Pension prescriptions: from 20 to 80 - how to maximise returns

Retirement experts suggest retirement planning strategies to meet the needs of investors in a range of circumstances.

The pension landscape has changed dramatically in recent years. Not only are retirees no longer obliged to buy an annuity thanks to the new freedoms that have given retirees unfettered access to their money, but the introduction of auto-enrolment legislation means millions of workers have been pushed into saving towards their retirement.

But with those changes have come much greater responsibilities for individuals, and a growing number of options for them to choose between. For instance, those at retirement now need to select the best option for them from a range of ways to manage their pension pot, while younger savers wanting to buy a first home are being offered a new 'two in one' Lifetime Isa that could double as a pension.

Whatever your pension situation, it will pay in the long run to take control of your own destiny, which may involve seeking expert financial advice. But the process can be a pretty confusing one, so we have asked financial advisers and planners to share some of the common pension problems they come across.


...trying to fund both a pension and a house purchase

This is a predicament millions in their 20s and 30s find themselves in. Naturally, for many, saving towards a house deposit will be the priority. But advisers caution that getting onto the property ladder should not be at the expense of efforts to fund your retirement.

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Rebecca Taylor, a certified financial planner at Aurea Financial Planning, says it makes no sense to turn down 'free money' on offer from the government via top-ups into the Help to Buy Isa or Lifetime Isa. The latter is due to be launched next April.

With the Help to Buy Isa, first-time buyers pocket a bonus of £50 for every £200 they save each month. An initial £1,000 can also be put in, attracting a bonus of £250.

Don't panic! Your Help to Buy Isa is not useless!

The Lifetime Isa scheme will offer a bonus of £1 for every £4 invested, and the maximum that can be put into the Isa each year is £4,000. The maximum annual bonus on the Lifetime Isa is therefore slightly higher at £1,000 versus £850 for the Help to Buy Isa.

Both the Help to Buy Isa and the Lifetime Isa accounts work in the same way as cash Isa accounts, and the Lifetime Isa can also be used to invest in stocks and shares. But Taylor says wannabe homeowners setting money aside each month towards a deposit should avoid the stock market.

Lifetime Isa versus Help to Buy Isa: which is best?

'The idea of saving hard to get onto the property ladder is short term and it is a very high-risk strategy to consider investing into volatile investments for anything less than at least five years,' she says.

Taylor adds that the stock market route should only be used by those who are using the Lifetime Isa as a supplementary pension vehicle, rather than for a house purchase.

But, on the whole, those with access to a workplace pension should stick with it in preference to a Lisa, thanks to the valuable employer contributions and tax relief from the government.

However, it's worth selecting a fund yourself rather than relying on the default option. Some advisers, including Lee Robertson of wealth manager Investment Quorum, suggest an allocation of 100 per cent to equities for young savers who have just started paying money into a company pension.

The theory is that savers are well-placed to ride the ups and downs of stock markets because they do not need to draw on the money for a long time.

A global equity fund, which spreads its bets far and wide, is viewed as a sensible place to start. Examples that may fit the bill include Money Observer Rated Funds Fundsmith Equity or Artemis Global Income.

Others advisers, however, prefer some bond exposure to help protect against stock market slides. Taylor says: 'An 80 per cent equity and 20 per cent bond split has great opportunity for long-term growth, providing just enough diversification to help when the markets crash.'

She adds that retirement provision at this stage should be kept simple and low-cost. One option is Vanguard's LifeStrategy 80% fund, which has an ongoing charge of 0.24 per cent.


...trying to work out how much they'll need to save

When it comes to saving towards retirement, the wonders of compound interest means it really does pay to tuck away savings as early as possible. But for late starters it is time to go back to the drawing board and self-audit, says Robertson.

'In practice this means looking at the entirety of what you spend each month and cutting back on unnecessary discretionary spending. Clients are always surprised that they can save a couple of hundred quid a month, which can then be put into their pension,' he says.

To be more scientific about your planning, Taylor suggests calculating your pension 'gap'. To do this, jot down how much you have in any pension provisions already in place (for example final salary pensions from previous jobs), and in savings (deducting an amount for emergency funds - three to six months' salary in cash).

Add up the value of any pension funds and savings, and then calculate the likely income they'll produce: she suggests using a figure of 3.5 per cent to give an annualised return that can be achieved as income.

'The difference between your estimated retirement outgoings (which typically don't involve costs such as monthly mortgage payments) and income from these various sources plus the state pension is the pension "gap" that you need to fund,' says Taylor.

'A word of warning here: many people will think that 3.5 per cent is a conservative figure, but I disagree: it assumes you are happy to draw down on capital over time, while inflation also needs to be taken into account.'

'Once the shortfall is known, an action plan needs to be put together to start to fund it. Again, we need to work backwards, starting with the annual income needed, then convert this to a capital sum.

'If we use the same rate as above and, for example, there is an annual income gap of £3,500, then we need to save investments valued at £100,000 to fund this.'

How this is invested will ultimately depend on the level of risk an investor is willing to take. But bearing in mind that retirement is generally two decades or longer, Taylor suggests 50 per cent in equities and 50 per cent in bonds for someone who is 'medium risk'.

Robertson, however, thinks the equity weighting for most people should be much higher. 'With the pension freedoms there should no longer be the mindset of a retirement date, unless you are buying an annuity.

'Instead, if you are 20 years away from retirement, you need to be thinking about the next 40 years and have a portfolio that reflects that timeframe.'


...approaching retirement and wanting to avoid volatility

Volatility is part and parcel of stock markets, and is the price investors pay for the fact that over the long term shares tend to outperform cash.

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But there are various ways to reduce risk. Multi-asset funds and absolute return funds, for example, are designed with the aim of offering a smoother ride in exchange for offering more conservative returns.

Unfortunately, many absolute return funds have failed to deliver on their promises over the years. Henderson UK Absolute Return, Threadneedle UK Absolute Alpha and Newton Real Return are viewed as among the best of the bunch.

Ultimately, though, it is diversification that reduces risk. It makes sense for most investors to invest in a wide range of assets, shares, bonds and property, as well as a small weighting in 'safe haven' alternatives such as gold and infrastructure.

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Rebalancing, which involves selling investments that have performed well, also helps reduce risk.

Joe Sanders, a chartered financial planner at Informed Financial Planning, says risk-averse savers near retirement who are content with their pot size could in theory move to cash.

But he adds that this is not a wise move, as 'over the next 20 years inflation could be more dangerous than market volatility for those who choose cash over investment risk'.

For many at retirement, advisers recommend mixing and matching between an annuity and drawdown. The secure lifetime income from an annuity plus the state pension can be used to fund your basic income requirements, covering bills and everyday living expenses.

However, to adopt this strategy your pension pot will need to be in excess of £100,000, advisers say.


...keen to leave a legacy for their children

Given that retirement is often 20 years plus, you might assume that retirees keen to leave a legacy for their children would be prepared to speculate in order to try and accumulate a bigger pot to pass on.

But Sanders says that judging by his experience with retirees, the main focus is 'beating inflation' and avoiding inheritance tax.

'Thanks to new rules brought in a couple of years ago, it is now much easier to pass a defined contribution pension pot down the bloodline. Heirs now just pay income tax at their marginal rate when the money is withdrawn,' says Sanders.

Moreover, even that only applies when the person from whom they are inheriting the money was over the age of 75. For deaths before the age of 75 there is no tax to pay.

Therefore, for those in the position of being able to draw on other assets, the pension pot should be the last thing to touch, as defined contribution pensions can be passed on to any named beneficiary, including children.

However, this does not apply to those in defined benefit or final salary schemes, which can only be inherited by a dependant. This has led growing numbers of defined benefit scheme members to consider cashing in their annual income for a lump sum.

This is a difficult decision, as the benefits are usually generous. Sanders notes that for many, this guaranteed income is essential, because they do not have other resources to rely on in retirement and it may be needed to pay for care fees.

But for those who have other assets to help generate retirement income, transferring may prove worthwhile for inheritance tax planning purposes.

'A spousal income is built into most defined benefit schemes. Typically a spouse would inherit 50 per cent of the member's income. Some defined benefit schemes also offer a legacy income to dependent children.

'For some this is a valuable option, but it could potentially be a poor return compared to inheriting a lump sum from a defined contribution scheme - a tax-efficient way of leaving a legacy,' says Sanders.

'The death benefits of a defined benefit scheme are extremely rigid, and if a client is not married and has no financially dependant children, the fund may die with them. If they want someone else to inherit their fund, I usually advise them to move it into a defined contribution scheme.'


One of the biggest dilemmas for retirees who decide against buying an annuity is establishing how much income to withdraw each year in order to avoid the nightmare scenario of eventually finding the retirement cupboard bare.

Most financial advisers stress that a maximum withdrawal rate of 4 per cent is sensible, and that it's preferable for retirees to draw only the income produced by the pension investments (the natural yield), rather than stripping away capital.

But recent research by Morningstar concluded the 'safe withdrawal rate' for UK pension savers is lower, at 2.5 per cent.

Morningstar's premise is that over any 30-year period the income payments will always be met, increasing in line with inflation. The overall capital value may fall, rise or remain intact, depending on market conditions, but it will last those 30 years.

Morningstar's study is notably more conservative than other academic research that has been carried out on the same subject.

For example, William Bengen, a former financial planner, carried out the same calculations two decades ago, but instead used a portfolio of 50 per cent in US shares and 50 per cent in US government bonds. Bengen's research found the safe withdrawal rate was 4 per cent.

But Dan Kemp, co-author of Morningstar's report, says that for British retirees a safe withdrawal rate of 4 per cent is unrealistic, for several reasons.

'In the current environment of low yields and high asset prices, clients and their advisers need to set realistic return expectations.

'The generous investment returns of the last century that supported a comfortable and long-lasting retirement portfolio for previous generations of retirees are no longer with us,' says Kemp.

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