Reply to: How much money do you need to retire

[IR35 Avoider]

Surely it's not the same type of annuity which is required for your comparison, it's an annuity on the same terms.

So with the pension:- 25% tax free cash, balance into a CPA of whatever requirements in terms of escalating guarantees etc.

With the ISA - 25% as cash, balance into a voluntary annuity on the same basis.

The question then becomes "what is the return on a voluntary annuity compared with the CPA". The voluntary annuity has pretty much the same rate as a CPA but much less of it is taxable of course - since a good chunk of it is return of capital.

Would this be enough to put the ISA route ahead? I have no idea but for a standard rate taxpayer it seems possible.

I think purchased-life annuities are caculated on the basis of less-favourable mortality tables than compulsory ones, that's why I stressed that it had to be the same type of annuity.

Having looked around the web for info. on self-directed annuities, I am unable to locate the information for any products, not even the two I found there a year or two ago when I last looked. Merchant Investors, for example, now publish bugger-all information online, you now have to go to through an IFA just to find out what products they offer. So in practise, for someone whose objection to an annuity is not being able to control their investments after the annuity stage is entered, I can't prove my case at the moment.

I seem to recall that the Prudential product (which allowed investment in funds but not individual shares) had a product charge of something like 0.75% a year, in addition to any fund management charges, so we could use that as a basis for discussion. For someone who is a basic-rate payer when contributing, this extra charge in the annuity stage might be enough to more than offset the bigger tax benefits available from a pension compared to an ISA.In fact, doing a crude calculation, I think it does. The extra tax-relief on a pension that comes from the 25% lump sum is worth 5% of the final capital (25% of 20% basic rate tax.) For the Prudential product, assuming an annuity bought at 75, 15 year life expectancy, 75% of capital invested, the extra charges total 15*0.75%*75%=8.4%. So for a basic-rate contributor who wants to self-invest after age 75, I'll concede for the time being that the ISA route is better. This is only true based on currently available products and their associated charges though. I would hope by 30 years time when it will matter to me, that more competitive self-invested annuity products will be available.

[expat]

Hmmm.... don't think it's a foolproof though, according to digital look Northern Crock shares are currently yielding 40% but I can't imagine there would be many takers for those !

HYP author Stephen Bland might be one

Many newcomers to investing are shocked by the events and collapse in Northern's price.

But where was it written that shares don't carry risk and that very occasionally even a major share like Northern will plunge dramatically due to some highly adverse events, maybe go bust completely? Good returns over the years may have blinded the naïve to this potential but it is always lurking there in the background. Diversification and strategic ignorance are the tools to combat it for High Yield Portfolio investors. Long run, an HYP can easily survive a share going completely out of business and still do well notwithstanding the failure.

...

Stephen holds shares in Northern Rock

[ChimpMaster]

My "semi retire at 45" plan was all going quite nicely until my builder told me last night our new extension was going to cost £100K.

Wait a few years - soon the whole house will only be worth £100k.

[moorfield]

My "semi retire at 45" plan was all going quite nicely until my builder told me last night our new extension was going to cost £100K.

[ASB]

I leave aside the tricky question of how you buy the same type of annuity with each - may not be easy.

Surely it's not the same type of annuity which is required for your comparison, it's an annuity on the same terms.

So with the pension:- 25% tax free cash, balance into a CPA of whatever requirements in terms of escalating guarantees etc.

With the ISA - 25% as cash, balance into a voluntary annuity on the same basis.

The question then becomes "what is the return on a voluntary annuity compared with the CPA". The voluntary annuity has pretty much the same rate as a CPA but much less of it is taxable of course - since a good chunk of it is return of capital.

Would this be enough to put the ISA route ahead? I have no idea but for a standard rate taxpayer it seems possible.

[IR35 Avoider]

Also the pension wrapper doesnt always beat the ISA wrapper. See http://www.telegraph.co.uk/money/mai...n03.xml&page=1

I've only had time to do a quick scan of the article. They don't explain how they arrive at their figures. I suspect they assumed different paths for what to do with the money after retirement, so that they weren't comparing like with like.

Briefly, up to the point of buying the annuity, pensions beat ISA because of the 25% tax free allowance. At that point, to ensure fairness of comparison, you must buy the same type of annuity with both; since the pension has yielded more capital, it will buy a bigger annuity.

I leave aside the tricky question of how you buy the same type of annuity with each - may not be easy. You need to assume you can put three quarters of the ISA money into a pension at that point. No doubt someone will argue that the fact you don't have to buy an annuity with the ISA is the whole point. That doesn't get you anywhere. In a scenario where the ISA money doesn't go into an annuity; once you risk-adjust, charge-adjust and tax-adjust the differing returns from that point the pension must still win, because there was more capital to start with.

A legitimate way to prove me wrong would be to show that higher charges are unavoidable during the annuity stage of the pension route, and that these outweigh the tax advantages.

[wantacontract]

I am thinking:

House paid off
Car Paid off
£20k per year for me
£12k per year for wife

Retire at 45-48........

bit lamo this last comment, but hoping to inherit some decent money from mom and dad.....

something which i would have never thought about when i was younger and full of pride.....

[moorfield]

I think only you yourself can figure out how much
See http://www.fool.co.uk/Investing/guid...Portfolio.aspx for more info on the HYP approach.

Hmmm.... don't think it's a foolproof though, according to digital look Northern Crock shares are currently yielding 40% but I can't imagine there would be many takers for those !

[electronicfur]

A pension is just a wrapper for any investment portfolio that carries with it certain advantages and disadvantages. It is easily the best for minimising tax (it beats ISAs even for people who are basic-rate taxpayers all their lives)

Well I used the term traditional pension as that is the most common pension arrangement, within the pension wrapper; whilst the most common HYP arrangement is outside the pension wrapper.

I'm not sure how good a HYP within a SIPP would be. The fact you are forced to buy an annuity means the capital of your pension pot is important and the HYP strategy concentrates on growing income, rather than capital.

Also the pension wrapper doesnt always beat the ISA wrapper. See http://www.telegraph.co.uk/money/mai...n03.xml&page=1

[IR35 Avoider]

I have personally been building up a HYP, High Yield Portfolio, instead of a traditional pension

Just me being pedantic, but a pension and HYP (or any other form of investment) aren't alternatives to each other. A pension is just a wrapper for any investment portfolio that carries with it certain advantages and disadvantages. It is easily the best for minimising tax (it beats ISAs even for people who are basic-rate taxpayers all their lives) but it means you can't get the money until you're old and you will be forced to take three-quarters of it as an annual income during your lifetime.

I think you could run a HYP within a pension to age 100 or whatever you live to, though from age 75 it would have to be switched into and run within a self-directed investment-linked annuity. (Not sure if there's more than one company offering complete freedom to invest in shares in this type of annuity, so you might not have a lot of choice over the charges you pay. Most interesting products of this kind I've come across were from Merchant Investors and Prudential, but the I think the Prudential one only allowed you to invest in funds.)

[Lockhouse]

One thing I still need to investigate at the moment is what it means if the company HYP is earning income and I am out of contract for a period. Will the company get classed as an investment company?

If out for a "long" period. Yes. The usual HMRC subjectivity rules apply.

[electronicfur]

I think only you yourself can figure out how much you annual income you need to retire on, as everyone is different.

I have personally been building up a HYP, High Yield Portfolio, instead of a traditional pension. Used the yearly ISA allowance, and then any extra outside.

See http://www.fool.co.uk/Investing/guid...Portfolio.aspx for more info on the HYP approach.

The advantage of the approach for me is that after the initial share pick it doesnt require a lot of time, and it's aim is to build up an annual income that rises at more than the rate of inflation. Additionally it means I'm not restricted by government pension rules, dont have to worry about what they will do to those pension rules in the future. Also I can access my money when I want, and don't need to buy an annuity with it when I do choose to retire, but can just live off the annual income, keeping the capital intact.

Now that I am contracting I am considering building up the HYP within the company. One thing I still need to investigate at the moment is what it means if the company HYP is earning income and I am out of contract for a period. Will the company get classed as an investment company?

Cheers,
EF

[IR35 Avoider]

but what seems like a lot of money now will seem like peanuts in 20 years. The problem is it isn't just inflation, average salaries rise quite a bit faster than inflation

This is a very good point, something that I only came across for the first time over Christmas.

Happiness (to the extent it is generated by money) depends mostly on your earnings relative to your peer group. You need to be able to afford the things they can. If like me you're planning to be retired 40-50 years, you have no way of knowing what future goods and services you're going to want. If I'd retired in 1960 in Britain I wouldn't have anticipated satellite TV, car ownership, double-glazing, central heating, mobile phones, foreign holidays, internet and dental implants might be essential in my future.

For a long retirement, you need to plan to keep up with the annual growth in employment earnings, not just the rate of inflation.

[IR35 Avoider]

The house you live in is not an asset - it is a cost center. As asset is that which produces income after costs have been taken out. Having your own house may be a necessity, but it is not an asset I would put towards my cashflow projections, because I will not be selling it or renting it out for income.

Eh? All I was saying is that you would have to pay for your house, out of money you earn.

I think I know which writer you got that idea from - I can see the point he was making, strictly speaking he's wrong, but as a way of thinking about things to prevent people kidding themselves into overspending I guess it might be useful.

I try to spend as little as possible now - with the support of my wife. I probably go through about £20k a year on everything ex-tax (bills etc right down to eating out and holidays). Like I said, £5k is the upper target, and it would be nice to have it. £3k is likely and will do for the interim. You have to aim high.

If I count the mortgage I spend about 22K a year before holidays, subtract the mortgage (which I treat as negative invesment income rather than an expense) and the extra car costs that come from commuting, add in holidays, and I hit 15K. If your 20K include mortgage/rent then we're not so different. I wonder why you think you need up to three times as much money if that's what you live on at the moment?

You need to consider the effect of compounding in your calculations.

I did. It would take you a lot longer, or you'd have to save a lot more, without compounding, or if the investment return were lower.

In addition, look at the option of re-investing positive cashflow from one asset into another one. For example, imagine you had 2 BTL properties, with 1 completely mortgage-free due to your hard work. You could use the rental income from that house to pay off the mortgage on the other one, in addition to your own payments. Continue onto next property or into another asset class. Long term, this works great.

This doesn't make any difference to the calculations. I assumed all investment income was reinvested anyway, and I assumed you made the maximum return you can reasonably count on.

there was a time when I also thought that £15,000 was enough.

My £20,000 target for income will theoretically have to be upped if children arrive. I say theoretically, because I've only been talking about my own finances. In practise my position is better than I have described, because the wife works, and contributes, and saves, and I haven't counted her contribution/savings/income from savings as part of my figures.

[ASB]

I don't think this is any more tax efficient than a pension - in fact it is considerably worse.

If you keep the money in the company you will have already paid 22% Corporation Tax.

If you make company contributions to a pension you avoid the 22% CT, plus at retirement you can take 25% of your pension fund as a lump sum tax free.

Also consider that dividend distributions in your retirement will have a 10% tax credit which effectively reduces the higher rate threshold.

If you have a strong dislike to pensions for some reason then your idea could be worth persuing. I just don't see it being the most tax efficient route though.

I'm not sure it is necessarily considerably worse. Provided you keep under the higher rate threshold when extracting the dividends then there will - currently - be no further tax to pay on them.

If the contributions are paid into a pension fund then 75% of them are taxable at the basic rate when benefits are paid out. This is not necessarily a huge difference overall. Also this tends to get towards the forced annuity route.

Thus there may be more flexibility with retaining the cash in the company and retirement relief etc. could swing the tax balance. But there are risks too. Being classed as an investment company and getting taxed at the full CT rate, changes to the taxation of dividends, changes to retirement relief etc. It seems to me likely that the regime will get less charitable in this area.

From a simple view of max pension per source pound personal contributions probably just beat company contributions in most cases. But flexibility of use of the fund becomes an issue.