‘Should I stop investing my pension and buy an annuity?’

Don is 61 and draws £38,400 a year from his self-invested personal pension (Sipp), which he manages. His wife receives £40 a month from a former workplace pension. They have grown-up children who have been provided for in a joint will.

Don and his wife’s home is worth about £620,000 and has an interest-only mortgage of £295,000, which expires in November. They also have a property abroad worth about €625,000 (£553,082) with a mortgage of €200,000, which provides them with rental income of €20,000 to €30,000 a year.

“We need to produce a sustainable income so are seeking a stable income from our investments and annual growth in my Sipp of 4 to 5 per cent a year,^” says Don. “Our monthly expenditure is around £1,100 a month or £13,200 a year, so I’m happy with an annual income of £38,400. That said, I have looked into annuities as the rates are good at the moment – for example, a single annuity could boost my income to about £67,000 a year. I could then put £30,000 of this a year into my wife’s Sipp, which currently only has a value of £1,258 and is entirely invested in Fundsmith Equity (GB00B4MR8G82). We are also considering a joint annuity as my wife would continue to get half the value of the payout when I die.

“The interest-only mortgage on our main home expires in November. We need to reduce this, so extra income would help, although my Sipp could cover a substantial part of this. However, I have already taken the 25 per cent tax-free lump sum from my Sipp to help fund the purchase of our overseas property.

“We also have a bank loan of £2,000 and credit card debt of £800.

“I have been investing for five years, although before retiring I worked in banking and finance for 40 years so am familiar with financial instruments. I would say that I have a medium risk appetite – I would be prepared for the value of our investments to fall by up to 15 per cent in a year.

“I usually hold about 60 per cent of our investments in equities and 40 per cent in bonds, although have been reducing my holdings in Royal London Sterling Extra Yield Bond (IE00BJBQC361), Invesco High Yield (GB00BJ04GF14) and Schroder High Yield Opportunities (GB00B5143284).

“Although my Sipp, which has a total value of £773,933, has performed well in recent years, there is currently a downturn so I hold a large part of it in cash – £472,022 – for when the market improves. When I do invest, I would like to put money into investments with upside potential and stable pricing.”

Don and his wife’s portfolio
Holding	Value (£)	% of the portfolio
Cash	487,200	39.42
Overseas property minus mortgage	376,096	30.43
Schroder High Yield Opportunities (GB00B5143284)	59,454	4.81
Invesco High Yield (GB00BJ04GF14)	38,105	3.08
Don Isa*	25,713	2.08
Fundsmith Equity (GB00B4MR8G82)	22,378	1.81
Nanoco (NANO)	19,217	1.55
Wife Isa**	18,917	1.53
Euro denominated cash	18,594	1.5
Schroder Monthly Income (GB00B66FVB83)	17,232	1.39
Royal London Sterling Extra Yield Bond (IE00BJBQC361)	13,003	1.05
7IM AAP Income (GB0033953943)	10,029	0.81
BNY Mellon Global Income (GB00BLG2W887)	9,011	0.73
CT Diversified Monthly Income (GB00BYZ62Z90)	6,698	0.54
Legal & General International Index (GB00BG0QP596)	6,647	0.54
Rathbone Global Opportunities (GB00BH0P2M97)	6,438	0.52
Don general investment account***	6,138	0.5
IFSL Marlborough European Special Situations (GB00B90VHJ34)	5,150	0.42
Legal & General International Index (GB00BG0QP604)	4,978	0.4
Legal & General Future World ESG Developed Index (GB00BMFXWS95)	4,915	0.4
Lindsell Train Global Equity (IE00B644PG05)	4,735	0.38
FSSA Asia Focus (GB00BWNGXJ86)	4,680	0.38
Fidelity Enhanced Income (GB00BYSYZP12)	4,460	0.36
Trojan Global Equity (GB00B0ZJ0230)	4,343	0.35
HL Select UK Growth Shares (GB00BD5M6140)	4,314	0.35
CT American (GB00B6WD1G18)	4,311	0.35
Jupiter Monthly Alternative Income (GB00B4M78461)	4,265	0.35
Liontrust Sustainable Future Global Growth (GB0030030067)	4,195	0.34
CT UK Monthly Income (GB00B8BV4509)	4,192	0.34
Man GLG High Yield Opportunities (GB00BJK3W271)	4,105	0.33
Janus Henderson Global Real Estate Equity Income (IE00B95B5D80)	4,086	0.33
IFSL Marlborough Multi Cap Income (GB00B908BY75)	4,047	0.33
Jupiter Merian North American Equity (GB00B1XG9G04)	3,739	0.3
LF Lindsell Train UK Equity (GB00BJFLM263)	3,563	0.29
Invesco Global Emerging Markets (GB00BJ04FQ53)	3,503	0.28
First Sentier Global Property Securities (GB00B1F76P93)	3,436	0.28
Fidelity America (LU1064925735)	2,978	0.24
Legal & General Active Global High Yield Bond (GB00B0CNHH27)	2,640	0.21
Aviva (AV.)	2,619	0.21
Legal & General Global Technology Index (GB00B0CNH163)	2,341	0.19
UBS Global Enhanced Equity Income Sustainable (GB00BL0RSP87)	1,696	0.14
Phoenix (PHNX)	1,665	0.13
Total	1,235,826

*Don’s Isa is invested in 88 Energy (88E), Bango (BGO), CT American (GB00B6WD1G18), Fundsmith Equity, Jupiter Merian North American Equity (GB00B1XG9G04), Legal & General International Index (GB00BG0QP596), Nanoco (NANO), Schroder Monthly Income (GB00B66FVB83) and Schroder US Equity Income Maximiser (GB00BYP25698).

**His wife’s Isa is invested in Baillie Gifford Global Alpha Growth (GB00B61DJ021), CT American, Fundsmith Equity, Jupiter Merian North American Equity, Legal & General Global Technology Index (GB00B0CNH163), LF Lindsell Train UK Equity (GB00BJFLM263) and Schroder US Equity Income Maximiser.

***Don’s general investment account is invested in CT American, Fidelity Global Technology (LU1033663649), Fundsmith Equity, Fundsmith Sustainable Equity (GB00BF0V6Q57) and Schroder US Equity Income Maximiser.

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS’ CIRCUMSTANCES.

Zoe Brett, senior technical consultant at EQ Investors, says:

Assuming you have accrued sufficient state pension entitlement, your regular expenditure of £13,300 will be covered by inflation-proofed, secured income when you reach state pension age. You should both obtain state pension forecasts and if there is any shortfall, assess the viability of making additional National Insurance contributions to maximise your state pension entitlements.

Annuity rates are currently generous and unlikely to remain at these levels in the long term. So if you want to purchase an annuity, now would be a good time to do so. However, annuity rates alone should not be the deciding factor.

Locking your drawdown assets into an annuity will result in you paying more income tax than necessary as you will receive a specific level of income rather than managing the tax payable by drawing for your needs. Locking the Sipp assets into an annuity would also mean that you can’t make lump sum withdrawals from your Sipp, for example, for larger expenditure.

You could take advantage of the high annuity rates by purchasing a temporary annuity to provide a secured, inflation-proofed income to cover your income needs between now and state pension age. This would ensure that you do not lock all your Sipp into an annuity and you could choose an income to match your expenditure requirements.

We would review the amount you are drawing from the Sipp to ensure that it is in line with what you need so are not unnecessarily depleting your fund, particularly in times of market volatility, and paying more tax than necessary. It may be better to cease withdrawals altogether given your other income and withdrawable assets – at least until the market is providing a higher and stable rate of return in line with your growth objectives.

If you pre-decease your wife her state pension, when she starts to receive it, and small income from her former workplace pension would cover the bulk of her regular expenditure needs. She would also have the income from the property abroad as well as assets inherited from you, so we do not foresee financial hardship based on your current requirements.

Your Sipp could cover the mortgage repayment in part or full, however any withdrawal from the Sipp would be taxed at your marginal rate. Repaying the mortgage with a blend of assets over multiple tax years and using the various tax allowances in both your names may make more sense. Also factor repayment of the euro mortgage, loan and credit card into this strategy.

You could use any excess income and withdrawals from less tax-efficient products to build up a pension for your wife, and use your respective Isa allowances. This would help to manage tax in the future and retain more of your wealth.

Your overall invested assets are too high-risk for your medium risk appetite. And the reduction of your bond fund holdings has exacerbated this issue. You both should complete risk profile questionnaires to assess the suitability of your portfolios. It is important to consider tolerance, capacity for investment risk and the investment time period. We suggest having a diversified portfolio in line with your risk profile and objectives.

You have sufficient cash as an emergency fund for the time being. When the market has recovered, review the cash holdings and ensure that you have cash worth two years’ expenditure set aside. This is generally a good idea for people who live off assets rather than income derived from earnings. Although you have income from the property abroad, rental income can become unstable at short notice.  

We would use cash flow modelling to estimate your financial health over your lifetimes and how likely you are to meet your financial goals. Review your goals at least annually or more frequently if your circumstances change.

 

Shelley McCarthy, managing director and chartered financial planner at Informed Choice, says:

A cash flow forecast and financial plan would help you understand how sustainable your income requirements are and the level of risk that you need to take. They would also help you to understand the risk you are taking in terms of the sustainability of future income, against the option of purchasing an annuity. And a cash flow forecast and financial plan would help [to assess] your wife’s financial situation if you died before her and whether an income of around £23,000 from your pension would be sufficient.

Since your initial enquiry, annuity rates have dropped slightly, but are still significantly higher than they have been over the past few years. Whether you buy an annuity really depends on what you want to achieve. If you would like a guaranteed income for life, this absolutely makes sense. If you would like flexibility in terms of the income you are taking, potentially better death benefits and are comfortable with investment risk, continuing with drawdown may be appropriate.

There are also potential compromises, such as using a proportion of your fund to purchase an annuity, based on income requirements, or using a fixed-term or hybrid annuity solution.

When purchasing an annuity, you need to consider a number of factors, such as the level of spouses’ pension included and whether you include any indexation. The figure you have quoted is based on a level annuity, so the value of this will erode over time with inflation. Also, generating such a high level of income would take you into the higher-rate tax bracket, meaning that you would pay 40 per cent tax on some of that income. The tax burden could increase further when you start to receive your state pension.

You mentioned contributing to your wife’s pension. However, if she has no earned income, as rental income is not pensionable, she is limited to a gross contribution of £3,600 per tax year, although can continue to contribute to her pension until age 75. And this would not be offset against your tax bill.

You have not said in whose name the overseas property is held, but it may be worth moving this into your wife’s name [if it is not already] so that the income is assessed against her and she can offset it against her annual personal allowance [for income tax which is currently £12,570] and reduce your overall tax bill. 

Consider how you are going to repay the interest-only mortgages. Generating additional income could assist with making overpayments and reducing the balance. However, some of that may be offset by likely higher interest rates when you remortgage later this year.

As over half of your own portfolio is held as cash, reviewing how you are invested is important. If you maintain this level of cash your chances of maintaining your selected income level throughout retirement will deplete.

Also, focus on time in the market rather than timing the market. When drawing an income from a portfolio, I suggest first drawing from cash, perhaps keeping as much as three years’ worth of withdrawals in cash. This is to avoid having to make withdrawals at an inopportune time, for example, a market crash.

You also need to regularly review your rate of withdrawal and continue to test the robustness of your portfolio to maintain the rate of withdrawal.