Mr Rees, is 59 and has been investing for 20 years. He says: "I am semi-retired and have adequate financial resources to fund my lifestyle until I reach 65. My investments are in individual savings accounts (Isas) and self-invested personal pension (Sipps). My objective is to avoid breaching the expected reduction in pension lifetime allowance (LTA) of £1m."
His Sipp is worth just over £500,000. A tax-free lump sum of £149,948 was taken in October 2013 when the portfolio was worth £599,796 and no further drawdown has occurred since.
He has a defined-benefit pension worth £20,000 a year from age 65.
Avoid breaching pensions lifetime allowance
MR REES' PORTFOLIO
|Amundi ETF MSCI Europe Ex UK UCITS ETF (AEXK)||£3,374||0.5|
|Artemis Income Acc (GB0032567926)||£2,685||0.5|
|Artemis Strategic Bond QI (GB00B2PLJR10)||£10,335||1.5|
|BlackRock European Dynamic A Acc (GB0000495209)||£2,316||0|
|City of London Investment Trust (CTY)||£5,455||1|
|Edinburgh Investment Trust (EDIN)||£1,968||0|
|First State Glbl Listed Infrastructure B GBP Acc (GB00B24HJL45)||£5,273||1|
|HSBC American Index Retail Acc (GB0000470418)||£6,750||1|
|iShares Global Water (IH2O)||£5,280||1|
|Jupiter Strategic Bond I Acc (GB00B4T6SD53)||£10,246||2|
|Lowland Investment Company (LWI)||£3,695||0.5|
|Marlborough UK Micro Cap Growth P Acc (GB00B8F8YX59)||£4,240||0.5|
|Scottish Mortgage Investment Trust (SMT)||£27,257||4|
|Utilico Emerging Markets (UEM)||£4,976||1|
|Witan Investment Trust (WTAN)||£22,359||4|
|db x-trackers FTSE All-World Ex UK UCITS ETF 1C (XWXU)||£126,730||20|
|iShares MSCI Emerging Markets Small Cap UCITS ETF (SEMS)||£16,227||3|
|iShares MSCI World GBP Hedged UCITS ETF (IGWD)||£115,625||19|
|PowerShares FTSE RAFI All-World 3000 UCITS ETF (PSRW)||£34,987||6|
|Vanguard Emerging Markets Stock Index GBP Acc (IE00B50MZ724)||£16,379||2.5|
|Vanguard Global Small Cap Index Fund Acc (IE00B3X1NT05)||£55,405||9|
|Vanguard LifeStrategy 60% Equity A Acc (GB00B3TYHH97)||£54,112||9|
|Vanguard FTSE 100 UCITS ETF (VUKE)||£24,211||4|
Source: Investors Chronicle, as at 6 May 2015
iShares MSCI World Momentum Factor UCITS ETF (IWFM)
iShares MSCI Euro Momentum Factor UCITS ETF (IEFM)
Db X-Trackers MSCI EFM Africa TOP 50 Capped Index UCITS ETF (XMAF)
THE BIG PICTURE
Chris Dillow, the Investors Chronicle's economist, says:
This portfolio is ideal for a younger person. Its low-cost, low-maintenance trackers are great for younger investors as they minimise the effect of fund charges compounding nastily over time. And the big overseas holdings diversify human capital risk, which is bigger for younger people who have more years of work ahead of them (some might add that the high equity exposure is also a young person's strategy, but I'm not so sure: the advice that one should hold more bonds as one ages is, in fact, dubious). And yet you are nearing retirement.
I'm not sure, though, that this is as paradoxical as it seems. You might well have 30 years of investing ahead of you, assuming (reasonably) that you use some form of drawdown rather than annuitisation. This makes you, for investing purposes, a young person.
Although I like the overall shape of this portfolio, your expectations for returns might be a little high.
Five per cent per year is an entirely reasonable expectation for equity returns. But you have a 12 per cent weighting in cash and bonds. I would assume a zero return on these - and possibly worse, if a continued global economic upturn reduces investors' safe-haven demand for bonds. A more reasonable expected return would thus be around 4.5 per cent. More importantly, there are big risks around this. There's probably around a one-in-six chance of a zero return or worse on this portfolio even over the next five years - so you might not have to worry much about the possible cut in the pension lifetime allowance.
Would such a loss jeopardise your retirement plans? If so, could you comfortably(ish) respond by working longer or trimming your outgoings? If the answer's no, think about shifting a little towards cash.
James Baxter a partner at Tideway Investment Partners, says:
This portfolio, assuming it has been held like this for the past five years, will have delivered excellent returns in what has been a strong bull market for both equities and bonds. There is a great selection of active managers alongside the passive approach taken on the Sipp, but the thrust of the strategy in both cases is equities via broadly-invested collective funds. There will be a high degree of correlation among the majority of funds selected in both the Sipp and Isa.
This portfolio is definitely in 'risk and growth' mode rather than 'capital preservation and income' mode.
Risk and growth is absolutely fine when there is no call on the money and you have time on your side. But its success as an investment strategy will largely come down to timing. There are plenty of five-year periods when this portfolio would have generated a total return loss. In fact, if you look at Barclays' gilt equity study this year you will see that, since 1900, the chances of making a real profit (after inflation) on a five-year investment into either broad UK equity or UK gilt indices is not much better than flipping a coin - it's broadly a 50/50 bet. Furthermore, judging now whether broad markets are likely to generate a positive or negative real return for the next five years is impossible.
Volatility is ruinous when you start taking withdrawals from your funds. So if this is the ultimate plan at some point a 'capital preservation and income' approach would be prudent.
We encourage investors like this at retirement to distinguish between capital that is going to be irreplaceable and essential to generate income in retirement, from other capital that can be invested without any specific purpose or date and that can be kept for the long term to ride out volatility.
Mr Dillow says:
This portfolio is the sort I like. It's dominated by low-cost index trackers, which are ideal for a long-term investor who wants a low-maintenance portfolio. Actively managed funds are used only sparingly to get exposure to specific asset classes, such as infrastructure stocks or UK high-yielders.
Another feature of the portfolio is its international exposure. This is consistent with the philosophy of trackers. The idea here is that you know no more than the average investor, so you should hold the same basket of shares as the average investor - and the average investor has only around 8 per cent of his equities in the UK.
There is, however, another justification for big overseas exposure. Most of us have made a massive investment in the UK economy simply because we work in it: we have invested our human capital here. The basic principle that we shouldn't put all our eggs into one basket also advises us not to invest our financial capital here. Investing overseas is a way of protecting ourselves from the perhaps small but nasty risk of the UK economy suffering localised low growth, which would cause us to suffer job losses or wage cuts as well as losses on domestic shares.
This is also the justification for your investments in emerging markets. The case for these is not that they offer growth, but rather that they might protect us from the risk of secular stagnation in the west.
Mr Baxter says:
A 'capital preservation and income' mode would advocate a bigger exposure to fixed-term, fixed-return securities, known as liability-matched investments, a much lower level of equity exposure and elements of the portfolio aiming to reduce volatility.
MR REES'S QUESTIONS ON THE LIFETIME ALLOWANCE
If future investment growth of my Sipp needs to be noted for lifetime allowance (LTA) purposes, then assuming 5 per cent growth of both my crystallised Sipp and my defined-benefit pension (valued at age 65 at 25 times £20,000 a year = £500k) I forecast I will breach the expected £1m LTA before retirement. Can I protect myself from 55 per cent tax?
Barry O'Sullivan, an investment manager at Lowes Financial Management, says:
HMRC 'Individual Protection 2016' is expected to protect total benefits valued over £1m, up to a maximum of £1.25m. The value of your pension benefits on 6 April 2016 will become your personalised LTA. 'Fixed Protection 2016' is expected to fix the LTA at £1.25m regardless of the value of your pension benefits, and no further pension contributions are allowed.
For maximum protection you could opt for Fixed Protection, and also Individual Protection if you qualify on 6 April 2016. The LTA test for your defined-benefit pension is actually 20 times your starting income (plus any tax-free lump sum if you opt for this). You have almost 60 per cent of your LTA remaining to be used for your defined benefit-pension and for any Sipp fund growth.
If I draw down with a combined pension fund of more than £1m and are therefore exposed to 55 per cent tax, how is this done? Is it 55 per cent on all of the drawdown?
Mr O'Sullivan says: Using an example of £1.1m from next April, £100,000 would be the excess over the LTA. It is only the excess that is taxed, and there are two different rates. Any of the excess taken as a lump sum is taxed at 55 per cent, or 25 per cent if the excess is designated to provide income, such as drawdown. So, after tax, you could have a £45,000 lump sum paid into your bank, or £75,000 left in a drawdown pension. You can actually take a combination of both.
Mr Baxter says:
The onus is on the individual to declare how much of the LTA they have used each time they come to crystallise a new pension. The scheme administrator of this newly crystallised pension is responsible for deducting the excess rates at source.
If the new crystallisation event breaches the LTA then, if the excess amount is taken as income, or income drawdown, a 25 per cent rate applies. If it's taken as cash a 55 per cent rate is applied. If the account straddles the LTA, the excess rates apply only to the excess amount.
For drawdown accounts, the 25 per cent is taken as a one-off charge as the excess amount goes in to drawdown, withdrawals are then taxed as a normal account on a marginal rate basis. If it's a defined-benefit pension it's applied each and every month to the excess portion before normal rates are deducted.
If you stay in your defined-benefit scheme you can keep deferring your pension until it gets to £30,000 a year (£600,000/20) so you probably do not have a problem.
How should I avoid breaching the LTA?
Mr Baxter says:
We would recommend obtaining and reviewing a transfer value offer for the defined-benefit pension. A 30 times multiple for an age 60 defined-benefit pension is quite common at present and could be worth £500,000 in this case. Big transfers can often be the difference between being well under, or at or over the LTA. For those over 55 the transfer can then be crystallised this tax year with the higher LTA to secure the maximum tax-free cash sum possible, noting that income withdrawals can then be deferred and the drawdown account will not be tested again irrespective of investment returns.
Transfers can suit those investors that are comfortable having invested funds and have enough money to hold their own risk against living particularly long or fluctuations in investment returns - and unused drawdown funds are now very tax efficient to pass to the next generation.
Mr O'Sullivan says:
Your potential defined-benefit income is escalating while it's deferred, so taking your benefits early, while income is relatively lower, would use less of the LTA (remember the test is 20 times income).
Start drawing income from your Sipp. The fund growth test at age 75, or if you buy an annuity, doesn't take withdrawals into account, so withdraw what you need to make sure the fund is no higher than the £449,847 you started with.
If your defined-benefit scheme allowed it, you may be able to partially transfer out up to three pots of £10,000 to release as lump sums (75 per cent is liable to income tax) under the DC 'small pots' rules. These lump sums don't use any of the LTA, and would reduce the value of your defined benefits.