High earners can feel hemmed in by continued tax raids pension savings, but by thinking outside the box they can find ample tax-efficient routes maximise their retirement savings.
Retirement planning is one of the most challenging elements of managing your wealth, and arguably the most important. How much you should put aside, where to put that money, how much income you can secure – and for how long – are all weighty questions. And of course, while your “accumulation phase” can be well defined, none of us know how long our retirement will last.
With life expectancies climbing ever higher, you could need to fund several decades in retirement. The thought of running out of money in your old age – known as “longevity risk” – hardly bears thinking about. Yet equally, no one wants to stint themselves in what should be their golden years. The need to strike a careful balance therefore makes taking proper financial planning and investment management advice essential.
Here, leading wealth managers from the findaWEALTHMANAGER.com panel offer their insights on how to get serious with your pension planning so that you can make the most of life.
People are living longer and longer nowadays, while the state retirement age keeps rising, meaning that many people will find themselves having to fund a retirement lasting several decades largely independently. Managing your retirement “divestment” phase well so that you have sufficient income to have everything you want or need and yet do not run out of money by living longer than expected (longevity risk) is a careful balancing act where mistakes might be disastrous.
First on your agenda here should be a realistic appraisal of how much money you and your family will need to fund a desirable lifestyle in retirement, making sure to take account of any foreseeable expenses/gifts and changes to your family balance sheet that may have to occur (a common error is to underestimate the associated costs of getting older). Knowing how much money you will need and setting this against a sensible estimate of your lifespan will greatly inform the appropriate investment and tax planning strategy for your retirement funds.
As Nicholas Grant, Investment Manager at Psigma Investment Management, notes, since it is impossible to know exactly how long one will live the only secure income options are the State Pension, a defined benefit scheme or a lifetime annuity. However, since even these in total may not generate the level of income necessary to fund your desired lifestyle most people will need to consider other ways of generating an income from their assets during retirement.
Selling possessions or property, or becoming a landlord are options, but these may not appeal for a number of reasons, not least the reduction of tax benefits for the latter. Nor are simple savings anywhere near as attractive as they once were, meaning that an investment portfolio might be the best way to achieve a long-term income.
Our wealth management experts urge savers to be highly aware of the way that inflation will erode the buying power of their money over time – one of the primary reasons an investment portfolio is likely to be preferable to keeping your assets in cash and a risk that is all too often overlooked if professional advice isn’t taken.
Here Grant says:
A common mistake is to avoid any investment strategy due to the perceived risks and ‘de-risk’ to cash. Although you know where you stand with cash and can roughly estimate how long it would take to spend it, inflation is an important factor.
Inflation can significantly erode future buying power, e.g. £1 in 1970 is worth 7p today, therefore affecting the ability to maintain a decent standard of living in the future. All of this means you need to consider adding in some risk and investing in a strategy that could help you achieve longer-term income from your assets.
While most people will want risk to be tightly managed when it comes to monies as important as retirement funds, there is also such a thing as being too risk averse in clinging to cash, particularly given today’s rock-bottom interest rates.
As Jeremy Greenwood, Relationship Manager at Seven Investment Management, observes:
Making a return on your cash has become harder over the past few years given interest rates have basically hovered around zero. Bank accounts and cash ISAs provide negligible returns.
For example, if you have £25,000 in a typical high street bank ISA and its interest rate remains at 0.01%, even if the investment is over 20 years, it will only grow by £50.05. Meanwhile, the effect of 2% inflation on £25,000 would mean you’re left with spending power of just £16,740.25.
In this light, low or no-risk options for your retirement funds may actually start to look very risky indeed. It is vital to counter the long-term erosion of wealth by aiming for portfolio growth to stay ahead of inflation at least – and that means diversifying out of cash.
While investing in equities or bonds is often (correctly) described as risky and investments in cash won’t fluctuate, this decision will just see you lose money every year,” says Greenwood. “That may not be the ‘stable’ return you were looking for.
There are no guarantees when it comes to investing, but this doesn’t mean you should avoid risky assets as doing so would also mean avoiding returns, adds Artur Baluszynski, Director and Head of Research at Henderson Rowe. Holding a well-constructed investment portfolio is still the best way to achieve your retirement goals. The key is to start as early as possible as the longer the time-horizon, the more powerful the compounding power of the market.
Although it is not guaranteed and will involve an element of risk, the income that can be generated from an investment portfolio may be attractive and stable, while also providing an element of capital growth, explains Grant. There can also be flexibility far in excess of other income generation routes. Investment portfolios can be tailored precisely to suit the individual’s risk appetite and, furthermore, the profile of an investment portfolio can be readily adjusted to accommodate your income needs as they evolve.
Here, investors need to be highly aware of the variation in risk-return payoffs inherent in portfolio composition and take a close look at asset allocation strategy. As Grant observes, a typical “balanced income” portfolio could comprise as much as 75% equities (these being among the highest risk investments), while others may be more diversified to hold up to 50% equities and yet still generate attractive returns. “For example, Psigma’s Core Balanced Portfolio Strategy still delivered a 3.32% yield between January and October 2016, which equates to 79% of the FTSE 100 total return, but with less than half of the risk over the same timeframe*,” he notes.
Because there are so many variables at play, it is no easy task to set an appropriate asset allocation for your retirement funds and then adjust this intelligently over time to accommodate both the accumulation and decumulation phases. Add tax planning issues into the mix and the picture gets even more complex. There are broad rules to observe however, our experts say.
No single asset mix is right for everyone, however most retirees will be best served if they have a dynamic asset allocation, says Baluszynski. This means systematically rebalancing your portfolio’s exposure to assets that offer the best risk-adjusted return.
According to Baluszynski, younger investors should not be afraid to take risks since their longer time-horizon gives them more chance to recover from losses and playing it safe is no real way to produce any significant wealth. Accordingly, their portfolios should have a broad exposure to equity and other risks assets. Emerging market equities and bonds, along with energy assets, trade at attractive valuations and yields in current markets and, although they are very volatile, they should play a significant role in most long-term portfolios, he says. Some of these assets can currently offer a yield of 5%.
In contrast, investors with a short-term time-horizon and limited funds should focus on cash proxies, high-quality fixed-income investments and high-quality dividend-paying companies as their strategy is to avoid losses at all costs. Baluszynski counsels a portfolio built around money market funds, investment grade corporate bonds and short-term government bonds, with the emphasis far more on building the risk management strategy rather than chasing returns. In line with the reduced risk of losses being taken on, this kind of portfolio would generate yield of around 1.5%.
There is, of course, a broad spectrum of needs and it is vital to have your circumstances considered in the round to ensure the right mix of investments for you and your family. Income generation might not be your main focus, for instance. It may be the case that you have large sums of money and little need of additional income and so wealth planning and preservation for future generations is your focus, along with perhaps mitigating Inheritance Tax. findaWEALTHMANAGER.com’s panel of wealth management institutions are experienced in all manner of pension and tax planning scenarios and you might find the free consultation they offer to possible clients a very useful conversation indeed.
Finally, always bear in mind how higher management costs can dramatically erode the income return from your investments and take a careful look at fee schedules before signing up for any service or product.
As Grant highlights, some fee structures are based on commission charged every time a manager makes a change to a portfolio – something that might become inordinately expensive in a choppy investment environment. As we continue to see a volatile investment backdrop it will mean that portfolios that are actively managed and charge commission could experience higher charges, he says. Select a manager that offers a ‘clean’ fee option, where there are no additional charges on trades or other hidden fees.
Greenwood agrees that the effect that fees have on portfolio returns is often not understood by investors and flags a chart that Seven Investment Management regularly uses with its clients to underline the point. Clients realise that portfolio returns can compound, but do not often link the same effect to fees and see that marginal increases have a disproportionate effect on what they’re getting in returns. We also make sure we cap our clean fees on a family basis to ensure our clients feel we’re delivering value for money, he added.
As our experts have made clear, retirement planning can be a particularly complex area of managing your wealth – and one where it is easy to make very costly mistakes. On the flipside, having an intelligent savings and investment management strategy in place can give you great peace of mind and ensure that you are able to live life to the fullest in retirement.
The majority of the institutions on the findaWEALTHMANAGER.com panel have specialist financial planning expertise in-house (or are able to provide this through an affiliate) but not all firms are the same. The Find A Wealth Manager (FWM) smart online tool matches your specific needs with the strengths and specialities of each firm. Alternatively, if you have a question you can contact the FWM independent team, they have helped thousands of affluent individuals find a trusted professional to manage their investment portfolio to generate a retirement income.
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*return based on net performance of the Psigma Core Balanced Portfolio Strategy to end October 2016.