others are systematic; the danger of a rise in mortgage rates (which is a high enough danger over the next few years that you should budget for it) and illiquidity risk; the possibility that you'll not be able to sell quickly if you need to raise cash.

I suspect you can bear these risks. Your high income from other sources means you should be able to afford voids or higher mortgage rates. And the low probability that you'll need to raise cash in a hurry means you are probably better placed than most to take illiquidity risk.

BTL isn't for everyone - those with low incomes and/or high debt. But as you're not in this category it is sustainable for you.

Steve Wilson says:

You don't say if your mortgages are interest only or repayment, but interest rates are historically low, and will likely remain so for a while, but you should be mindful of interest rate rises as your monthly outgoings could rise substantially if we do see some inflation.

You should be mindful that property is not liquid and you cannot control the capital gains tax position so, when you come to sell those as second homes, they will be liable to capital gains tax on the gain. You have three children, and in my experience they very rarely become totally financially independent and may come back to Mum and Dad for help on the housing ladder, or education costs in the future for their own children. Unfortunately you cannot just sell part of a property, realise some capital and help the kids out as you can with say an investment portfolio using various tax exemptions.

• NONE OF THIS SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THE READER'S CIRCUMSTANCES.