Bridge to State Pension

[Joe45]

I’m 59 and about to enter retirement. Over the past few years I’ve kept a careful track of my spending, and separated discretionary from non-discretionary. I reckon our non-discretionary spend is around £22,000 annually.

My approach to retirement investment planning is as follows:

I’ll need £22k pa index linked for around 9 years at which point two State Pensions kick in and these will reduce this requirement to £5k. To bridge this initial gap I’ll need 22 x 9, so around £200k.

I assume I can invest in something that will match inflation. SP is index linked so inflation should be neutral.

The subsequent £5k pa shortfall will continue for (say) 20 years. I can probably assume a 4% safe withdrawal rate, so a lump of around £125k should achieve this.

This gives a total pot for my non-discretionary spending at £325k. I plan to invest this in something steady like VLS40 which ought over the long term, to keep pace with inflation.

The balance of my portfolio will cover discretionary spending such as holidays. This can be invested in riskier assets (eg VLS80).

When I combine the two pots I get an composite allocation around 60:40 which feels comfortable.

Does anyone else take this approach?

[dealtn]

I assume I can invest in something that will match inflation.

Interesting assumption.

[tacpot12]

I don't take the approach you are suggesting, but I think your logic is basically sound. I'm retired and aged 57. I have c£360K invested and need c£20K pa until State Pension, and then around £6K pa as I also have a couple of DB pensions that pay about £5K pa (in todays money) from age 65. I have my funds invested in something more risky than VLS40/60/80. My investments are not currently keeping pace with inflation, but I expect that they will have done better than inflation in the period until I am 67.

I would say that you need a cash buffer, to avoid you having to sell assets at low points in the market. The problem is that keeping money in cash will further reduce the return on your investment overall, so I think I would suggest that you only keep one or two years of income in cash, and only use it immediately after a market crash.

I can't see much point buying a mixture of VLS40 and VLS80. It would be better to put half into VLS60 and the other half into another global fund from another provider such as HSBC, so you have some diversification in the underlying investments.

[Joe45]

I assume I can invest in something that will match inflation.

Interesting assumption.

Perhaps my choice of words was a little clumsy. What I mean is that I feel confident that I can invest in something that over the medium term will provide a return that will come close to keeping up with inflation. I don’t think that’s unrealistic. CGT would be a fair bet, for example.

[dealtn]

I assume I can invest in something that will match inflation.

Interesting assumption.

Perhaps my choice of words was a little clumsy. What I mean is that I feel confident that I can invest in something that over the medium term will provide a return that will come close to keeping up with inflation. I don’t think that’s unrealistic. CGT would be a fair bet, for example.

Agreed. My "interest" was an apparent existence of a "thing" that would be a riskless way of maintain pricing parity. I don't think such a "thing" exists. Now it is clear your meaning was different to my initial interpretation.

[JohnW]

Does anyone else take this approach?

It looks like a well recognised approach, a liability matching approach, so I'd say many would.
The risk you're trying to manage is of running out of money, I guess. You don't say how much you have, but if it was so much that the spending you need to keep body and soul together for the first year of retirement was 1% of it then you're at low risk and could safely invest it just about any way.
When our reserves are closer to the margin the risk needs to be managed better, and two ways broadly exist: diversify the risk, which only takes you so far as it still leaves market risk; and hedge the risk, which can almost eliminate it but at a cost.
Your strategy of 'building a bridge' to the safety of the state pension is a hedging attempt, but we don't know how successful VLS40 will be at providing your needs, so it's not complete hedging. Complete hedging would be to purchase inflation linked government bonds that provided to required 9 years of full funding as well as a trickle thereafter; or buy a 9 year limited inflation linked annuity for the 'bridge' (but still need something for the subsequent trickle).
First problem: do those annuities exist and how painfully expensive are they? Second problem: because the real yields on the inflation linked bonds are negative I think, buying them will cost you more than you'll get back; but it might only be 1.5% or so loss for the certainty that the strategy will work.
One could only speculate on whether the VLS40 strategy will work, so your approach is certainly not 'pure' matching of resources with liabilities because we don't know how VLS40 will do over the next decade. We do know however that it has only 5% in inflation linked bonds, and that its 55% nominal bonds can take big hit if inflation strikes big time, and that stocks can and have failed to match inflation over 9 year periods although a global stock fund would be out of luck if that happened to it.
Overall, your approach has a lot going for it.
http://web.archive.org/web/201109060407 ... Plan2.html

[Steveam]

Assumes no risk to inflation proofed state pensions. You may be right but government finances are likely to be very squeezed over the next 20 years and “wealthy” pensioners could easily become a target.

Best wishes,

Steve

[airbus330]

Since an attack on pensions would certainly sink the Conservatives chance of winning the next election, you probably have 4 years of safety before an attack is mounted on pensioners. NI on pension earnings has been floated and I'd expect that to be in the next Labour manifesto. The triple lock is going on for at least one more year, and again to touch it would be poison for the Torys.
On a different point, LS products have a disproportionate exposure to the UK market. If you think the UK is going to struggle to recover, something more global might be worth thinking about.

[StepOne]

I’ll need £22k pa index linked for around 9 years at which point two State Pensions kick in and these will reduce this requirement to £5k. To bridge this initial gap I’ll need 22 x 9, so around £200k.

I assume I can invest in something that will match inflation. SP is index linked so inflation should be neutral.

The subsequent £5k pa shortfall will continue for (say) 20 years. I can probably assume a 4% safe withdrawal rate, so a lump of around £125k should achieve this.

If I understand this correctly, then you don't need to withdraw anything from the 125k for 9 years. You've assumed a 4% withdrawal rate, so you could allocate a current lump sum of £90k. After 9 years this will have grown to £128k, which will cover your annual 5k shortfall, and you will have 35k left over today to add to your discretionary pot.

[Joe45]

I’ll need £22k pa index linked for around 9 years at which point two State Pensions kick in and these will reduce this requirement to £5k. To bridge this initial gap I’ll need 22 x 9, so around £200k.

I assume I can invest in something that will match inflation. SP is index linked so inflation should be neutral.

The subsequent £5k pa shortfall will continue for (say) 20 years. I can probably assume a 4% safe withdrawal rate, so a lump of around £125k should achieve this.

If I understand this correctly, then you don't need to withdraw anything from the 125k for 9 years. You've assumed a 4% withdrawal rate, so you could allocate a current lump sum of £90k. After 9 years this will have grown to £128k, which will cover your annual 5k shortfall, and you will have 35k left over today to add to your discretionary pot.

I think that’s right but I was attempting to take account of inflation and be somewhat cautious with my calculations. In any event it’s a pretty broad brush approach and I am fortunate to have a substantial pot to accommodate misjudgments!

Grateful for all the constructive comments.

[Shaker]

Sound logic but be wary of relying on State Pension as a big part of your income for the rest of your life. Do you think SP rules will be the same in 15-20 years time?

The other parts of your plan makes sense to me.

[Chrysalis]

When you say you have ‘two State pensions’ which will provide £17k per annum, can you explain?
The New State Pension is £175 per week or £9100. What is the other £8k? If it’s a DB pension, have you considered taking it early, reduced? This will reduce the need for drawing down so much on your investments in the early part of retirement.
Also, have you checked that you will have full entitlement to state pension (checked your personal forecast on the gov.uk website). If not, you can make voluntary contributions while you aren’t working.
Personally, I’d say within a decade of state pension I would not be worried about it being removed. There might be some tinkering with pensioner benefits, but surely starting with the universal pensioner benefits (as we’ve seen with the TV licence) and perhaps the ‘triple lock’. We shall see..

[Joe45]

When you say you have ‘two State pensions’ which will provide £17k per annum, can you explain?
The New State Pension is £175 per week or £9100. What is the other £8k? If it’s a DB pension, have you considered taking it early, reduced? This will reduce the need for drawing down so much on your investments in the early part of retirement.
Also, have you checked that you will have full entitlement to state pension (checked your personal forecast on the gov.uk website). If not, you can make voluntary contributions while you aren’t working.
Personally, I’d say within a decade of state pension I would not be worried about it being removed. There might be some tinkering with pensioner benefits, but surely starting with the universal pensioner benefits (as we’ve seen with the TV licence) and perhaps the ‘triple lock’. We shall see..

I’m including the wife’s pension. Sorry for failing to make this clear. And yes I have checked our pension forecasts on-line and will ensure we have the maximum available.

I did however read an article in the Times a couple of weeks ago disclosing how some retirees had been misled by the on-line record and unnecessarily made additional NICs. The nub of the advice was check with HMRC first, and (as I recall) it’s probably not worth having more than 30 years’ contributions prior to 2016.

[Chrysalis]

I did however read an article in the Times a couple of weeks ago disclosing how some retirees had been misled by the on-line record and unnecessarily made additional NICs. The nub of the advice was check with HMRC first, and (as I recall) it’s probably not worth having more than 30 years’ contributions prior to 2016.

Yes I think it’s the NI record that flags if you have gaps and suggests you might fill them, when it’s not always necessary.
On the state pension forecast it should make clear whether you have already accrued the full SP or if you have years left to contribute. Only in the latter case do you then need to check whether you have gaps or partial years, as it’s usually cheaper to fill gaps than to make full voluntary contributions for years when you aren’t working. But if you’re going to meet the full SP requirements anyway by the time you quit working then absolutely no point paying to fill gaps.

The requirement for the new state pension is 35 full years of NI contributions, but it’s a bit more complex than that in relation to the transition in 2016.

[Lootman]

The New State Pension is £175 per week or £9100.

The requirement for the new state pension is 35 full years of NI contributions, but it’s a bit more complex than that in relation to the transition in 2016.

It is more complicated because for a good few years most people here will have their SP amount based on the old system and not the new rules. So the amount could be all over the place. For example I will get about £180 per week and a friend of mine collects over £200 per week.

You could of course also get less than £175 per week if you do not have enough years of contributions and cannot or do not buy them.