How do we maintain an income of £36,000 a year when we retire?

Simon is age 60 and earns £40,000 a year. His wife is 56, has two part-time jobs and is also self-employed, and in total earns around £9,000 a year.

They have two children aged 17 and 13.

Simon and his wife’s home is worth around £375,000 and mortgage free.

"I would like to work three rather than four days a week, which would reduce my salary to around £30,000 a year," says Simon. "And I would like to retire at age 65. But I want to maintain our net household income at about £3,000 a month.

"I have just started receiving a defined benefit (DB) pension which pays out £15,000 a year income and a £100,000 tax-free lump sum. The various segments of this pension will increase each year in line with Retail Price Index or Consumer Price index inflation, capped at at 3 or 5 per cent. This pension is contracted out of the state earnings related scheme and will pay my wife £9,800 a year if I die.

"My wife will start to receive a DB pension of £5,000 a year from 2026, and we both expect to receive the full state pension. 

"This means that I need to fund an income shortfall between age 65 and when I start to receive the state pension at 67. I am thinking of starting to make uncrystallised funds pension lump sum (UFPLS) withdrawals of around 4 per cent a year in about five years' time.

"I also need to build up our pensions and savings to maintain our income throughout our retirements. I currently contribute £8,000 a year to a workplace pension via salary sacrifice. My employer contributes equivalent to 6 per cent of my salary and rebates the National Insurance (NI) contributions it saves by doing this. The pension is invested in the Aviva Pension Stewardship UK Equity Income (GB00BF8L0Y32), Aviva Pension Stewardship Managed (GB00B00GX866) and Aviva Pension Stewardship UK Equity (GB00BF8KTG54) funds.

"I also have a self-invested personal pension (Sipp) worth about £114,000 but I do not contribute regularly to them. I am unsure whether to consolidate my pension plans into my Sipp or keep them separate for flexibility.

"My wife doesn't make regular pension contributions but invested £5,000 from an inheritance into a small stakeholder plan earlier this year.

"Our retirement could be for a long period of time so we need to invest for growth as well as income. The value of our funds has fallen since the outbreak of Covid and invasion of Ukraine. I have been investing for 50 years and this has not caused me to have sleepless nights. But I know that you should not withdraw from investments when their values are depressed to preserve them for the longer term.

"I am thinking of putting £20,000 of the £100,000 tax-free lump sum from my DB pension in NS&I Premium Bonds. I would put the rest in an individual savings account (Isa) over next few years, and invest it in income generating funds, direct share holdings, bonds, property and infrastructure.

"I prefer ethical funds such as Baillie Gifford Positive Change (GB00BYVGKV59) and in April invested £2,000 in Fundsmith Sustainable Equity (GB00BF0V6P41). But I am invested more widely with what I think is a moderate level of risk. In April, for example, I put £2,000 into each of MI TwentyFour Dynamic Bond (GB00B5VRV677), Caledonia Investments (CLDN), Mercantile Investment Trust (MRC), JPMorgan Claverhouse Investment Trust (JCH), Edinburgh Worldwide Investment Trust (EWI) and Schroder British Opportunities Trust (SBO).

"I have avoided what I consider to be overly speculative specialist funds.

"I selected some investments on the basis of advice from my investment platform in 2018. But I have also invested some of the Sipp in my own choices and, although they have skewed the balance of this portfolio, most of them have performed better. For example, the timing of my investment in Fidelity Special Values (FSV) was successful."

Simon and his wife's total portfolio

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

John Clamp, chartered financial planner at Bowmore Financial Planning, says:

Consolidating your pensions is likely to make it easier to administer your investments and improve your retirement income strategy. This could save you time and mean less onerous tax reporting.

The Sipp probably offers a wider choice of investments than your workplace pension, and potentially greater flexibility on income withdrawals which could help you to optimise your tax position in retirement.

However, before consolidating your pensions thoroughly review the existing plans to ensure that you wouldn’t lose any benefits such as protected tax free cash or guaranteed annuity rates. Also, your current workplace pension probably needs to stay where it is until you have received the final contribution from your employer.

Ask your pension providers if they offer the full range of pension flexibilities because although the UFPLS income option is universal, it is common for providers to limit the extent to which you can implement it. For example, your scheme might only permit one UFPLS each year or stipulate that a minimum value for each withdrawl.

The ability to vary your income could be helpful if, for example, your children require help with education costs. Also consider the flexibility each scheme offers your nominated beneficiaries if you die. They can receive your pension benefits tax free if you die before age 75 or subject to their rates of income tax if you die after age 75.

Your investment strategy is high risk and should have helped you to build wealth over the long term. While actively saving, you benefit from volatility because each month's contributions purchase a greater number of shares or units when prices are depressed. But in around five years, when you move into the decumulation phase, it may be sensible to start reducing risk. With 50 years' investment experience a high risk investment strategy probably doesn’t cause you any angst. But when you are making withdrawals a market downturn results in 'pound-cost-ravaging' because you need to sell more shares or units to provide the same amount of income.

The Sipp portfolio would benefit from a major cleanse because there are far too many funds to be able to keep reasonable track of. It is tempting to add funds in the hope that some of them will outperform. But spreading the investments so thinly risks watering down the value that a quality fund manager’s longer term strategy could add. Close analysis of the funds will show areas of overlap and you could use this information to help you decide which ones to cut.

Your UK exposure is far higher than we consider suitable in both your Sipp and workplace pension. Regardless of the economic backdrop, markets are cyclical so significant geographical diversification is essential. If you are concerned about the impact of foreign exchange movements, get overseas exposure via funds' hedged share classes.

Also broaden your pension exposure into funds which are less closely correlated with equity markets - as you plan to do in an Isa. Real estate investment trusts, and infrastructure, multi-asset, absolute return and strategic bond funds could help to cushion equity market downturns.

Kay Ingram, chartered financial planner, says:

Your plan to maintain a net income of £3,000 per month in real terms could be upset if inflation, which is currently 9 per cent, remains high for a lengthy period. Although the segments of your DB pension increase each year these are capped at 3 or 5 per cent so if inflation is higher, your income may not keep up.

You could dip into your pensions and Isas to top up your income to the desired level. A 4 per cent withdrawal rate has been a long-established rule of thumb but could result in your funds running out too soon if returns, net of charges, fall below this level. So it might be wiser to set your income withdrawals at the level of the natural income these accounts yield.

Alternatively, consider withdrawing from the investments at the rate of their average long-term risk adjusted return, with a cap and collar below and above this, to maintain their real value. When one you dies, the surviving spouse's income will fall so preserving invested funds for later is important.

Beware of withdrawing pension funds, other than the tax-free cash sum, to build up your pension pots while you’re still working. If you withdraw even £1 of income in excess of the tax-free lump sum, this triggers the Money Purchase Annual Allowance. This restricts pension savings, including any employer contributions, to £4,000 a year. This makes UFPLS, where each payment is treated as 75 per cent taxable income, unsuitable until you stop contributing to pensions.

Your wife's former workplace pension is linked to inflation, but if she was contracted out of the state additional pension she may get less than the full state pension at age 67. The government estimates that only 50 per cent of those who reach state pension age this year will qualify for the full state pension – despite having paid more than 35 years' NI contributions.

Each year’s NI contribution made before 2016 earns 1/30th of £141.85 a week. The amount earned at April 2016 is protected. For each year after April 2016, you earn 1/35th of the new state pension, up to an overall maximum of £185.15 a week, increased annually.

If your wife isn’t paying NI because her earnings and profits are below the level required, she could make voluntary contributions to increase her state pension. She can pay self-employed Class 2 NI which costs £3.15 per week. It’s payable by direct debit or as a lump the January following the end of the tax year. If she does not qualify as self-employed, she can make Class 3 voluntary contributions of £15.85 a week.

Your wife has two part-time jobs, but doesn’t earn enough to automatically attract an employer pension contribution. You automatically get employer contributions to a pension between ages 22 and 66 if your earnings for a job are £10,000 or more. But if your wife earns over £6,240 a year for one of her jobs she can ask to join the employer's auto enrolment scheme.

Your wife could pay up the value of 100 per cent of her earnings and profits into her stakeholder pension plan each year. This gets 20 per cent tax relief even though she does not pay tax. A £9,000 investment in her pension would cost her £7,200 as the pension provider would collect the balance from HM Revenue & Customs.

NS&I Premium Bonds don't offer a guaranteed return. But while income yielding Isas are higher risk they could provide a better long term tax-free return than NS&I Premium Bonds.

Consolidating your personal pensions could reduce charges and cut administration. Check the investment choice, charges and flexible retirement options they offer.