Saturday 31 August 2013

Should I put my UK Pension into Income Drawdown or Buy an Annuity

As I sit here, as a late 40 year old, writing this post 41% of my wealth is held within pension wrappers including a very healthy SIPP.  If I stay the course with my Investment Strategy then Early Retirement will likely appear around age 44.  Running a forecast to that age, which looks at my intended contribution profile and expected portfolio diversification into both the pension and non-pension assets, would result in 44% of my wealth being within pensions at that point.  This is of course only going to be true if the my investments perform on average over that period which of course is a big if but is all I have to use for forecasting.

If I then continue with the Transition to Retirement Strategy which includes the purchase of a home for my family and includes rapid pay down of the mortgage in the 11 or so years until I can access my pension assets then my pension wealth will rise quickly as a percentage of total wealth.  This is because my non-pension assets will need to generate my salary as well as pay down the mortgage while the pension continues to grow in value from investment return.  To demonstrate the severity of this if I step my retirement forward 10 years to age 54 my pension wealth could be as high as 83% of my total wealth.  This excludes any equity which I will have in the family home which might frustrate The Investor over at the excellent Monevator somewhat.  That’s a lot of wealth tied up in a wrapper that has a track record of being tinkered with by government.  What’s also interesting is that as I leave the early retirement phase of my life and become a typical retiree my position is probably not that much different to most people who have saved in a pension for a typical retirement.

Step forward 1 year to 55 and it all gets interesting, at least under current pension rules, as I can now start to access my pensions.  The no brainer for me is that I’ll firstly take the 25% tax free lump which in line with the Transition to Retirement Strategy will be used to pay off the mortgage, maximise that years ISA contribution and invest the remainder as tax efficiently as possible.  At that point my forecast suggests around 75% of my total wealth is now within the pension.

Unless I’ve missed a trick I believe I now have essentially two options if I want to generate an income from the remaining pension pot.  I can put the pension into Income Drawdown or alternatively buy an Annuity.  Let’s look at the Pro’s and Con’s of each option plus run an example for each option based on my situation assuming I was 55 today.

Sunday 11 August 2013

The S&P 500 Cyclically Adjusted Price Earnings Ratio (S&P500 CAPE) Update - August 2013

This is the monthly review of the S&P500 including a couple of S&P 500 valuation metrics.  The last review can be found here.

S&P500 Price

At market close on Friday the S&P500 was Priced at 1,691.  That is a rise of 1.4% when compared with 1,669, which is the average closing Price of each trading day last month.  It is 20.5% above last year’s August monthly Price of 1,403.  Note that for this index I only look at monthly average Prices as opposed to hourly or daily as I’m a very long term investor and just don’t need the noise associated with more granularity.  I’ll leave that for the traders out there.

We can then look at how this Price compares to history which is shown in the chart below.

Chart of the Monthly S&P500 Price
Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media when displayed over a long term.  It looks sensational and in my opinion isn’t very helpful.  Let’s therefore adjust it to the chart below where I try to show what is really going on with Prices.  I make two adjustments:

  • Correct the chart for the devaluation of the US Dollar through inflation.  
  • Show the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  For example let’s say we have two historic prices of 10 and 100.  If they both increase in price by 10% then they increase by 1 and 10 respectively.  On a linear scale it would appear as though the second has increased by a factor of 10 more than the first where on a logarithmic scale they will appear to have changes the same.  Less sensational but more correct. 

Chart of the Monthly Real S&P500 Price
Click to enlarge

Thursday 8 August 2013

Now I’m Being Asked to Encourage My Own Rent Increases

I have little tolerance of the Assured Shorthold Tenancy (AST) process which is nothing short of a scurge in this great country of ours.  Having now just completed my annual AST dance which goes something like:

  1. An email is received from the “Property Manager” of the Local Lettings Agent.  “Dear RIT.  Your current AST is due to expire.  Therefore if you want to stay in your current rental accommodation it’s time to renew.  The Landlord is looking to increase the rent by (insert a large random number based on no facts here).  Additionally we will be looking to extort a renewal fee of (insert a smaller random number again based on no facts here).”  I know they are also taking at least 12% of every month’s rent from my Landlord as they are so incompetent that they have occasionally sent me the Landlords monthly Statement so I’m assuming they’re also extorting renewal fees from that direction as well.
  2. I then do some research and find out what rentals of a similar type as mine are going for in my area.
  3. I send an email in reply which goes something like.  “Dear Property Manager.  Having now conducted local market rental price research for similar properties and in recognition of our long standing respect for the property which keeps the Landlords costs down (which I know all your tenants can’t claim) plus an untarnished record of continued on time payment of rent (which I also know all your tenants can’t claim) I believe a fair rent is (insert current monthly rental amount here) or (insert current monthly rental amount minus a few £'s here)."
  4. This then results in some “healthy” negotiation until eventually they play the eviction threat card which goes something like “I want you out by (insert a date 2 months in the future here) and will be sending you a Section21 notice immediately.”
  5. At this point I know I am close to the lowest rental amount possible.  This has in the past resulted in rent decreases, increases or freezes.  Unfortunately this year it was a 2.1% increase.

It was with much amusement that I today received a badly torn envelope in the post which had another local Lettings Agents name poking out and was addressed to:
     Private & Confidential: Please Forward
     The Legal Owner(s)
     RIT’s Flat Number
     RIT’s Street Number

Sunday 4 August 2013

Retire to Europe – Option 1 - Malta

As a British Citizen I am in the enviable position of having the right (at least for now) to take up residency in any 1 of 26 other EU countries.  Countries as far north as Finland, as east as Cyprus, as west as Portugal and as south as Malta.  A melting pot of languages, cultures and history which when combined provides for a myriad of potential lifestyle options and life experiences.

Prior to retirement these options can be limited as you’ll likely be making decisions based on where you can get work and your language skills but once you reach financial independence these become less of a barrier as you:

  • won’t need to consider how to make a living through work;
  • many potential side hustles/jobs can still be performed in your native tongue/s; and
  • you’ll have time on your hands to learn the local language.

Of course as Ermine’s comment rightly pointed out in the Transition to Retirement post your human setting, which include access to family and friends, will also likely be a limiting factor on packing up and moving to a new country for many.  Personally I'm in the fortunate (or unfortunate depending on how you look at it) position of having few ties to the South East of England but instead have family and friends spread far and wide throughout the world.  This includes a healthy number of good friends and family on the Continent.  This means that a move to Continental Europe actually brings some family and friends closer while I leave some good friends in the South East.

My current plan has me moving out of London and the South East of England to either another UK location (Shropshire or Suffolk being current favourites) or to Europe.  A large driver of this is the price of housing and other basic costs in the South East.  By moving away I will be presented with the opportunity for a more fulfilling life as I’ll have the opportunity to move further up Maslow’s Hierarchy of Needs pyramid shown in the figure below.  In brief Maslow detailed that every person has the desire and ability to move up the pyramid but they cannot move onto the next level of the pyramid until they have met the needs on the lower level.  By moving away I won’t have to expend as much of my retirement wealth (nor worry about it as it won’t represent such a large a portion of my total assets) on the lower Physiological Basic Needs which includes Shelter and providing a pick a Safe retirement location I’ll be able to concentrate on moving through Belonging, Self-Esteem and hopefully achieve Self-Actualisation.

Maslow’s Hierarchy of Needs
Click to enlarge (Source:

Sunday 28 July 2013

A Transition to Retirement

I am currently at the point where if I can maintain my current savings rate and forecast average investment return run rate I expect to have accrued sufficient wealth for full financial independence in a little less than 3 years.  This will mean I will have the option of either:

  • continuing to work in my current full time career knowing that I don’t need the company but that the company needs me; or
  • taking early retirement from my current day job which will allow opportunity for everything from doing nothing to side hustles to part time work (whether in my current or a new career) to a new full time career which might include my own business;

all at the relatively early age of 44.

With only a few years to run until Financial Independence I now believe I'm at the point where I need to start thinking about how to transition from my current position to retirement.  Before I document my first musings on what the strategy might look like to financially transition to early retirement let me first detail some relevant considerations that need to be accounted for based on where I am today:

  • I am planning to be in the position where I will need to generate no active income with all expenses being covered by investment return from my accrued wealth.  Planning this way means any work undertaken, which might earn an income, becomes an activity that brings enjoyment or learning opportunities only. 
  • I am a higher rate, 40%, tax payer and expect to be a basic rate, 20%, tax payer in retirement.  This along with the facts that as part of a pension salary sacrifice arrangement my employer adds to my pension a large part of the 13.8% Employers National Insurance Contribution that they now save, plus I also get the 2% Employees National Insurance contribution above the Upper Earnings Limit added to the Pension, means I have a lot to gain by making large pension contributions.  At current rates my pension contribution is about 50% of my monthly 60% of gross earnings savings rate.  This means that over the next 3 years, after accounting for expenses, taxes and investment types in and out of the pension, I expect my Pension wealth to move from 41% of total net worth today to something closer to 44%.  I am therefore left with only 56% of my total net worth to live off until age 55 when I can start to Drawdown on my Defined Contribution Pension.  Of course that assumes the UK government doesn't change the retirement age or other pension rules meaning I'm also carrying a bit of contingency in my planning.
  • I haven’t yet bought a home and while I will have the assets to sell to buy the home outright a small mortgage looks prudent to maximise my wealth retention by paying some short term interest payments which will allow long term minimisation of taxes.  Some of these tax minimisations will include not cashing in any of my Stocks and Shares ISA wealth as I want that tax free income forever, avoiding payment of any capital gains tax and not selling some offshore Non-Reporting Funds where the gains are subjected to income tax rather than capital gains tax, which I foolishly bought before I knew what I was doing, while I'm a higher rate tax payer.  This will reduce any Capital Gains Tax from 28% to 18% after allowing for my Annual Exempt Amount (£10,900 for 2013/14) and the tax on the gains of my Non-Reporting Funds from 40% to 20% or possibly even a portion at 0% if I'm careful.