Maurice is 70-years-old and has finally decided that he wants to stop work. He has a self-invested personal pension (SIPP) fund of £230,000 and would like us to tell him how much income he can afford to take each year.
We start by collecting information about all of his and his wife Olive’s income and expenditure.
Maurice currently receives a state pension and nominal pension from an old employment and Olive receives two small index-linked pensions totalling £3,900 per annum. She will also be entitled to a state pension in her own right in three years’ time.
They also have some investment bonds, one of which is expected to provide inflation-linked income. The others will provide a regular income but it is unlikely to keep pace with inflation.
Maurice and Olive’s current expenditure is around £38,500 p.a. Maurice expects that their current rate of spending will continue for another four to five years, after which it will reduce to £30,000. They would like to take an extended holiday to celebrate his retirement and estimate this will cost around £14,000.
He does not need any further tax-free cash at this stage but we recommend that he withdraws it at age 75, by which time we expect it to be £52,594, to avoid a tax charge in the event of his death. He is happy to do this on the basis that he could use the money to repay some or all of his daughter’s outstanding student loan.
The cashflow model looks at all these sources of income against the stated income requirements. Both Maurice and Olive are in good health and could reasonably be expected to survive for 30 years or more.
We decide, therefore, to create the model until Olive, who is eight years younger than Maurice would reach age 95. The model is discounted for inflation at 5% so that the income in real terms remains steady and fund growth is assumed to outstrip inflation by 2% p.a. in line with his attitude to risk and current portfolio.
The results show that there is a small shortfall in Maurice’s income requirements over the five years that he wants to take higher income, which could be met using direct withdrawals from his SIPP plan1. It also shows that if his bond income is impacted by inflation as expected2 he will eventually need to recommence taking income from his plan at age 78, and that income will have to increase to compensate for the effect of inflation.
More importantly, it shows that this level of income can be maintained if he receives the investment returns he expects.
1 Income shortfall funded by drawdown income from the SIPP (pink)
2 The value of bond income gradually reduces over time as inflation eats into the real value (yellow)
We also note that Maurice could achieve his initial income objectives using an annuity, however, this would not give him the flexibility to stop and start his income as he needs, and avoid having to pay income tax on income that he doesn’t need.
It would also mean that he could not pass the fund on as tax-efficiently to his daughter after his death.
After Maurice begins to take income from his plan we will review it at least once a year to see if it remains on track. After checking whether anything has changed in his personal circumstances we will re-run the cashflow model based on the updated value of his fund.
This tells us whether the fund can continue to support the level of income he requires, or if any changes need to be made to his expectations.
Fiona Tait is technical director at Intelligent Pensions