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How do I generate £60,000 a year from my Sipp?

This reader needs a core return of £60,000 a year from his Sipp from 2023
How do I generate £60,000 a year from my Sipp?
  • This reader wants to generate 5 per cent a year from his Sipp, and pass on what he can later on
  • He believes his attitude to risk has evolved from high to medium risk
Reader Portfolio
Paul 61
Description

Pensions, Isas and property

Objectives

Generate income in retirement, contribute to Isas for any future grandchildren, pass on wealth

Portfolio type
Investing for income

Back in 2017, Paul submitted his portfolio details to Investors’ Chronicle (IC 17/11/2017) with a view to selling his business, retiring and travelling in three or four years’ time. Since then, his circumstances have moved on considerably, with him opting out of a final-salary scheme for a £1m cash equivalent transfer value.

Paul, 61, and his wife receive around £150,000 to £200,000 a year in dividends from their company, as well as salaries of £7,000 and £25,000 a year, respectively. Both will retire at the end of 2022, when Paul will be 63 and his wife 58. At that point they plan to sell the business for £450,000 to a business partner. They will then seek a minimum annual income of £80,000 for 10 to 15 years, with this dropping to around £60,000 thereafter.

Once the business is sold they will have no mortgage debt and will have £250,000 in an Isa. They will also receive another 12 months of further dividends and salaries amounting to around £200,000. Their main house is valued at roughly £1m, while a European holiday home is valued at £400,000.

“My Sipp needs to provide a core £60,000 a year from 2023,” Paul says. “This requires a total return of 5 per cent, which I realise will not always be the case.

 

“Naturally I want to pass on as much of my Sipp as possible but I will dip into the capital to maintain the £60,000 and pass on less. I will also put aside £120,000 to avoid forced selling in market dips.

“The additional £20,000 a year will be made up partly from my wife’s final-salary pension which will be £12,000 a year from early 2024. I will have invested around £250,000 from the business sale into a stocks-and-shares Isa and I will top up the balance of £28,000 a year from there, although it may be better to change the withdrawal mix between my Sipp and our Isa for tax-efficiency.    

“A further £11,000 a year will come from my wife’s two public sector pensions, which pay out £10,000 in total from 2031. She also has a Sipp with around £200,000, which we’ll draw from in the more distant future.”

Paul and his wife have two sons, who are both in their 20s and on the property ladder so he does not expect them to need much further support. However, he does want to contribute to Isas, from birth, for any future grandchildren.

“My aim is a £20,000 global tracker investment per grandchild at birth," he says. "This may happen in the next five years and will most likely be funded by future inheritances from our parents. Our sons will inherit our property, after any care costs, as well as any remaining Sipp balances.”

When it comes to investment approach, Paul believes his attitude to risk is evolving from higher risk to medium risk.

“I have very recently attempted a rebalance towards more medium risk (less technology, less emerging market, more defensives and income funds) but wonder if my Sipp is still more higher risk than medium risk," he says. "I am invested in private equity for future growth but realise there is a fair amount of risk there. By putting aside two years' income I believe a market drop of 25 per cent in any given year is manageable."

 

Paul's Sipp
HoldingValue% of portfolio
Rathbone Global Opportunities (GB00B7FQLN12)£87,0007.50711882
Scottish Mortgage Investment Trust (SMT)£77,6006.696004832
L&G Global Technology (GB00BJLP1W53)£76,5006.601087238
HSBC FTSE All-World Index (GB00BMJJJJ30)£73,1006.307705583
iShares Automation & Robotics UCITS ETF (RBTX)£71,4006.161014755
iShares Global Clean Energy UCITS ETF (INRG)£65,5005.651911295
Schroder Oriental Income (SOI)£61,4005.298127535
Pantheon International (PIN)£51,5004.443869186
WorldWide Healthcare (WWH)£51,1004.409353697
iShares Core S&P 500 UCITS ETF (CSP1)£48,3004.167745276
Vanguard FTSE Emerging Markets UCITS ETF (VFEM)£47,3004.081456554
Vanguard FTSE 250 UCITS ETF (VMID)£43,7003.770817154
HICL Infrastructure (HICL)£41,8003.606868582
Schroder Multi-Asset Income fund£40,0003.451548883
iShares MCSI Japan IMI UCITS ETF (IJPN)£40,0003.451548883
City Of London (CTY)£39,7003.425662266
iShares S&P US SmallCap 600 UCITS ETF (ISP6)£38,0003.278971438
Fidelity China Special Situations (FCSS)£31,5002.718094745
HarbourVest Global Private Equity (HVPE)£30,0002.588661662
Octopus UK MultiCap Income (GB00BG47Q440)£26,2002.260764518
Bluefield Solar Income Fund (BSIF)£25,2002.174475796
3i Infrastructure (3IN)£25,0002.157218052
L&G Global Infrastructure Index (GB00BF0TZJ52)£20,0001.725774441
BlackRock Gold & General (GB00B99BDY18)£7,1000.612649927
Cash£40,0003.451548883
Total£1,158,900 

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

 

Richard Harwood, financial planner at Brewin Dolphin, says:

The key points to consider are sustainability and tax-efficiency. You have a Sipp valued at approximately £1.2m from which you are looking to draw £60,000 a year net of fees. That immediately highlights two issues. The suggested level of drawdown would make you a higher-rate taxpayer, probably leading to 40 per cent income tax. That drawdown would come from a fund that is likely to be the asset that provides most inheritance tax protection once you have sold your business. It would seem more efficient to limit drawdown from the Sipp to a level where only basic-rate tax is payable. This could still provide the largest share of your desired income.

The lower level of drawdown should give a much greater chance of maintaining the Sipp fund. As it is inheritance-tax-efficient the long-term aim would be to restrict growth, to reduce the chance of a Lifetime Allowance Tax Charge aged 75 but to maintain the fund, even if it means taking more from the existing Isas and proceeds from the company sale.

Your wife appears to have approximately £23,000 a year in final-salary pensions from the private sector and NHS. So, in terms of pension income between you, your plans would appear to generate £73,000 gross or approximately £62,400 a year net.  Of course, any state pensions could increase this to close to your desired £80,000-a-year target.

Your wife’s Sipp could be retained as an inheritance-tax-efficient investment and allowed to grow until it approaches the lifetime allowance (once the defined-benefit pensions are accounted for). But you could draw both tax-free cash and a taxable income from it whenever desired.

Your wife’s pensions do not start from 2022 so there would be a need to 'gap-fill' from the business sale and accrued dividends, but it should only require approximately £100,000 from that. The remainder should still leave somewhere over £400,000. In simple terms, that would be expected to provide £20,000 each year for more than the desired 10 to 15 years. This would appear achievable even without accounting for the state pensions.

From the accrued dividends and company sale proceeds, it would make sense to invest this in your wife’s hands (for tax-efficiency) while each year feeding £20,000 into an Isa for each of you and funding the shortfall between pensions and your desired £80,000. There should also be the surplus required to fund Junior Isas for the grandchildren.

By monitoring the Sipps and trying to avoid running them down, this should maximise the estate ultimately passed on at death. Even if that means running down the value of the savings in personal hands.

All of the above is geared to meet your primary objective for income. Any inheritance is most probably going to be surplus so can be passed to your children, using a deed of variation to the will if required.

Your investment comments would very much categorise you as a higher-risk investor by most measures. I suspect that you would be unhappy investing into what most people feel is a balanced portfolio but would suggest that you seek a recommendation from a professional investment manager. I would suggest diversifying funds across the asset classes that you are happy with and ensuring that you have sufficient contingency funds to weather any storm.

 

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

To get a £60,000 annual income from this portfolio requires a total (real) return on it of just over 5 per cent. That’s likely in average-to-good times, but you should budget on longer-term returns perhaps falling a little short of this, implying that you’ll see your wealth dwindle slightly over time. This shouldn’t be a problem. But it might require a tricky psychological adjustment: having spent a lifetime building up wealth, seeing it decline even moderately will feel strange.

I stress that what matters here is total return, not yield. You can create your own dividends simply by selling some stock. Investing for income is dangerous because a high yield is usually compensation for something. That something might be cyclical risk in the case of miners and housebuilders, or the belief the company has gone ex-growth, as with tobacco or utilities. You should only buy income funds if you think the market is exaggerating these defects. Don’t do so because you need an income. You can get that elsewhere.

It’s reasonable for you to avoid bonds. Their virtue is that they insure us against some downturns in equities, such as those caused by fears of slower economic growth. But they don’t protect us against all possible equity bear markets: if shares were to sell off because of fears of higher interest rates bonds might also do badly. And even if we get normal times, bonds will give us negative real returns.

In planning on having lots of cash, you’re giving yourself an alternative form of insurance. Which is wise.

As for private equity, I think it is a good idea. I suspect a lot of listed shares have gone ex-growth – many only come to the market at all after they’ve enjoyed their best returns – and so unquoted companies offer better prospects.

There are, though, two drawbacks here. One is that private equity is illiquid: in investment trusts, this means that you might have to sell at a big discount to net asset value. Do not therefore buy it if you might need to raise cash. The other problem is fund manager risk. Private equity returns are skewed: there are a handful of great performers but many duds. One or two right or wrong holdings can therefore make a big difference to a fund's returns. You should therefore spread your investments across managers.

You are right that big holdings in technology and emerging markets are adventurous. But there is a way of managing this. Over the longer run, we could have outperformed buy-and-hold strategies by selling when prices fall below their 10-month (or 200-day) average. This rule isn’t infallible, but it has the virtue of saving us from the long and savage bear markets that really destroy our wealth. It does so because sentiment-sensitive shares such as tech and emerging markets are driven in part by momentum. And the 10-month rule tells us when momentum has turned. Right now this rule is telling us to get out of emerging markets, but to stick with tech.

Finally, you are dead right to want global equity trackers for your grandchildren. If you want a long-term low-management investment, such trackers are really your only sensible option.