Reader Case Study - How to use savings to cover gap to social security UK

[michaels]

Start with the numbers:
Self 51
Wife 55 non-earner
Owned home no mortgage
Both with entitlement to UK full state pension at age 67 (currently 9k pa rising with inflation)
150k in available assets
650k in pension wrapped assets (610 self, 40 DW) available from age 55.

Layoffs loom at work

Maths question - what is our Safe constant real terms fire income if I don't/can't find alternative employment?

[michaels]

Apologies for the UK situation which may be unfamiliar.


State pension = social security currently pays 9k each year which is scheduled to increase every year by at least inflation.  This means that as we reach 67 my wife and I will each get the then equivalent of 9k pa.  This is in 2033 for my wife and 2037 for me.

To achieve this income until the pension becomes available I could put 336k in savings accounts paying 2% below inflation and we could then pay ourselves 9k per annum until the pensions become available.

This would leave a pot of 464k to which I could apply a SWR, for example:
2% gives an additional 9.3k pa or 27.3k total
3% gives an additional 13.9k or 30.9k total
4% gives an additonal 18.6k or 36.6k total

I'm not asking whether we could live on this income but whether this is a sensible way of doing the calculation.

[For those interested the values in USD are about $35.5 - $47.5.  We have no mortgage on our home and in the UK we don't have to pay any health insurance, property taxes are approx $2.8k a year and other prices are similar to the US]

[Kwill]

You might add 'UK' to your title to get more targeted help. There's quite a few of us here who are in the UK, even if we are in the minority.

This seems vaguely plausible to me, but I tend to avoid maths when possible. Some people like @PhilB and @MarcherLady and @never give up seem like they are very good at this sort of thing. Maybe one of them can come and help.

My biggest question would be the one you say you're not asking, which is how much you'd actually need to live on. Given that you can access your pension wrapped assets in just four years and have a fair bit saved beyond that, it seems like you could be completely fine or in real trouble, depending on what your spending is like.

[michaels]

You might add 'UK' to your title to get more targeted help. There's quite a few of us here who are in the UK, even if we are in the minority.

This seems vaguely plausible to me, but I tend to avoid maths when possible. Some people like @PhilB and @MarcherLady and @never give up seem like they are very good at this sort of thing. Maybe one of them can come and help.

My biggest question would be the one you say you're not asking, which is how much you'd actually need to live on. Given that you can access your pension wrapped assets in just four years and have a fair bit saved beyond that, it seems like you could be completely fine or in real trouble, depending on what your spending is like.

Thanks KP.  Short answer is our current spend is somewhere between 27-29k so I think we are fine but still want a sensible way to model it.  Putting funds into cash to safely cover the pension gap seems like a very negative way of doing things but also seems to reduce sequence of returns risk quite nicely.  There would also seem to be scope for persuing a variable draw down approach with 27k (ie 2%) set as the floor as per cfiresim.  I have also run scenarios through the SWR google sheet.

A second reason for asking is that it may be we are currently understanding what we can actually afford which seems a shame.

[MarcherLady]

Hi Michaels, like Kwill I'm struggling to understand the question.

But while I was posting you've clarified a bit.

You mention 150k in available assets, then you talk about moving 336k into savings accounts paying 2% below inflation - where is that 336 coming from? 150 plus the rest out of your private pension? Because you can't access that until you are 55, another 4 years. It might make more sense to start drawing down on your wifes private pension to top up your income - you can access that now, since she is 55, but 40k isn't going to last long.

Plus the state pension is inflation-linked, but you have not inflation-linked your 9k (presumably it's actually 9k*2? that you are taking out, if inflation goes up will you be able to increase your withdrawals, or prune your outgoings?

And, final question, have you got a line on a savings vehicle that will take your 336K? Do you know that part of the plan is feasible?

I think, given the details you've given us I would do the following:

-Take a realistic look at what you think inflation will do over the next 17 years and adjust your expected spending to take that into account.
- Use whatever cash you have to live off now.
- Avoid drawing down on your wife's pension as long as you can to give that little pot a chace to grow a bit, unless you can't manage on your available cash.
- Review what your asset mix is in your pension, I'm not clear whether it's a SIPP or a DC, but the type of pension you have and the fees you pay will make a lot of difference to whether x% is actully a Safe WR or not.

[former player]

Seconding the shout out to @PhilB @MarcherLady and @never give up to whom these kinds of questions are mother's milk.

Going by my very much more amateur version of how to look at this, it looks to me as though in order to maintain your current spending your various pots will need to produce:

29k per year for 12 years (up to 2033)
20k per year for a further 4 years (up to 2037)
11k per year thereafter.

The first four years of needing 29k per year will need to come out of your non-pension assets of 150k and DW's pension pot of 40k.  You will probably need this in cash or something close, as four years is a shortish time for stock market investments.  After four years you would be left with 74k between these two pots.

The next twelve years can come out of your pension pot.  In four years time at lets say about 3% compound growth (historically achieveable in the UK market) your pension pot of 610k will have grown to about 680k.  Again using 3% growth this pot would be producing 20k per annum rather than the 29k per annum that you are looking for, and over 12 years that will reduce the pension pot by something over 110k (this is the point at which more precise calculation eludes me).  But at the end of those 12 years you should still have a pension pot of maybe 550k.  You've also still got your 74k in non-pension assets and DW's pension.

Because one of the 9k pensions kicks in at this point you are back to needing only 20k a year from your reduced pot of 550k for four years.  The reduced pot at 3% will produce about 16k a year, plus a reduction in the pot of about 16k, leaving a pension pot of maybe 530k at the end of the four years.  Again, you've still got for 74k in non-pension assets.

After those four years the second 9k pension kicks in and you only need 11k a year from your pension pot.  The pension pot is 530k and at 3% will produce 15k a year.  So at this point as long as your annual expenses stay at 29k you start getting richer and richer until you die.  You've still also got the 74k in non-pension assets and DW's pension as well.

So I think that you are nicely set up to cover your expenses from your current assets.  Congratulations, you are Financially Independent and if made redundant can instead turn it into Retired Early.  So welcome to the FIREside.

[michaels]

So my thought is - split the pot into two, one part to replace the state pension - 9k x 12 years + 9k x 16 years, the 9k being index linked.

I assume that I can put this money whether in the pension wrapper or not into 'money market funds' which I assume will make a -2% pa real return - ie inflation goes up the return on these funds goes up but still remains 2% below - no idea if this is reasonable.

Thus to put aside 9k x (12+16) doesn't cost 252k but instead costs 336k but gives me the 18k index linked until state pension age.

Take this 336k out of my total pot of 800k leaves 464k which I then applied a traditional SWR at different rates to to get the total income figures given above.

As mentioned none of this looked at drawdown strategies, tax etc.

[PhilB]

Apologies all, I missed the bat signal on this one!

First up, congratulations on having got to a point where you are comfortably FI.  A quick calculation before I do the kids' breakfasts shows the following;

Say you put the remaining 75% of your pension after taking the tax free lump sum into drawdown at a conservative rate of 3%.  3% of £457,500 is £13,725.  That will all be tax free until your SP starts if your wife transfers 10% of her PA to you (married couple's allowance).  Once you both have your SPs in payment it gives you £30k pa post tax in total income vs your current spending of £27 - £29k so that looks solid long term.

To bridge the gap until both SPs are in payment would take £224k to give you that same £30k spending each year.  That compare to your available tax free funding of £150k (currently available) plus wife's pension of £40k (easily withdrawn within PA) plus lump sum from your pension of £152k so £342k in total or £128k of headroom!

I'll play some more later, but as far as I can see the only possible cloud on your horizon would be if they enacted the increase in pension access age early.

[Playing with Fire UK]

Are you putting £2,880 into your wife's pension annually to get it topped up? Or has she started drawing it already? Search for pension recycling first. This is not financial advice. Depending on the numbers it may be worth continuing to top up your pension after/if you stop working but before 55.

Tracking spending is really important, if you can spend some time reviewing the past few years of spending (this year is probably not representative) it'll help with these questions.

[PhilB]

Okay, kids fed.

One point before I get into the numbers again, I'm treating your pension as if it's accessible for drawdown immediately in my overall calculations.  I know that in reality you can't actually withdraw from it until 55, but you can 'notionally' withdraw from it by using your available assets for cashflow and making double withdrawals or whatever after 55 to repay yourself.  The 'cost' of not being able to withdraw until 55 is that you can't use your PA in the tax years between stopping work and reaching 55 - if you stop now then depending on your birthday that's 3 or 4 years - call it £10k in extra tax.   On the other hand, I'm guessing that you didn't both have birthday's last week and that you won't get your last paycheque tomorrow so I'm going to assume that £10k downside nets against those upsides.

Running the numbers again, lets assume that as well as 75% of your pension going into a 3% pension drawdown pot, we also put £100k into a similar ISA drawdown pot.  This ups your ultimate post tax income to £33k pa once you're 67, it knocks £3k a year off your bridging requirement/  It also gives an added layer of safety in that you could spend it in extremis or it would offset some future shrinking of the state pension.

That brings your bridging requirement down to £176k to have £30k pa until 67, or £200k if you wanted to factor in 2% negative real returns on this bridging pot.  To fund this you have £242k of available funds so still plenty of headroom.

I wouldn't really hold that many years of bridging in cash, but even if you did I'd say the above looks very solid indeed for an immediate retirement that more than covers your current spending.  Congratulations again.

[PhilB]

Are you putting £2,880 into your wife's pension annually to get it topped up? Or has she started drawing it already? Search for pension recycling first. This is not financial advice. Depending on the numbers it may be worth continuing to top up your pension after/if you stop working but before 55.

This is definitely worth doing for your wife as you can get the whole £720 uplift out tax free.  Less so for you as you'd be paying tax so the gain drops to £180.  I wouldn't factor it into your long term calculations though as it seems like a loophole ripe for plugging!

[never give up]

Whoops I also missed the bat signal here but thankfully for you michaels highly competent UKers have responded saving you from my warblings.

You’re in a great position so congrats for not having to worry about job layoffs.

[michaels]

Thanks all for your input and calcs

There seems to be agreement that putting the 'pension replacement funds' into a ring-fenced low volatility negative growth pot and the remainder in a sensible long term saving mix investment I can have the 18k pension income close to 'guaranteed' plus a 3% swr pot paying about 15k pa  on top.

1) Is it realistic to think I can find a 'safe' fund that will grow by rpi - 2% (I have suggested money market funds but I know there are also specific products) for the pension replacement pot?
2) How much is investing this way this costing me compared to how much risk I am avoiding my not having this pot 'invested' - remember it is paying out for up to 16 years, slightly front loaded so average time to spending the money is 7 years.

[PhilB]

I think everyone would agree with ringfencing the long term drawdown pot separately from other funds.  I don't think you'll get unanimity on how to invest the pension replacement fund though.  16 years is one hell of a long time to be in cash.  Most people would say that cash is good for a maximum of 5 to 10 years at the outside.  If you want guarantees then the only thing guaranteed is index linked gilts and they yield about -2.9% over 10 years.  Freedom from risk is expensive.

In your shoes I'd be looking at a mixture of cash deposits / bond ladders to cover 5 to 8 years with the rest in something with plenty of equities that you sell to top up the cash fund.

[Playing with Fire UK]

I'd be looking at a big chunk of equities for that length of time, but I'm a) scared of inflation more than market crashes and b) not you. Portfolio Charts has some great tools to model different asset allocations in drawdown but nothing will give you 100% safety (it's US focused so you'll need to change the settings to UK).

Remember that you can use your withdrawals to rebalance, so you take from the stocks when they are doing well and the cash/bonds/etc when the stocks are doing badly.

[michaels]

I'd be looking at a big chunk of equities for that length of time, but I'm a) scared of inflation more than market crashes and b) not you. Portfolio Charts has some great tools to model different asset allocations in drawdown but nothing will give you 100% safety (it's US focused so you'll need to change the settings to UK).

Remember that you can use your withdrawals to rebalance, so you take from the stocks when they are doing well and the cash/bonds/etc when the stocks are doing badly.

I always think that approach smacks of timing the market rather than time in the market - if you are taking a judgement on equities being 'high' valued then you are actively managing, even if it is just at the margin.  [Says the '100% passive' investor who is currently 70% global equities / 30% cash cos he can't see any value in bonds and equities are 'high' - despite the models saying that actually 80% equities gives the highest no failure returns over 40+ years based on historic outcomes]

[Playing with Fire UK]

I'd be looking at a big chunk of equities for that length of time, but I'm a) scared of inflation more than market crashes and b) not you. Portfolio Charts has some great tools to model different asset allocations in drawdown but nothing will give you 100% safety (it's US focused so you'll need to change the settings to UK).

Remember that you can use your withdrawals to rebalance, so you take from the stocks when they are doing well and the cash/bonds/etc when the stocks are doing badly.

I always think that approach smacks of timing the market rather than time in the market - if you are taking a judgement on equities being 'high' valued then you are actively managing, even if it is just at the margin.  [Says the '100% passive' investor who is currently 70% global equities / 30% cash cos he can't see any value in bonds and equities are 'high' - despite the models saying that actually 80% equities gives the highest no failure returns over 40+ years based on historic outcomes]

If you are sworn never to time the market I think it is still technically permissible to rebalance to your chosen asset allocation that is written on a stone tablet and locked in a vault. So you wouldn't be making a judgement on whether stocks have done "well" (which was lazy and heretical language on my part, many apologies for the offence which was unintentional) just calmly acknowledging that your asset allocation is 70% equities and they have now grown to 76% so a year's spending can be withdrawn and the accounts will be closer to your asset allocation. :)

Everyone is welcome to judge whether to exile me from the passive club.

[michaels]

I'd be looking at a big chunk of equities for that length of time, but I'm a) scared of inflation more than market crashes and b) not you. Portfolio Charts has some great tools to model different asset allocations in drawdown but nothing will give you 100% safety (it's US focused so you'll need to change the settings to UK).

Remember that you can use your withdrawals to rebalance, so you take from the stocks when they are doing well and the cash/bonds/etc when the stocks are doing badly.

I always think that approach smacks of timing the market rather than time in the market - if you are taking a judgement on equities being 'high' valued then you are actively managing, even if it is just at the margin.  [Says the '100% passive' investor who is currently 70% global equities / 30% cash cos he can't see any value in bonds and equities are 'high' - despite the models saying that actually 80% equities gives the highest no failure returns over 40+ years based on historic outcomes]

If you are sworn never to time the market I think it is still technically permissible to rebalance to your chosen asset allocation that is written on a stone tablet and locked in a vault. So you wouldn't be making a judgement on whether stocks have done "well" (which was lazy and heretical language on my part, many apologies for the offence which was unintentional) just calmly acknowledging that your asset allocation is 70% equities and they have now grown to 76% so a year's spending can be withdrawn and the accounts will be closer to your asset allocation. :)

Everyone is welcome to judge whether to exile me from the passive club.

Apologies for misunderstanding. 

What worries me is that it is a very slippery slope and easy to get lured over to the darkside 'P/E 100 -  equities are obviously overvalued' way of thinking.

[Playing with Fire UK]

You are entirely right to be concerned. I agree it is a slippery slope. Thanks for questioning so I could clarify what I meant.

Have you seen the Monevator series? This post looks at using cash to bridge the gap to SIPP age, but equally applies to bridging until SP age. It won't give you any definite answers but is one well-reasoned way of looking at the issue.

[michaels]

You are entirely right to be concerned. I agree it is a slippery slope. Thanks for questioning so I could clarify what I meant.

Have you seen the Monevator series? This post looks at using cash to bridge the gap to SIPP age, but equally applies to bridging until SP age. It won't give you any definite answers but is one well-reasoned way of looking at the issue.

Thank you.  Link has an even more depressing minus 3% real return on cash.