Calculate your cash needs and pay less for funds

Jeremy and Rose have been investing since 1994, and have combined investments of £740,000 in individual savings accounts (Isas) and £331,000 in self-invested personal pensions (Sipps). They hold them with Bestinvest.co.uk and Hargreaves Lansdown, and review them once a year.

At age 65 John will start to receive a final-salary pension of £27,500 a year which is index-linked.

"My preference is to retire now," says John. "We plan to use our Premium Bonds as income, and then draw on our Isas and Sipps.

"We need to consider what the options and strategies are for our investment portfolio, firstly over the next four years, and then for when I am 65 and start drawing on my final-salary pension, soon after which we will also be able to start receiving our state pensions. Inheritance tax planning is not a great concern as we intend to spend most of what we have.

"I would say our that our investment risk appetite is medium, and we want to have a balanced portfolio.

"We are fit and in good health so think we should plan for income needs well into our 90s, although may need provision for care costs as we get older. Our interests include culture, travelling, skiing and visiting our grandson in Switzerland.

"When I'm 65 we would like to buy a second home or move house.

"We estimate that our spending amounts to £40,000 a year; however, we would like the option of being able to spend more.

Jeremy & Rose's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

With a balanced portfolio of over £1m, you should, on average, be able to take over £30,000 a year and leave your capital intact. If you retire now, you'd probably see a slight rundown in capital if you were to take £40,000 a year for four years, until Jeremy starts receiving his final-salary pension. But such a probably small run-down is perfectly sustainable.

You are in this strong position not just because of your wealth, but also because you don't plan to pass on assets. Even if your portfolio only makes modest returns and you live for a long time, this should mean you can take a decent income simply by running down your wealth.

Martin Bamford, managing director of Informed Choice, says:

Your assets need to support a retirement that sounds reasonably active, especially in the early years. It will also have to bridge the gap between now and when Jeremy starts to receive his final-salary pension, and cope with occasional capital withdrawals in the future.

A good way to understand what is affordable would be to engage a financial planner to construct a comprehensive lifetime cash flow forecast. This would show you various scenarios for the future, with the cash flow based on several assumptions around growth, expenditure and price inflation. You need to ensure your money has a high chance of lasting until you die, so I would suggest basing any projections on living to age 99.

It would also make sense to consider several disaster scenarios and what impact these would have on your future retirement income. We would usually factor in the financial impact of death, disability and the need for long-term care at various points in retirement.

Cash flow forecasting would be especially useful in determining if you can afford larger things such as a second home or new cars, and would also guide you in determining a sustainable withdrawal rate from your portfolio.

A rule of thumb is that 4 per cent of the capital value can be withdrawn each year without too great a risk of running out of money during your lifetime. Based on the value of your Isas, Sipps and cash assets of about £1,115,000, this would provide £44,600 a year. The lower the withdrawal level you can afford, the more sustainable the withdrawals should be over your lifetime.

Behavioural coaching is especially important when investing money in retirement. This helps to prevent your emotions driving investment decisions that you would not otherwise make. An independent financial adviser could also help with rebalancing, tax-efficient withdrawals, establishing the best order of withdrawals and tax planning.

Simon Bonnett, senior consultant, private clients at Beckett Financial Services, says:

You are looking for a cash flow over 30 years within which you fully intend to enjoy your retirement, and you have built up enough assets to do this. You have enough in your Sipps and Isas to provide around £35,000 in annual income for the next 30 years, even if you liquidate holdings for cash and take capital as your income.

However, constant attention to investments is necessary to prevent inflation ravaging their buying power.

If John retires now, he should use his tax allowances and consider taking a combination of Isa income, Sipp tax-free lump sum and taxable pension income - all reviewed annually. When the final-salary pension and state pensions start paying out, reassess your income requirements and consider reducing the Sipp taxable income and tax-free lump sum.

If John works until 65, the final-salary pension plus natural yield from both your Isas would then provide the projected £40,000 a year net expenditure. When you start receiving your state pensiona at 66, the Isa income can drop or continue, depending on your income requirements and planned capital expenditure at that time.

You should both ascertain what your state pension entitlement will be by completing a BR19 form available from the Department for Work & Pensions. For example, you could both receive £8,296 a year from the full new state pension providing a £16,592 gross income boost. The state and final-salary pensions will broadly cope with inflation, and your investment income over the long term should rise and maintain purchasing power.

Rose could consider collapsing her pension in one go with the new flexible access rules if her pension allows this. Using her personal tax allowance she would only pay around £12 income tax, based on the current fund value of £15,413 if she has no other taxable income.

The positive changes in the inheritability of pension funds have changed the focus for many people from where the income might be drawn first. In most cases, this means first considering income and capital from Isas and general investment portfolios - before a pension.

Your NS&I Premium Bonds and shares could be used for emergency cash requirements. You could use your Isa funds and the tax-free element from John's pension to buy a new or second home.

Although you fully intend to use your savings before you pass away, death is never planned so make sure your wills, power of attorney and Sipp expression of wish forms reflect your current wishes, to ensure a smoother transition of family wealth to your beneficiaries.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You're spending too much on fund charges. And the benefits of absolute return funds - stable (ish) returns - can usually be achieved by a balanced portfolio of bonds, equities, cash and gold. For the most part, you already have this, so the absolute return funds add little.

I suspect you've assessed funds in isolation rather than considering what their contribution to your portfolio is. Viewed in isolation, absolute return funds look good. But in the context of your overall portfolio they add little.

I would regard your bond funds as insurance: they would probably pay out okay in some circumstances in which you lose on equities: if or when we get a global economic downturn, increased risk aversion or further fears of secular stagnation. This insurance, however, is expensive. It comes at the price of low average returns in normal times, and possible losses if yields rise: the latter might not be offset by gains on equities if they are, say, a response to rising commodity prices or interest rates.

Cash wouldn't offer the good returns that bonds can deliver in a recession or flight to quality. But it has less potential downside. So consider whether you need to pay the fees of active bond funds when cheaper bond exchange traded funds (ETFs) are available.

I'd also raise a warning about your property funds. If retail sales stay weak and consumers continue to shift online, or Brexit-induced job losses reduce demand for office space, commercial property might suffer. Do the prospective returns really justify taking on this risk?

What exactly are you trying to achieve with your equity funds? Although drawdown is more tax-efficient than taking income, there is a case for equity income funds, as these give you exposure to large defensive stocks - history tells us that defensives do well on average over the long run. But are your other funds really doing anything that cheap global trackers are not? I'm not sure.

Martin Bamford says:

Because you are bridging an income gap between today and the start of payments from John's final-salary pension in four years, and state pensions after that, the withdrawals are likely to be higher in your early years of retirement. From a risk perspective, making higher withdrawals from a portfolio in the early years of retirement can be damaging to its value, especially if markets dip during this time. This sequence of return risk makes it important to ensure the portfolio is well diversified across different assets.

This is a well-constructed portfolio of funds that should perform well in a variety of market conditions. But I would suggest replacing some of the more expensive actively managed funds with low-cost index trackers. This would help reduce the overall cost of managing the portfolio, and charges can have a big impact on returns over the longer term. Index trackers seem to be of greatest benefit in large, efficient markets such as UK and US equities.

Check what the availability of lower-cost funds is and if there are any additional charges with the platforms you are using. You might benefit from a review of these platforms and perhaps migrating to a lower-cost option.

Samantha Owen, associate director and portfolio manager, Beckett Asset Management, says:

You have an immediate and future income shortfall which needs to be met from your investments. You will need to replenish some of the cash savings for extras such as being able to spoil the grandchildren and extra escapes to the sun without having to sell down investments at times when the portfolio value is falling.

Your investments broadly reflect your medium/balanced risk profile, and the portfolio is reasonably well diversified.

You review the portfolio once a year, however, you may have suffered from portfolio drift because of running winners and not rebalancing.

To overcome the issues of keeping on top of the portfolios, and managing risk and liquidity, you may want to consider managed funds in line with your risk profile and objectives, if you are going to be busy travelling and enjoying retirement.

The Isas generate a natural yield of around 2.3 per cent, yet with the majority of holdings in them you hold the accumulation units. If you switched to the income versions you could turn on a natural tax-free distribution stream to help meet your needs.