Tideway DB Transfer Case Study 2

Taking a transfer to create more cash and income in the early years of retirement

By James Baxter, September 2019


Most of us are entitled to a state pension and as a couple who have both worked and paid national insurance contributions you could anticipate as much as £17,600 p.a., although for those still in the 50’s these won’t be paid until age 67. There is a helpful website that allows you to find out how much your state pension will be and when it will be paid here: www.gov.uk/check-state-pension.

For some who take defined benefit transfers in their mid 50’s the transfer can provide both a bigger tax-free cash sum and higher income (than the scheme pension) in the early years, with flexibility to reduce it later in life. This allows them to smooth out their income to include the state pensions, sometimes called ‘bridging’ to the state pension age.

Mark, a Tideway client who transferred with us in 2016, is doing just that. Whilst the figures and situation described below are completely real, Mark is not his real name.

The key facts of the transfer decision

Mark was 55 when Tideway advised him to transfer and had done a considerable amount of analysis on the transfer offer on his own and talked to several financial advisers before he engaged with Tideway for advice. He was working shift work as an engineer at the time and was keen to take a career break having worked for the same employer for 35 years. A divorce had made a big dent in his net worth and a pension sharing order meant his pension entitlement had been roughly halved. He had outstanding debts of approximately £150,000 including a mortgage, credit cards and a car loan.

The normal retirement age for Mark’s scheme was age 60 and in 2016 the scheme told Mark his age 55 starting pension would be either £27,865 per year with no lump sum, or £21,626 pension with a maximum £152,417 lump sum. His employer had offered a transfer value of £1,202,103 and he had also obtained fixed protection against the reducing lifetime allowance at £1.25m.

We recommended that Mark transferred the full £1,202,103 to an AJ Bell SIPP and, using the fixed protection, take the 25% tax free cash sum of £300,526. The remainder of his transfer value (after all initial fees), was invested in Tideway’s Stable Return 2 portfolio, one of our more cautious portfolios, which forecasts a return of inflation plus 1.5% p.a. after all fees.

Our advice allowed Mark to wait until the new tax year to avoid higher rate tax on any pension withdrawals and then from April 2017 he started a monthly income. He is currently drawing a pension of £42,000 a year, some £20,000 a year more than the scheme pension he gave up.

Why we recommended the transfer

Here are the key reasons why we were happy to recommend the transfer:

  • We understood Mark’s objectives and could see how he would really benefit from a capital injection as well as a pension and the transfer we recommended also offered almost £150,000 of extra tax-free cash. This gave him the ability to be debt free and have a decent capital cushion invested outside of the pension.
  • The scheme pension at 55 after taking the cash sum would not have met his lifestyle needs at that time and would have meant he would need to immediately go back to work. With the assistance of Tideway’s ongoing financial planning, the option to have higher income in the early years via the transfer route gave him a realistic option of retiring early at 55 with the flexibility to go back to work if he wanted to later.
  • Importantly, he was able to understand the transaction, be comfortable with the risks he was taking and understood the trade-off he was making between higher cash and income in his 50’s and 60’s potentially at the expense of longer-term guaranteed income post age 70. He expected his income needs to drop in his 70’s.
  • Based on his own circumstances, he had a very generous offer. We calculated that with a forward scheme pension inflation assumption of 2.5% he would need a return net fees of just 3% per year on average to sustain equivalent income payments equivalent to the scheme’s age 55 pension to beyond age 90.

How has it worked out?

From recent reviews with Mark we know he is delighted with his transfer decision. He knows it was the only viable route to making the career change that he wanted. He did not work for the first couple of years but is now consulting on a part time basis keeping his overall income within the £50,000 p.a. higher rate tax threshold.

His fund has made just shy of 4% per year invested on a cautious basis making an overall profit of £108,000 some £20,000 more than the income he has drawn to date and leaving him with a balance of £922,000 invested in his SIPP. He plans to keep withdrawals at this level for a few more years but, with ongoing advice from Tideway, will reduce them in future as he gets in to his 60’s and his and his wife’s state pensions start.

Mark has had some health issues since stopping full time work, which have made him even more focused to enjoy the early part of his retirement.

How we would assess his position

Mark has been drawing more income from his SIPP than the scheme pension would have paid but for almost one full year less due to him waiting for the new tax year before commencing any income withdrawals. However, our own calculations show that Mark has received almost the same overall taxable income at approximately £88,000 from his SIPP as he would from the scheme, although from here on he will be getting almost £20,000 gross, £18,000 p.a. net of tax more.

Avoiding having the pension paid in his last year of working when he was a higher rate tax payer saved around £5,000 of tax.

The higher tax-free cash sum combined with this means he is some £155,000 in cash to the good. The investment returns on the extra £150,000 of tax-free cash sum invested outside the pension have achieved 4% p.a. resulting in an additional £18,000. So, in hard cash terms after tax he is around £168,000 ahead of the scheme benefits at this point. Assuming he maintains these drawings at £42,000 per year he will be a further £98,000 ahead in cash terms by the time his and his wife’s state pension starts when they are 67. Dropping the withdrawals by £16,000 at this point will coincidentally bring them roughly in line with the scheme pension, but at this stage Mark will be some £250,000 ahead in cash terms. This is about 12 years’ worth of the scheme pension surrendered after tax, or 17 years’ worth of the widow’s pension that would have been payable.

Putting these returns into our drawdown calculator, £42,000 from now to age 68 and then £28,000 from then on, we get the following projection for the drawdown account balance using real return assumptions after all fees of 1% (Scenario 1) and 2% (Scenario 2).

This is something we can keep under review from year to year and Mark fully understands that if investment returns fall below these levels the account would run down more quickly. Mark fully expects his core spending needs to fall as he moves into his 70’s and in the meantime is enjoying significantly higher income, with debts repaid and a capital reserve.

Investment risks looking forward

Of course, to achieve positive real returns today after fees it's essential to take some investment risk.

With 20-year gilt yields only offering a 1% return the ‘risk free’ return would be no return at all; it would be negative after fees.
To manage the risks, we take several steps:

  1. The portfolio is invested via collective funds so that it gets invested in hundreds of individual securities and would not be damaged by the demise of any one company.
  2. We invest for income as well as growth, so that there is always some cash being created every year to cover withdrawals.
  3. We invest in a range of strategies including short dated bond funds which would be very resilient in any market correction, and these can be cashed in separately from the more volatile funds, so that our clients should never be forced sellers of investments at a loss in down markets. The more volatile investments can then be held for the long term to get the best returns.

Mark’s Stable Return 2 portfolio

The portfolio creates natural income each year of 3% a year forecast to be about £27,600 in the next 12 months after all costs. As Mark’s withdrawals exceed this by £14,400 this amount needs to come out of capital each year.

Mark's asset allocation

Mark holds 35% of his portfolio in cash and short dated bond funds around £322,000 in total so based on his current drawings there is enough in the low volatile funds to cover capital encashments for around 20 years. This level of funds in short dated bonds or cash could be a real drag on the performance of the portfolio, however we use Tideway’s GBP Credit fund which invests in short dated hybrid capital bonds and has made 3.8% p.a. compound after fees over the last 3 years (according to FE Analytics 17th September 2019). Allowing for the SIPP costs and Tideway’s wealth management fee this is still a positive real return above inflation from a very low risk investment.

Further information

To find out more about Mark’s experience please do contact one of our advisers on:

Tel: 020 3143 6100
Email: info@tidewayinvestment.co.uk

Important considerations

  • Defined benefit transfers are complex, risky and always irreversible transactions. They will not be suitable for many DB pension holders.
  • The information here should not be construed as advice to transfer but rather an illustrative example as to what can be achieved in a transfer and under what circumstances a transfer can be considered suitable advice.
  • Investment returns post transfer are not guaranteed, and your capital is at risk in a Stable Return 2 portfolio managed by Tideway.
  • Past returns are no guide to future returns.
  • We would always recommend that you review your investments regularly with a qualified financial adviser to ensure your needs and objectives are maintained.
  • There is a legal requirement to seek advice from a properly qualified adviser and appropriately authorised firm if a transfer value is greater than £30,000.

Tideway Investment Group comprises the following entities: Tideway Investment Partners LLP and Tideway Wealth Management Limited. Tideway Wealth Management Limited is an appointed representative of Tideway Investment Partners LLP, which is authorised and regulated by the Financial Conduct Authority. FCA number: 496214.

Tideway Wealth Management Ltd
107 Leadenhall Street
London EC3A 4AF

+44 (0)20 3143 6100

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