Can our drawdown fund last until we are in our 90s?

George and Patricia are 76 and 75. He receives an annual income of about £50,000 a year from sources including the state pension and a fixed annuity that pays out £21,000 a year. His wife receives a state pension of £8,000 a year. They have two children in their 40s and grandchildren. George and Patricia's home is worth around £800,000 and mortgage-free. 

"I have a pension worth about £450,000 in drawdown from which I've been taking £18,000 a year to stay within the basic-rate income tax band," says George. “Our day-to-day expenditure is met by our pension income. If I die before my wife, who currently receives a state pension of about £8,000 a year, she will probably need to continue to draw down at a similar level to remain comfortable as the payout from my fixed annuity will halve.

"I estimate that the drawdown fund needs to last us into our late 90s. If we both die before then, the drawdown pension will provide an inheritance tax (IHT) free sum for our children. I think that an average annual return of at least 4 per cent would meet our objectives and leave a worthwhile inheritance to our children.

"As my annuity is fixed, the drawdown funds are our protection against inflation. Our other investments are a mixture of cash, equity and bond investments to satisfy my wife's more cautious nature. She would not be comfortable with the value of our investments falling more than 15 to 20 per cent in any given year, although I could tolerate their value falling by up to 20 to 25 per cent in any given year. We use our non-pension investments for exceptional expenditure such as special holidays, home improvements and buying cars. For example, we have paid for holidays for our whole family every couple of years and hope to continue doing this, which necessitates taking extra money from our investments.

"I hold investments in individual savings accounts (Isas) worth about £61,000 and my wife holds Isa investments worth about £108,000.

"I have invested small amounts for more than 50 years and we have invested more substantially for the past 20 years. When choosing investments, I have tended towards yield rather than growth.

"Recent trades including selling 500 shares in Darktrace (DARK) for £2,500 and then purchasing 600 shares in the same company for £2,100. Earlier in the year I sold BAE Systems (BA.) shares worth £7,350 and Ashtead (AHT) shares worth £4,650.

"I am now thinking of investing in AstraZeneca (AZN), Games Workshop (GAW) and Tesco (TSCO)."

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

Matthew Baines, chartered financial planner at Beckett Investment Management, says:

Your overall financial planning position looks healthy. You are drawing £18,000 a year from a pension valued at £450,000, which is a drawdown rate of 4 per cent a year. You are invested at a moderate level of risk, which in the long run should mean that you can meet your income requirements without too much capital erosion. But I would make some changes to the way in which you are managing your income. 

I presume that you have taken your pensions' tax-free cash as you are drawing taxable income and using your full 20 per cent tax band. You use your Isas and cash savings for ad hoc expenditure such as holidays but should change how you draw your income, for a couple of reasons.  

You hold about £290,000 in cash and Isas. Added to your home's value of £800,000, this brings your estate value to £1,090,000. Assuming that your wills leave everything to each other and then your children, you effectively have £1mn you can leave to your children free of IHT. This means £90,000 is subject to IHT on the second of your deaths at a rate of 40 per cent, so if you both died tomorrow there would be an IHT liability of £36,000. 

Your pension can be passed on free of IHT when you die, so it makes far more sense to begin running down your Isas and cash, and cease drawdown from your pension. This will protect your IHT-free assets and eventually eliminate or reduce any IHT that may be due.  Also, drawing £18,000 of income taxed at 20 per cent only provides you with a net income of £14,400.  By drawing income from Isas or cash you can reduce your withdrawals to this level preserving your capital for longer. Annual withdrawals of £14,400 from Isas and cash worth £290,000 only equates to a withdrawal rate of 5 per cent a year and, with interest rates of up to 4.8 per cent obtainable on certain fixed-rate accounts, you may only see modest capital erosion. Even if you assumed no return at all on your Isas and cash, if you ran them to zero – which of course you won’t – you would still have sufficient funds to last you for 20 years – well into your 90s.

Depending on how much ad-hoc spending you undertake, it is feasible that your pension could remain untouched well into your 90s, which would leave your estate far more IHT-efficient. You would also be able to leave more to your family because you could withdraw £3,600 less each year due to the increased tax-efficiency of your withdrawals. 

I would review the rates available on savings accounts as these have improved significantly and there are some good ones available on fixed-rate accounts. You hold cash worth £87,000 in your pension, but pension providers' interest rates are often vastly inferior to the best buy rates outside pensions. So I suggest fully deploying the cash in your pension. If you want to maintain the level of cash you currently hold, you could switch some of your investment Isa holdings into a cash Isa. This would mean that you have a more cautious Isa portfolio and a more aggressive pension, which makes sense if you leave your pension for growth and use your Isa as part of the income strategy I suggested. 

Most of the funds in your pension are beating their benchmarks, with only a couple lagging. And one of these – Scottish Equitable Schroder US Mid-Cap (GB00B3FG4K14) – is only lagging because of its lack of exposure to the large US technology companies that experienced such rapid growth throughout the global pandemic. This also means that it has not suffered the same falls over the past 12 months. Your pension is predominantly equity-based and if you are comfortable with the risk equity markets present, I suggest deploying your cash in line with this strategy. You have significant exposure to the US and UK, but perhaps some further exposure to east Asia and Europe would be beneficial when deploying your cash.

Your Isas have many holdings. I would suggest simplifying them, particularly as you have some very small holdings which will not make any meaningful impact on the Isas’ overall performance. If you enjoy trading individual company shares, hold a certain amount of the Isas in a managed cautious or moderate risk strategy, such as a single fund or range of funds, and use these and your cash as your initial funds for drawing on. Doing this would enable you to leave your individual shareholdings for longer-term growth.

Rosie Bullard, portfolio manager and partner at James Hambro & Partners, says:

You appear to have planned your financial future well. Budgeting for a withdrawal of 4 per cent a year is sensible, and it does not materially diminish the capital left for your children and grandchildren to inherit. Taking ad hoc capital withdrawals to enjoy holidays with the whole family every couple of years does not appear excessive. 

When investing, you tend to favour yield rather than capital growth. But we encourage a total return approach to investing, particularly given the difference between capital gains tax and income tax rates, for the time being. Taking a total return approach – being ambivalent to whether the return comes from capital growth or income yield – also allows a broader approach to investing. For example, if an investor had solely focused on assets that generated income they would have broadly ignored technology stocks because many of these do not pay a dividend. But the MSCI All Country World Index technology sector has gone up over 90 per cent in US dollar terms over the past five years, so the foregone return would have been significant.

We like the allocation to direct shareholdings in the Isas because this reduces total costs and allows for more control over risk exposures. However, we suggest more diversification away from the UK. Although the FTSE All-Share index has performed relatively well this year, its total return has been just over 90 per cent over the past 10 years versus the MSCI All Country World Index's total return of over 220 per cent, in sterling terms, to the end of November 2022. 

Your portfolio could also benefit from exposure to other assets, such as an allocation to alternatives including absolute return funds, which have a low correlation of returns to those of equity and bond markets. As you are withdrawing from your portfolios, this allocation could provide a source of funds when equities and bonds are under pressure – as has been the case this year. 

You could reduce your allocation to cash in NS&I and bank accounts. We suggest keeping six to 12 months' worth of your expenditure in cash. 

Review the consistency of your position sizes. For example, even if your holding in EnQuest (ENQ) doubles, it will not make a material difference to your total wealth. Also think about the number of holdings you have. Some academic studies suggest that 20 to 30 stocks provide sufficient diversification. Our portfolios tend to have 45 to 50 holdings, but this is across all asset classes. We believe that this number allows each position to make a meaningful contribution to performance, if it does well, and ensures we focus our time effectively. You do not want too many positions [so that you can] cover them thoroughly from a research perspective. 

Are you contributing to your Isas? I assume that each year you are, given the cash available. It is important to keep making the most of Isas as the long-term benefits of compound growth inside a tax-efficient wrapper can be very effective.