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How can I generate a retirement income of £50,000 per year?

This investor wants to grow his pensions to at least £1.2m
March 11, 2021 , George Steger and Tom Fleming

This investor wants to take £40,000 per year from his pensions and £10,000 per year from his Isas in retirement

He and his wife need to reduce their number of holdings

They could consider cutting holdings in income funds that do not meet their growth objectives

Reader Portfolio
David and his wife 37 and 32
Description

Pensions and Isas invested in funds and shares, cash, residential property. 

Objectives

Retire at age 65, grow pensions to value of £1.2m+, take lump sum and £40,000 per year income from pensions, 5%+ average annual total return, draw £10,000 a year from Isas in retirement, start family, buy holiday home, reduce number of holdings.

Portfolio type
Investing for growth

David, age 37, and his wife, age 32, earn £80,000 and £25,000 per year, respectively. Their home is worth about £210,000 and has a mortgage of £120,000.

“I plan to build up my pensions to a value of £1.2m or greater, so that I can take a lump sum and then draw around £40,000 a year from them without significantly affecting their capital value," says David. "So I would like them to grow 5 per cent or more a year, in addition to new contributions, until I retire at age 65.

“I would also like to grow my individual savings accounts (Isas) to a large enough size to be able to draw £10,000 a year from them.

"We are also keen to invest as much as we can at the moment to benefit from growth over the next 25 to 30 years. We plan to start a family in the next few years at which point our disposable income is likely to reduce.

"I have two workplace pensions and a self-invested personal pension (Sipp) worth around £260,000 in total. My employer and I contribute £2,800 per month into my current workplace pension, and I add £4,000 per year to the Sipp. 

"My non-pension investments are worth around £110,000 and I contribute about £8,000 per year to them. I have a professionally managed Isa and Lifetime Isa (Lisa), and self-managed Isa. 

"I manage my wife's Sipp, which she opened a year ago, and she has an Isa and Lisa run by the same manager as mine. She is keen to invest about £6,000 per year into these accounts.

"We also have around £50,000 in cash, mostly in foreign currency, to which we add to each month. This is a long-term savings pot for a holiday home abroad, and an emergency fund in case we lose our jobs or cannot work. We plan to always have easily available cash to cover us for six to nine months.

"I take a long-term view with our investments and did not panic when the markets crashed last year. Instead, after March I diverted spare cash into our investments as I believed markets were oversold. 

"I first bought shares 10 years ago after reading some tips but one went bust and I lost around £3,000. So for five years after this I invested in funds and changed them rarely. But over the past five years I have tried to be better informed and invested more actively.

"I want to change some of the funds in my self-managed Isa as some of them are underperforming. I also think that I hold too many funds. Although they sound different, many of them hold the same companies and some have high fees despite having underperformed. Also, trying to keep an eye on so many is a nightmare. 

"I don't have much exposure to bonds or non-equity investments as I favour a higher-risk approach at this stage of my life, although maybe I should hold assets other than equities.

"My friends are very keen on Tesla (US:TSLA), bitcoin and other hot topics. It can be difficult to ignore the noise but I don’t understand cryptocurrencies enough to invest in them."

 

David and his wife's total portfolio
HoldingValue (£)% of the portfolio
Cash57,98013.37
David's professionally managed Lisa21,0354.85
L&G PMC Man GLG Continental Europe (GB00BD1JRQ18)17,1703.96
L&G JPM Life Diversified Equity (GB0030516636)15,4063.55
L&G PMC BNY Mellon Global Equity (GB00BD1JRV60)15,2983.53
L&G PMC North America Equity Index (GB00BGYBW716)15,2943.53
L&G PMC ASI Life Global (ex UK) Equity (GB00BD1FSZ51)15,2413.52
Scottish Equitable Baillie Gifford International (GB00B2482297)15,0193.46
David's professionally managed Isa14,2903.30
L&G PMC Japanese Equity Index (GB00BGYBVX09)14,2153.28
L&G PMC ASI Life UK Equity (GB00BD1FTZ27)13,9343.21
Scottish Equitable UBS Global Emerging Markets (GB00B0MTKQ07)13,4003.09
Aegon Technology (GB00B629ZJ09)13,2903.07
Scottish Equitable Invesco Asian (GB00B1NV0M88)13,2863.06
Aegon Fundsmith Equity (GB00BMH4KD13)13,1383.03
L&G PMC Multi-Asset (GB00B5W2CB33)13,1363.03
L&G Distribution (GB0030535289)12,5542.90
L&G PMC Global Equity (70:30) Index (GB00BGYBVC95)12,4752.88
Fidelity Index World (GB00BJS8SJ34)12,3812.86
Xaar (XAR)12,2862.83
Scottish Equitable Baillie Gifford UK Equity (GB00B1VRK174)11,8172.73
L&G PMC BNY Mellon UK Income (GB00BD1JS240)11,7002.70
TM Stonehage Fleming AIM (GB00B0JX3Z52)9,7282.24
Wife's professionally managed Lisa8,7362.02
Marlborough Special Situations (GB00B907GH23)8,1801.89
Aegon BlackRock Over 5 Year Index-Linked Gilt Index (GB00B4NHLL34)7,4421.72
Fidelity Global Dividend (GB00B7GJPN73)6,6501.53
Rathbone Global Opportunities (GB00B7FQLN12:GBX)5,4721.26
Energean (ENOG)5,4251.25
MI Chelverton UK Equity Growth (GB00BP855B75)3,8800.89
Jupiter UK Smaller Companies (GB00B1XG9599)3,6590.84
Northamber (NAR)3,2280.74
Aegon Overseas Tactical (GB00B3NVWV57)3,0440.70
Vanguard Target Retirement 2050 (GB00BZ6VKT06)2,8140.65
Vanguard FTSE All-World UCITS ETF (VWRL)1,8470.43
Wife's professionally managed Isa1,7940.41
Vanguard Global Emerging Markets (GB00BZ82ZY13)1,2910.30
Scottish Equitable Fidelity Special Situations (GB00B3FG3592)1,0600.24
Aegon Global (GB0007906687)8960.21
Vanguard FTSE Developed Europe ex UK UCITS ETF (VERX)8840.20
Vanguard LifeStrategy 100% Equity (GB00B41XG308)8880.20
Vanguard FTSE UK All Share Index (GB00B3X7QG63)8320.19
Vanguard FTSE North America UCITS ETF (VNRT)7780.18
Aegon Baillie Gifford UK Equity Alpha (GB00BKX59S27)6510.15
Total433524 

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

 

Chris Dillow, Investors Chronicle's economist, says:

It’s good that you'e adding money to your portfolio while you can. Long-term returns are uncertain, so we cannot rely on investment returns alone to provide a comfortable future. I would assume that to get an income of £10,000 a year from your Isa, you need a pot of around £250,000.

It’s possible that the tax treatment of pensions will become less generous in future as the government looks for easy ways to raise revenue. This might mean less tax relief on contributions and a cut in the lifetime allowance, which would mean higher tax on income and withdrawals from your pension. The best way to cope with this is to diversify your savings between pensions and Isas, so I’m not sure that it’s wise to aim for a pension pot of over £1m. 

You hold too many funds. The problem with this arises from a basic mathematical fact about equity markets. As you add shares to a fund, you reduce the importance of any individual stock’s idiosyncratic returns. But at the same time, you increase the importance of the stocks’ correlations with each other. A large chunk of these correlations arise from the fact that shares are also correlated with the general market. This means that any equity fund will be highly correlated with the market. So as you add more funds, you own assets that are highly correlated with each other and with the market. This results in a portfolio that, in effect, tracks the market.

There’s nothing wrong with a market tracker, and plenty right. But if you hold many funds you pay higher fees than if you had one market tracker. For a younger investor, this is very detrimental because fees compound over time. For example, over 20 years, an extra half percentage point of charges could easily cost you over £2,000 for every £10,000 you invest.

So cut some of the higher-charging funds from your portfolio.

Ordinarily, I’d advise you to start with the poorer performing funds, because markets are prone to momentum, meaning that losses lead to further losses. But these are not ordinary times. It’s possible that if the market continues to look forward to a post-Covid recovery, bombed-out stocks such as airlines and leisure companies will bounce back most, and poorly performing funds could recover. It’s usually a great idea to back momentum but this time might not be the case. Unusually, you might not need to rush to ditch dog funds.

I’m not sure that you should consider non-equity assets. Gold and bonds are useful ways of protecting a portfolio against falls in equities, but this 'insurance' is expensive. It comes at the price of negative real returns in normal times and, perhaps, significant losses if the world economy recovers more strongly than expected.

You find it difficult to ignore the noise about hot topics such as bitcoin and Tesla. But that’s a reason to continue ignoring it. If you find it hard to do this, others might find it impossible. It’s likely that these assets have been driven up not just by an objective assessment of their prospects but by herding. Peer pressure is an important influence on all sorts of decisions, including stock selection. And when overvalued assets fall, they fall a lot. So, while there’s upside potential in these they are also very risky.

 

George Steger, senior wealth manager and Tom Fleming, associate wealth manager at Investment Quorum, say:

If you retire at 65, you have a 28-year time horizon to build up your assets to meet your financial goals.

Assuming a pensions target of £1.2m, a £40,000 annual distribution equates to a 3.3 per cent a year withdrawal rate which, coupled with sensible risk adjusted returns, could contribute significantly to your retirement expenditure.

By remaining in employment, you will continue to increase your credit to the UK Basic State Pension, which represents a valuable supplementary income stream. 

As you are currently a higher-rate taxpayer, make full use of any available pension tax relief in the 2020/2021 tax year. Personal pension contributions attract tax relief of 20 per cent at source. If you are a higher-rate taxpayer, an extra 20 per cent of additional tax relief can be claimed via self-assessment. HM Revenue & Customs permits you to carry forward any unused pension tax relief from three complete tax years into the 2020/2021 tax year.

You cannot pay more than 100 per cent of your earnings into your pension in any tax year – regardless of any available allowance. Personal pension tax relief is granted in the current tax year only, so you can only claim higher-rate tax relief when your earnings exceed approximately £50,000.

You will need approximately £500,000 in Isas to generate an income of £10,000 per year in today’s money, assuming a 2.5 per cent real rate of return and 3.5 per cent withdrawal rate. Continue to maximise your Isa contributions, and invest them according to a strategy that targets a net headline return of 5 per cent a year net of fees.

Saving and investing as much as possible now is entirely sensible, and keeping between six and nine months’ expenditure in cash for emergencies is always advisable. Currencies are notoriously volatile so we generally avoid trying to second-guess potential future fluctuations. We advise our clients to hold their cash reserves in sterling.

Given your plan to have children, consider what would happen if you died or became incapacitated before you retire. This should help you work out whether you require further life insurance. Also give thought to trusts, wills, and wider protection such as life cover or family income benefit. And ensure that you have wills and Lasting Powers of Attorney in place.

Also you use both of your annual dividend and capital gains tax tax allowances of £2,000 and £12,300 each. 

You hold income targeting funds that do not seem to match your focus on global developed and emerging markets equity exposure. And you have a relatively high weighting to the UK. But a globally diversified portfolio with a considerable weighting to equities would seem better aligned with your attitude to risk and long-term investment horizon. So consider a greater allocation to the economies that will shape global commerce and provide growth opportunities in the decades to come – Asia, emerging markets and the US. Also consider introducing thematic exposure to pick up on long-term sector trends.

For global equity exposure, we suggest Liontrust Sustainable Future Global Growth (GB0030030067). This high-conviction equity fund's managers have a proven long term track record and sectoral experience. The fund aims for long-term capital growth and only invests in companies that conform to its Sustainable Future criteria. It also seeks to capture thematic plays while embracing three key sustainable themes: better resource efficiency, improved health and greater safety, and resilience.

Baillie Gifford Emerging Markets Leading Companies' (GB00B06HZN29) managers, Roderick Snell and Will Sutcliffe, invest via a growth style, take a long-term investment view and are willing to embrace uncertainty to get potentially superior returns. The fund’s exposure to Asia should capitalise on the weakening dollar and the region’s superior handling of the Covid-19 pandemic.