After more than 30 years selecting investment funds and shares and assembling specimen portfolios as a journalist, Heather Connon looks to select 10 funds for her own pension in the fourth instalment of her retirement diary.
Regular readers will know I’ve written about my plans to cut back on work and retire early previously in Moneywise.
I worked out that I will have around £550,000 in money purchase pots from three previous employers and considered the different ways I could start drawing down my pension.
The final stage is to decide how much tax-free cash to take and how to invest the balance. Should my retirement fund have any cash in it? What about an exposure to bonds and property? Are emerging and frontier markets too risky for a pension? These are the questions I am grappling with in the final stage of my retirement planning.
No annuity required
I am fortunate as my husband has an index-linked final salary pension scheme from his career as a teacher, which covers our living expenses and means that I do not need certainty of income. It means that I can rule out buying an annuity and can be a bit more adventurous with my choice of investments, rather than buying bonds or other investments with a predictable income.
I think I’ll need about £25,000 a year to live on. I have spent a long time debating whether to take the 25% tax-free cash: although I do not need a lump sum to pay off a mortgage or travel the world, I could use the £130,000 or so this would raise to fund five or six years of living expenses. I could then delay drawing income from my Sipp (self-invested personal pension) until I am closer to state pension age, which could have tax advantages.
Additionally, I will still do some freelance writing and have around £4,000 in income from a rental property, but this combined extra income is likely to be quite low and could well be below the £11,500 personal allowance.
I would invest some of the £130,000 rather than leaving it all in cash, so assuming a very generous return of 5% on the lump sum overall (including both invested funds and cash on deposit), this would produce an income of around £6,500. As far as investments are concerned, the first £5,000 of dividend income this year would be tax-free (although that allowance falls to £2,000 in the next tax year), and tax on the remainder would be at a low rate of 7.5% as I will be a basic-rate taxpayer.
As well as the personal allowance of £11,500 and the personal savings allowance of £1,000 of interest, low income earners also benefit from a 0% ‘starting rate’ of tax on up to £5,000 of savings interest. So if my total taxable income is below £17,500 – which it probably would be – there would be no tax on interest earned by any cash left in the bank. I could also use my Isa allowance to shelter £20,000 of the lump sum, so taken together that means the effective tax rate on this option would be quite low.
In contrast, if I don’t take a lump sum but start drawing down my pension straight away, I would incur income tax at 20% on anything above the £11,500 personal allowance. Financial advisers have also warned that with drawdown, the taxman can take 40% tax on payments, leaving me to claim the excess back when I fill in a tax return.
Taking the lump sum therefore seems the best option – and the remaining fund can carry on growing, assuming a fair wind for financial markets, for another five or six years.
The next issue is asset allocation: how should I spread my fund between equities, bonds, cash and other assets such as property? I looked at the Wealth Management Association website, which has a range of portfolios depending on the amount of risk investors want to take, and at other suggestions for the best spread of assets for those approaching retirement.
Using a model portfolio
While some model portfolios would recommend having a significant portion of a retirement fund in cash and lower-risk assets such as property and bonds, the size of my fund and the fact that I won’t have to depend on it exclusively for income, and that I will not start accessing it for at least fi ve years, means I feel I can be a bit more adventurous.
I will not hold any cash at the moment as the lump sum will give me plenty of liquid funds, although I will consider having a cash buffer when I am finally drawing down on the fund. While I acknowledge the security of income that gilts [government loans] and blue-chip corporate bonds give, I am concerned about their very low yields [the income they pay]and high prices due to the quantitative easing [money printing] programmes and abnormally low interest rates across the world. Likewise, I think that property yields are looking quite stretched at the moment – although equities [shares in companies] too have had a fantastic run.
My instinct has always been more for income than growth funds, even though I will not actually be taking any income from the fund now; I have spent years advising readers that income forms a key part of total returns and, as I will be reinvesting the income for now, I want to make the most of this compounding. Moneywise has a range of model portfolios based on its First 50 Funds for beginner investors (see http://ift.tt/2hGoCA9). But as I don’t consider myself to be a beginner investor, I have instead taken a few investment ideas from Moneywise’s sister magazine Money Observer’s model portfolios. That said, both Moneywise and Money Observer include some of the same funds in their model portfolios.
I want to use mainly investment trusts for a range of reasons: the charges tend to be lower; they can use gearing to boost returns; they can pay dividends out of reserves, which means they can use those reserves to keep income growing even in lean years – something unit trusts and other open-ended funds cannot do; and the charges all Sipp providers levy on investment trust portfolios are lower than those for open-ended ones. Fidelity, where I intend to open my Sipp, caps its charges for investment trust portfolios at just £45 a year.
I will have around £40 0,000 in my fund after taking out my tax-free lump sum, and I plan to invest it in a range of UK and global funds. But while my portfolio will have a majority of equity income funds, I will also have some exposure to property, fixed interest and infrastructure.
Brexit means go global
I have selected 10 funds for the portfolio. Only a fifth (20%) of the portfolio is in UK holdings, as I am worried about the impact of Brexit on the economy and am keen to tap into more global growth potential. Here, I have opted for Mark Barnett’s Edinburgh Investment Trust, a longstanding solid performer, and Invesco Perpetual UK Smaller Companies, chosen because history shows that, over the longer term, smaller companies do better than their bigger counterparts, and this trust has an excellent track record and skilled managers.
I have selected three global funds: the relatively conservative Witan Investment Trust*, where manager Andrew Bell has proved adept at allocating assets between his stable of managers; Scottish Mortgage*, a long-term favourite of mine with a very individual style; and F&C Global Smaller Companies* to add some growth spice.
There will also be a further two regional specialists: Henderson European Focus, as I feel that the European market offers good value at the moment, and Fidelity Asian Values, to get exposure to some of the world’s fastest-growing economies.
There is not a huge choice of fixed income investment trusts, but I am happy to plump for Invesco Perpetual Enhanced Income, run by the formidable team of Paul Causer and Paul Read.
Property is provided by F&C Commercial Property*, and I have also chosen to include 3i Infrastructure – despite its high premium – as I think this is a very attractive asset class.
I can switch funds at any time should any of these falter or other attractive areas crop up, although I do not intend to make frequent changes. When my tax-free lump sum runs out, I will switch to more reliable income producers.
|
Investment trust selection for my Sipp portfolio |
|||
|---|---|---|---|
|
Asset Class |
Trust |
Dividend yield (%) |
Allocation (£) |
|
Asia |
1.16 |
30,000 |
|
|
Europe |
1.87 |
30,000 |
|
|
Fixed income |
6.22 |
30,000 |
|
|
Global |
0.9 |
30,000 |
|
|
Global |
0.7 |
50,000 |
|
|
Global |
1.82 |
60,000 |
|
|
Property |
4.02 |
50,000 |
|
|
Specialist |
4.02 |
40,000 |
|
|
* Denotes Moneywise First 50 Fund for beginner investors. Source: Moneywise via Morningstar, 25 August 2017 |
|||
Heather Connon is a freelance financial journalist who writes for The Guardian, The Observer and The Independent. This article first appeared on our sister website, Money Observer.
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