UK based FI wannabe with good pension options

[thegoatreich]

Hi all,
first post here, and recent convert to the Mustachian ways and trying to apply the concepts to life in the UK. Very tempted to setup a case study, but at the moment I'm mainly after some advice of how to bring forward my retirement age from a job that currently has great pensions schemes.

The pension scheme is a local government scheme (LGPS) and my monthly input is 6.8% of my gross pay, and my company then put on an extra 13.5%. Nice. However, of course this money is untouchable until the earliest 55, but there are some penalties in withdrawing before the standard pension age, which is currently 68.

We also have additional options as part of the scheme to make extra payments into AVCs (additional voluntary contributions) which are essentially investment accounts which can be setup in the same way as other investments (index funds, bonds etc). There's a low management fee for this, at around 0.5%, and there are no additional fees for changing the asset allocations or for changing the contribution amounts. The huge bonus to this is that it's taken from my gross salary, meaning that as I'm in the 20% tax bracket here, I'm essentially getting 20% extra onto every amount I put into the account. I can't withdraw from this account until I'm 55.

My wife also has a pension where she contributes 5% of her salary, and her company match this.

I need advice on working out how I can use these schemes to my benefit, but still retire earlier than 55 if at all possible. I'm 38 now. Obviously the earlier I retire from work, I would no longer be contributing to either scheme, so the overall pay out when it came to claiming them would be lower, meaning I'd need to amass a greater non pension pot in order to make up the shortfall. However I can't find the balance between making the pension contributions and the investments now without my head exploding.

Yours,
confused.com

[worms]

Just to further complicate your options, you can also buy extra pension in the main LGPS scheme (up to £6,500 extra annual pension per annum, I think) instead of the AVC's.  Perhaps not that good an option for you, but it is there if you want and not likely to be advertised by Prudential or whoever operates your local AVC scheme.

Of course, you can also simply invest in a SIPP, still get the tax advantage and control the asset yourself, which might be the better option at your age.

[thegoatreich]

Yes that's a good point, I could potentially add to the pension pot with APCs if I was looking to retire early and wanted to make sure I still had enough coming to me when hitting pension age.

It is the Prudential that operate our LGPS scheme, and to be fair when we met with them last week they did mention SIPPs as an alternative, but they did say that the management fee of them tends to be higher. Admittedly I haven't looked at that to confirm just yet.

I just can't wrap my head around the best approach. ISAs>AVCs>Pension. ISAs are clearly liquid, and so would help with financing pre-55, however they don't have the same tax relief that the AVC/SIPP options do.

My current thoughts (which change which each blink of my eyes), are to keep paying into the standard pension pot at the current rate and contribute to an AVC/SIPP to see if I can build up enough wealth to meet the gap between 55 and 67 when the main pension kicks in, as well as state pension. Once that is done I can look to see if I need to top up my LGPS pot so that it doesn't suffer too much with the lack of payments between 55 and 67. Once all this criteria is met I can then look to fill up our ISA allowances to try and gain enough wealth to perhaps bring the retirement age down from 55.

All in all a pretty tough task if I'm honest. I can't even begin to factor in safe withdrawal rates just yet, my mind is full to the brim.

[cerat0n1a]

I think you've got a pretty good grip on things but essentially you need ISAs to cover the period between your RE date and 55, SIPP or some other pension (or more ISAs) to cover 55 - normal pension age and a pension for the rest of your life after that. Assuming you balance the amount in each pot correctly, the 4% withdrawal rate should hold OK for the UK. Pension obviously is by far the best in terms of tax advantages, particularly for higher rate payers but at the cost of the money being tied up for a long time, subject to political whims and usually higher charges on your investment.

Link below goes into a bit more detail.

http://the7circles.uk/savings-rate-four-pot-solution/

[thegoatreich]

Oh that link looks great thanks! I'm reading something similar on Monevator right now too http://monevator.com/sipps-vs-isas-best-pension-vehicle

I'm confused with the SWR though, how long is the pot supposed to last for? I thought 4% was the amount so that the actual capital never decreases, have I got the wrong end of the stick there?

[SpreadsheetMan]

.....
I'm confused with the SWR though, how long is the pot supposed to last for? I thought 4% was the amount so that the actual capital never decreases, have I got the wrong end of the stick there?

The "4% rule" is meant to ensure that the pot doesn't run out over the required time period. In certain cases it will run to zero, hopefully at the point you need it no longer...

Note that "4%" includes all fees/charges and also is based on US-only stocks which have a higher return than UK / European.

[cerat0n1a]

Note that "4%" includes all fees/charges and also is based on US-only stocks which have a higher return than UK / European.

These days, however, we are not limited to investing in our home markets, so there is no real need to take this into account.

Historically US stocks have out-performed the UK. No guarantee that this will be true in the future. Nor indeed that the 4% rule will always hold.

Isn't the LGPS a defined-benefits, based on career average salary type deal, the sort of thing that is not available to people in the private sector? If so, that is hard to value in terms of a %age withdrawal from a pot?

[Metric Mouse]

.....
I'm confused with the SWR though, how long is the pot supposed to last for? I thought 4% was the amount so that the actual capital never decreases, have I got the wrong end of the stick there?

Note that "4%" includes all fees/charges and also is based on US-only stocks which have a higher return than UK / European.

This is not fully correct...

4% of the initial value of the portfolio, and then adjusted upwards at the rate of inflation each year, gives a 90+% chance of not reaching a zero balance over a 30 year retirement.  This assumes a lot of shit, including expense ratios of 1%, etc.

[worms]

In terms of accounting for defined benefit pensions etc, I simply deduct my LGPS pension prediction (plus my state pension prediction) from my projected income requirement.  This leaves the balance that I need to fund from private investments, which is where I apply the 4% rule (although I work on 3%).

This also gives me a means of calculating the value of moving cash from private investment to either of the defined pots.  For example I know I can buy an additional LGPS pension of £6,500 per annum for about £67,000, whereas I would need about £165,000 in private investments to achieve the same return.  A similar calculation can be made for buying extra years of state pension, for those likely to fall short.

All the above is based on retiral at state pension age, though, and a different calculation needs to be added to account for required interim income and calculate a FIRE date/sum, or to calculate the costs/benefits of early withdrawals or pension deferments.

[Playing with Fire UK]

It is the Prudential that operate our LGPS scheme, and to be fair when we met with them last week they did mention SIPPs as an alternative, but they did say that the management fee of them tends to be higher. Admittedly I haven't looked at that to confirm just yet.

I generally assume that people who want my money will criticise the competition regardless. When you say 0.5% have you checked that this is the total expense ratio (TER), rather than the management fee onto which a platform fee and fund fees are added.

You will get the 20% tax deferment in any pension, this is not a reason to stay with your work provided pension.  You may be able to get the National Insurance saving as well when you contribute via your payslip. If this is the case it is worth weighing up the benefit of the extra money going in.

How far along are you with saving? Eg how many years' expenses you have saved now and what is your current saving rate? If it is going to take you another 15 years to retire, you don't need to worry about the 4% rule for your ISAs, you just need 55-38-15=2 years spending in something with low volatility. You can subtract the value of your ISAs from the total value of your stache.

Also consider how you see the next years at work, if you see a promotion on the line that would push you over the 40% tax bracket, think about stuffing the ISAs now. If you think you or your spouse could lose a job, think about stuffing the ISA before the pension. If you think the rules for putting money into a pension could improve for 20% tax payers (been spoken about for a while but no changes yet), think about stuffing the ISA. Conversely, if you think the terms for AVCs or extra years could get worse and the benefits would be grandfathered in then think about maximising the input into the pensions now.

Don't worry about safe withdrawal rates for now. By the time you get to FIREing you will have a much better idea about your ability/inclination to spend less when the markets are down, your tolerance for seeing investments soaring and plummeting, and whether or not you want to do something after FIRE which could bring in some extra cash. You'll also know how many years work it will take to nudge your withdrawal rate from 4% to 3.5% and have an idea of how you value that time.

[thegoatreich]

Thanks very much for the responses folks. Some really interesting reading there.

I'm basically at ground zero now. I have about 6 months left of a minor hair on fire debt to get rid of (car loan at 3.7%) and once done I'll be looking at a comfortable 50-60% savings rate not including the pensions. That gives me 6 months of reading and research so I've got a fighting chance of getting out of the rat race. I don't mind my job at all, but it's the commute that I can't stand any more. I'd still quit in a heartbeat to pursue something I'd find more satisfying, regardless of the pay (FU money at work).

[RobFIRE]

Well, pensions are the most tax-efficient way to save for the long term, so for your overall wealth increasing pension contributions is the winner. The disadvantage is not being able to access the money until age 55.

A couple of points on your situation. First of all if you retire early you will presumably have a pension shortfall due to a lower number of years of service completed. Not a problem, but in some years time you'll need to carefully look at the benefit statements provided to ensure you understand what you'll get based on a reduced service period.

Secondly on additional contributions. Certainly you should consider that, and due to the up-front tax saving it's the best long-term savings option. I would also look very carefully about the AVC offer from your existing provider. Following the Auto Enrolment rules a lot of the providers have had to cut fund charges (AMC/OCF and platform fees) to around 0.5 to 0.75%. However, if you look up SIPP providers on the Monevator website you will see that there are a number of online investment platforms that have flat-fee accounts and access to low-cost index trackers like Vanguard ones at 0.15% charges, with maybe £100 a year in flat fees. Once you have a reasonable SIPP value of around £40k or more the flat-fee option works out cheaper. In the short term probably doesn't matter to you, the AVCs can always be transferred to another provider later, but in the long term even what looks like a small difference of 0.25% a year in fees adds up to thousands of pounds in lost value.

In terms of pensions versus ISAs etc. what I suggest you do over the next few months is set up some simple spreadsheets to do some very simple modelling, for example estimate what position you would be in at age 50, 55, 60 if you continue with current pension contributions and have other savings, versus increasing your pension contributions a lot. You don't need to be an expert in spreadsheets, could just assume level salary and 5% investment returns to ignore inflation, see how much money you end up with in different pots at what age, and using the 4% rule how much income that would give you. Then adjust where you save your money and see what difference it makes. It should give you some idea as to how much non-pension money you could need to cover early retirement until AVC money available, regular pension available, state pension available. I suspect though, if you plan to make maximum use of the £15k ISA allowance each year, and then plan to increase pension contributions for any excess (unless you have a mortgage you need to pay down), you won't go too far wrong.