Drawdown Strategy — Joining the Chain Gang
Today’s post is unusual in that it’s part of a chain of linked posts by finance bloggers on both sides of the Atlantic. It’s about my Drawdown Strategy.
Drawdown strategy chain
This is the first blogger chain I’ve ever joined.
- The links were already into double figures when I found it, and I enjoyed the first couple of posts that I read.
It’s also a subject of increasing relevance to me and I thought I could benefit from clarifying my thoughts.
- I’m in the process of moving from what is best described as semi-retirement into the Full Monty.
And it’s something that isn’t discussed on the finance blogs too much, despite it being the culmination of the financial work that goes before it.
The chain began a few weeks ago now when Fritz at The Retirement Manifesto noticed that the Physician on Fire had published a post about his drawdown plan.
- Fritz thought it would be a good idea if he published a post, and as many other people as possible did so as well.
Here’s what the chain looks like so far:
- Physician On Fire — Our Drawdown Plan in Early Retirement
- The Retirement Manifesto — Our Retirement Investment Drawdown Strategy
- OthalaFehu — Retirement Master Plan
- Plan.Invest.Escape — Drawdown vs. Wealth Preservation in Early Retirement
- Freedom is Groovy — The Groovy Drawdown Strategy
- The Green Swan — The Nastiest, Hardest Problem in Finance
- My Curiosity Lab — Show Me The Money: My Retirement Drawdown Plan
- Cracking Retirement — Our Drawdown Strategy
- The Financial Journeyman — Early Retirement Portfolio & Plan
- Retire by 40 — Our Unusual Early Retirement Withdrawal Strategy
- Early Retirement Now — The ERN Family Early Retirement Capital Preservation Plan
- Mr. 39 Months “Drawdown” Plan — 39 Months
I’ll put direct links to each of these posts at the end of this article (so that you can visit them after you’ve read my version).
The basic question is:
How much money will I get when, and from where?
I decided to read all of the existing links in the chain so that I could refine this a little.
- You should do the same, but not until you finish reading this post!
Unfortunately for me, almost all of the posts to date — apart from Cracking Retirement — are from the other side of the Atlantic, so I can’t steal their ideas directly.
This is because:
1 — US tax rules are different to those in the UK
- similar retirement products exist, but tax rules (capital gains in particular) seem to be more complicated
- I’m not familiar enough with the US rules to take advantage of the best ideas from the American bloggers
2 — The healthcare situation is vastly different
3 — Property is a more problematic asset in the US
But I have used the existing posts to put together a checklist of what I need to cover.
Here it is:
1 — Age, retirement date and life expectancy
2 — Income needs
- this includes any life changes like moving house, college fees, elder care etc.
3 — Required assets
- and sensitivity analysis
4 — Healthcare
- including end-of — life “social care”
5 — Sources of income
6 — Tax
7 — Inflation
8 — Asset allocation
- and sequencing risk
9 — Order of withdrawal
I’m 56 at the moment, and I semi-retired aged 51.
- Since then I’ve done non-lucrative part-time work (( Like this blog )) and run down the taxable assets in my company.
My other half (OH) is 54, and still working.
- Her job is much more enjoyable than mine was.
- Her current contract ends in August this year and the plan is for her to take a few months off and decide at Xmas whether she should go back to work.
So we could be fully retired soon.
- At the moment I would say we have moved from accumulation into “transition”, but we are not yet fully into decumulation.
My life expectancy is 82, so I have 26 years to go (until 2043).
- OH’s life expectancy is 85, so she has 31 years to go (until 2048).
Of course, I hope that we’ll both beat those ages.
- We eat well and exercise, and we live in a good area.
Because of my semi-retirement, we have a fair idea of our spending requirements.
- These have been inflated in recent years because we’ve been supporting my mother-in-law (MIL) until she sold her flat and moved down to live in rented accommodation close to us.
- But now the MIL has her own money, and this year’s spending should be a good baseline.
We have no plans to move, (( Unless a future Corbyn-led communist government forces us out of the UK altogether )) but we currently live in central London so if we do move it will be to somewhere with lower expenses.
We have no children, so there are no college funds to worry about.
- These are much smaller in the UK anyway — perhaps £45K per child.
So I envisage three phases to our retirement:
- Elder care (with the MIL)
- Travel and high life
- Quiet decline
I will make the simplifying assumption that the excess spending in Phase 2 will be cancelled out by the underspend in Phase 3.
- All this will be adjusted as we go along, of course.
To retire safely, you need assets that are at least 30 times your required income.
Even if you have more than 30x income in assets, you should think about doing some sensitivity analysis.
- This usually involves Monte Carlo-style simulated runs of what might happen to you under various sequences of market returns
- You end up with a percentage figure that shows your chances of running out of money within 30 years (( The default setting — note that OH needs 31 years on paper ))
Good sites to use include:
Other calculators are available — please tell me your favourite in the comments.
We’re lucky enough to have assets that represent more than 100 times our required income
- This means that our withdrawal rate is less than 1%
- And we could — if we wished — take 100 years of withdrawals simply from cash.
So I don’t need to do a sensitivity analysis.
We have seven potential sources of income:
1 — Jobs
- OH is currently working, but will stop soon and might not go back
- We both have creative outlets to explore in retirement (( Including this blog ))
- But I have assumed that they will not produce any income
2 — State Pension
- I will qualify for the UK State pension at age 66, in 2026
- I am currently projected to receive £7K pa, but I intend to make voluntary contributions to make this up to £8K pa (( These are very good value — I will have a post on this in the next six weeks or so ))
- OH will qualify at age 67, in 2029
- We can’t get an official projection of her pension until she turns 55 in November, but if she is short of £8K pa, the plan will again be to make voluntary contributions
- Until recently, deferring the State Pension for a few years was a very good option, but the rules have changed recently, so we will take it as soon as possible (( Another future post of mine ))
3 — Rental income
- We have more than one property, but they don’t generate income
- For example, I have a half-share in my late father’s house — this is rented to a housing association for a peppercorn rent
- So I will ignore rental income
4 — Workplace Pensions
- I have two DB pensions and OH has one (but hers is four times as large as my two put together)
- All three should sum to roughly the same as the State Pensions
- These will all be accessed from age 60 (so 2020 for me, 2022 for OH)
5 — SIPPs
- We both have SIPPs
- I have started to access mine already, and OH is eligible from November
6 — ISAs
- We both have ISAs
- These are likely to be the last things that we spend (see the section on Tax for the logic)
7 — Taxable assets
- We have very little in the way of taxable assets. (For accounting reasons, some of our cash shows up as if it is taxable, but in practice it won’t be.)
There are three other theoretical sources of income that I am ignoring:
1 — Dividends
- I use a “total return” approach to investment, and so I don’t pay much attention to dividends
- During accumulation, I allowed the cash to build up until there was enough for manual reinvestment (in a different stock)
- In decumulation, I will (manually) spend the dividends as they arise each year
2 — Annuities
- Annuities offer poor value in the current economic climate and I have no intention of converting any of our assets into an annuity before the age of 75
- More on this here and here.
- The State Pension and Company DB pensions can be seen as annuities in any case
3 — Equity Release
- This is what those in the States call a reverse mortgage
- It’s a loan of cash against your house
- But because you make no repayments, the outstanding balance can snowball dramatically
- So Equity Release should only be considered as a last resort
From an accumulation perspective, the tax system in the UK is wonderfully simple:
- you get income tax relief on Pension contributions (including into SIPPs)
- you get no relief on contributions into ISAs
The annual limit for Pensions is £40K and for ISAs is £20K.
- Which is more than enough for anyone
- But additional income tax relief is available under the VCT and EIS schemes
All growth and income within these wrappers is tax-free.
When you get to decumulation, the situation reverses:
- income from a Pension (or SIPP) is taxable
- except that the first 25% is tax-free
- and assets beyond £1M — the Lifetime Allowance — are taxed at a punitive 55%
- income from an ISA is not taxable
The Lifetime Allowance has been reduced recently from £1.8M to £1M (in stages).
- At each stage you could take protection for the previous limit, on pain of not making more contributions.
So my pension has a frozen limit of £1.25M, whereas OH is capped to £1M, but can still make contributions.
The other tax to consider is inheritance tax.
- Each of us has a basic exemption of £325K
- If we were married, we could pass property between us on first death without tax
- This includes passing on ISAs intact
- There’s a new property allowance (£100K, rising to £175K) but as we have no children we can’t use it
Pensions can be passed on tax-free if you die before age 75.
- And AIM stocks and EIS holdings can be passed on tax-free once they have been owned for two years.
As we have no children and intend to live beyond age 75, our IHT planning is limited to:
- getting married at some point
- owning some AIM and EIS
I plan to largely ignore inflation for now:
- The State Pension has a Triple Lock for the time being
- Our Company Pensions are also inflation-linked
- A lot of our SIPP and ISA assets will respond to inflation
I would be worried by a sustained period of high inflation.
- But that is hard to imagine given the last 10 years of macroeconomics and central bank policies.
I’ve written before about the importance of asset allocation.
- The key point is that you need a plan.
- You shouldn’t get too bogged down in the details.
My own preference is to stick with a large equity allocation into decumulation.
- I think that target date funds that push you into a higher bond allocation as you age were a better fit for the days when everyone bought an annuity at the start of retirement.
Here in the UK, property is a tax-advantaged, appreciating asset.
- It’s also very expensive, which means that we have more that a third of or net worth in this asset class.
- This constrains the amount of equities we can hold to around 40%.
Within that, we split between:
- UK (large and small-cap)
- Emerging markets, and China
We also have some themed equity investments (Tech, BioTech, Water etc).
- And we hold some diversifying assets like private equity, commodities, infrastructure and hedge funds.
We have a large cash allocation at the moment (15%).
- This is to cope with emergencies, to guard against sequencing risk (( I don’t want to have to sell stocks during a bear market )) and to take advantage of any market crash in the near future.
One asset that I don’t hold directly is P2P loans.
- Interest rates have come down significantly, and the tax-treatment is unfavourable.
- If a SIPP or ISA platform allowed a “mix-and-match” approach between providers, I would reconsider.
- For now I will access this asset class via investment trusts.
Order of withdrawal
Finally we get to the meat of the plan.
We will take money from our SIPPs first.
- This is because we have income tax allowances (0% and 20%) to use up each year.
And because I expect taxes in the UK to rise in the future.
- I think the ISA will survive any changes in better shape than the Pension.
The 20% limit is now £45K pa per person.
- Add back the 25% tax-free amount and you can potentially withdraw £60K pa without paying 40% tax.
There is no way we can spend close to £120K pa, so I expect to recycle £40K pa back into ISAs.
- Any cash left beyond that will go into VCTs and EIS to reduce our tax bill.
As the Company and State Pensions kick in, the amount withdrawn from our SIPPs each year will reduce.
- If we ever exhaust our SIPPs, we will move onto our ISAs (which should be a lot larger by then).
The technicalities of how to withdraw are different for me and OH:
You might be wondering why neither of us plans to take the 25% tax-free lump sum from our pensions.
- It’s basically because at the moment we have no use for a cash lump sum.
- So we would just be converting tax-sheltered money into taxable money.
If the situation changes — perhaps we might want to buy a seaside cottage — then we will revisit the strategy.
And that’s it for our Drawdown Strategy.
Until next time.
Here’s a reminder of the Drawdown Strategy Chain so far:
Anchor: Physician On Fire: Our Drawdown Plan in Early Retirement
Link 1: The Retirement Manifesto: Our Retirement Investment Drawdown Strategy
Link 2: OthalaFehu: Retirement Master Plan
Link 3: Plan.Invest.Escape: Drawdown vs. Wealth Preservation in Early Retirement
Link 4: Freedom Is Groovy: The Groovy Drawdown Strategy
Link 5: The Green Swan: The Nastiest, Hardest Problem In Finance: Decumulation
Link 6: My Curiosity Lab: Show Me The Money: My Retirement Drawdown Plan
Link 7: Cracking Retirement: Our Drawdown Strategy
Link 8: The Financial Journeyman: Early Retirement Portfolio & Plan
Link 9: Retire By 40: Our Unusual Early Retirement Withdrawal Strategy
Link 10: Early Retirement Now: The ERN Family Early Retirement Captial Preservation Plan
Link 11: 39 Months: Mr. 39 Months Drawdown Plan
Originally published at 7 Circles.