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Bridge to State Pension

Including Financial Independence and Retiring Early (FIRE)
Joe45
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Bridge to State Pension

#349558

Postby Joe45 » October 21st, 2020, 2:22 pm

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
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Re: Bridge to State Pension

#349565

Postby dealtn » October 21st, 2020, 2:58 pm

Joe45 wrote:I assume I can invest in something that will match inflation.


Interesting assumption.

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Re: Bridge to State Pension

#349608

Postby tacpot12 » October 21st, 2020, 5:05 pm

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.

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Re: Bridge to State Pension

#349890

Postby Joe45 » October 22nd, 2020, 5:31 pm

dealtn wrote:
Joe45 wrote: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
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Re: Bridge to State Pension

#349893

Postby dealtn » October 22nd, 2020, 5:40 pm

Joe45 wrote:
dealtn wrote:
Joe45 wrote: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
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Re: Bridge to State Pension

#350398

Postby JohnW » October 25th, 2020, 6:40 am

Joe45 wrote: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
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Re: Bridge to State Pension

#350405

Postby Steveam » October 25th, 2020, 8:06 am

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

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Re: Bridge to State Pension

#350493

Postby airbus330 » October 25th, 2020, 1:44 pm

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.

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Re: Bridge to State Pension

#353310

Postby StepOne » November 4th, 2020, 9:15 am

Joe45 wrote: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.

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Re: Bridge to State Pension

#353395

Postby Joe45 » November 4th, 2020, 12:38 pm

StepOne wrote:
Joe45 wrote: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.

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Re: Bridge to State Pension

#353566

Postby Shaker » November 5th, 2020, 12:37 am

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.

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Re: Bridge to State Pension

#354909

Postby Chrysalis » November 9th, 2020, 5:06 pm

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..

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Re: Bridge to State Pension

#355750

Postby Joe45 » November 12th, 2020, 9:03 am

Chrysalis wrote: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.

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Re: Bridge to State Pension

#356544

Postby Chrysalis » November 14th, 2020, 3:59 pm

Joe45 wrote:
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.

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Re: Bridge to State Pension

#356555

Postby Lootman » November 14th, 2020, 4:21 pm

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

Chrysalis wrote: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.

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Re: Bridge to State Pension

#411487

Postby 1nvest » May 12th, 2021, 9:51 pm

Joe45 wrote: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?

I used this sort of approach: Assume real (inflation adjusted) figures and you can simplify to use just present day values. For the 'Investment' column its 325K start date amount, less the spending column value plus the income value and multiplied by your anticipated real gain factor, for instance I used 1.02 (2% annualised real) in the following. At 1.0 (just paces inflation then its all exhausted at around age 97. At 4% you end up at 95 with 442K (more than at the start) in inflation adjusted terms.



Investment wise, sequence of returns risk is a greater risk in earlier years. The way I opted to address that was to go with 50/50 initial Berkshire Hathaway and gold. Once purchased there's no need to rebalance, you can in part direct that by simply drawing the income from whichever is the highest value at the time. From a 2000 start date for instance to date it was around equal amounts of time taking from BRK and Gold and recently still has around 50/50 of both. From the mid 1980's it was a couple of early years of taking from gold and then subsequently just from stock, ending up recently at around 95/5 stock/gold weightings. When a 4% SWR was used the more recent SWR value is just 0.4% of portfolio value (i.e. with SWR you take a percentage amount at the start, such as 4%, and then uplift that £££ amount by inflation as the amount drawn in subsequent years, and as such that inflation adjusted value can become a relatively small percentage of the ongoing portfolio value when the portfolio (after withdrawals) grows ahead of inflation).

As a 4% SWR rule of thumb has tended to work OK and reflects the historic worst case 30 year outcome for a 60/40 stock/bond portfolio, you might assume that a 4% real growth rate is a reasonably conservative mid/longer term average, so returning to the above table you could very well end up with more inflation adjusted capital after 30+ years into retirement. Assuming a 4% real investment return then for the same 'ladder' a 220K start date investment value would be enough. But that assumes both of you survive to age 95, if one departs perhaps at age 80 and pension value halves whilst spending might remain much the same, then 325K and 4% gives a comfortable buffer, sees 250K of inflation adjusted value still remaining at age 95.

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Re: Bridge to State Pension

#411591

Postby Joe45 » May 13th, 2021, 10:59 am

Thanks for your input and yes my assumption of 4% is very conservative for several reasons:

1 The period in question is only 20 years (rather than the usual 30) as I figure that by the time I reach 80 I won't need much discretionary spending.
2 The standard modelling assumes constant real levels of spending which is not reflective of real life. Discretionary spending in retirement reduces over time.
3 The so-called 4% rule refers to portfolio survival over periods of high stress such as the Great Depression and 2 world wars, and takes no account of behaviour in times of stress (ie reducing discretionary spend during a bear market).

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Re: Bridge to State Pension

#411639

Postby 1nvest » May 13th, 2021, 12:33 pm

Posting this cross reference to another post of mine that you might find useful viewtopic.php?p=411614#p411614 I've backtested that to 1896 and saw good outcomes. Fundamentally a form of domestic 50/50 (UK stocks and cash deposits) and foreign 50/50 (US stock and gold). But with caveats. Pre 1932 and money/gold where fixed/pegged so it made more sense to hold money earning interest. Also during world wars you'd more likely prefer, given the uncertainties, to hold portable physical assets i.e. rotate all of cash holdings into physical metals or other similar tangible assets (paintings rolled up into tubes, diamonds, gold, silver ... whatever). Assuming that stocks were left as-is, otherwise a potential large capital gain tax situation might have arisen from liquidating the holdings.

Earlier years risk is more often the greater risk, more typically after a number of years the same inflation adjusted income will be a smaller percentage of the portfolio value as the portfolio grows in real terms. Once the same inflation adjusted income has reduced from perhaps a 4% initial value down to 3% or less, well that's like starting at a 3% or lower SWR i.e. is very safe.

In the post after the one I linked above that starts from 1987 the inflation adjusted income value had declined to being just 0.7% of the portfolio, whilst the portfolio had transitioned over to being more like 80/20 stock/reserves (cash and gold). So even if stocks halve and halve again that 0.7% might double and double again to 2.8% of the portfolio value and still be safe.

A nice aspect of SWR is that its a regular inflation adjusted income, not subject to market fluctuations.

In the 1987 start date case (second of the two postings) the reserves (cash and gold) were pretty much not required 'insurance'. In the 2000 start date case that insurance was called upon. As a example this US S&P500 with 4% SWR since 2000 case if you click the inflation adjusted tickbox in the chart would have been uncomfortable. Halved the portfolio value by 2003 and stayed down, and then halved down again in 2009 and stayed down since. Obviously a selected bad time/choice, all stock retirement started at the 1999 peak and over other cases/periods results for all-stock were far far better and that might have put 50/50 to shame. But 50/50 is the more balanced, not as great if a good time, not as bad or even good when stock heavy might falter.

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Re: Bridge to State Pension

#411670

Postby Hariseldon58 » May 13th, 2021, 3:22 pm

My approach relies on a pot of cash (premium bonds/savings accounts etc) to fund a few years, a small allocation to bonds and a largely equity approach.

I started this when I was 49 in 2007 ( 95% equities, this proved uncomfortable in March 2009 but it all worked out, more emphasis on having some cash now…)

It worked out well, I’d be cautious that the bond element of Life Strategy might not work out so well as a store of value in the event of inflation, rising interest rates, given the low prospective returns then cash/premium bonds is my chosen option. The rest in equities.eg Vanguard All World or similar.

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Re: Bridge to State Pension

#420720

Postby 1nvest » June 19th, 2021, 12:44 pm

dealtn wrote:
Joe45 wrote:I assume I can invest in something that will match inflation.

Interesting assumption.

Inflation bonds/index linked gilts when held to maturity pay whatever the rate when you bought, recently around -2.5% real yields. If the ILG market were broad enough you could load into having 20K of inflation adjusted income (bond maturing) for 9 years and a further 5K/year for year 10 to 30 which would cost around 375K in total of present day money but that provided the inflation adjusted 20K/year (and subsequent 5K/year) amounts. So near-as 300K of near as guaranteed inflation adjusted income costing 375K of present day money.

In absence of having actual Index Linked Gilt series to precisely cover that you can hold/rebalance between two index linked gilt funds/bonds with different durations to align to your ongoing duration.

That of course spends all of that money. Might be considered as the 'risk-free' choice. Other assets may do better - exceed expectations and perhaps leave some/much/all/more inflation adjusted capital still available at the end of the 29 years, but could do worse, possibly a bad sequence of returns seeing that all spent in a decade or less. Or as your intending to spend the money anyway, buying annuities might be considered. I know little about annuities but imagine that providers might provide £x amount of inflation adjusted income for y number of years type products, that given that you might die before the final payout and they get to keep the remainder should conceptually provide a better deal that the DIY approach.


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