Consolidating personal pensions into a SIPP

[Julie Coxon]

Hi Stephen / other investors

I have been following your HYP strategy for a few years to invest a very small personal pension with dividends reinvested – more to see how it might work out than anything else – I have another final salary pension as my main pension. However my husband who is a bit older has 2 occupational pensions and we are considering whether to consolidate them both into a single SIPP and invest them using HYP strategy. A lot of what is written on the site and in the newsletters seems related to building the portfolio by reinvesting dividends but how does it work once people need to take a income from the portfolio. Would you recommend this strategy for that? Would the idea be to just take the dividend income as a pension and leave the portfolio invested or do you have a formula for calculating how much can be safely drawn down – or is another strategy better once pension is in drawdown phase? The amount for the 2 pensions will be about £450 once he has taken 25% tax free lump sum. Not surprisingly various financial advisors are keen to invest the pot in exchange for a large fee (0.5% pa) for them and large fees for the fund managers. They feel putting it all into a HYP portfolio is very risky, however we do have my income followed by final salary pension, so it’s not as if all eggs are in one basket

I would be really interested in your thoughts on this
Julie

[Julie Coxon]

btw – the pot is £450K not £450 – that really would be a small pension!

[Stephen Bland]

I am not permitted to advise on your specific pension situation because that would constitute personal financial advice which I am prohibited for legal reasons from offering to readers.

On the more general aspects of your query, when you wish to take an income from your HYP, as you suggest you simply withdraw the dividends instead of reinvesting them. The idea is that you don’t spend the capital but retain it to continue delivering the dividend income.

Also for the above legal reason, I cannot comment on whether investing in an HYP is “very risky” because that is a judgement personal to each investor. One person’s “very risky” is another’s attractive investment so you need to decide for yourself if you can live with the degree of risk that comes with HYPs.

I agree with you though that vested interests who will receive no fee or commission if you stick with an HYP, are likely for that reason to lack impartiality and to encourage you in the direction of products from which they derive a cut in some way.

From my personal point of view, HYPs are certainly not “very risky”, though of course they do carry risk, both to income and capital. I practise what I preach so am very heavily invested in my own HYP and add to it if additional cash becomes available. I’m no spring chicken myself but definitely do not see that age changes my view, remaining quite happy to embrace equities within the structured approach of an HYP and accept the risks that go with this because for me it’s not “very risky”, quite the contrary. The level of risk that HYPs unavoidably attract is perfectly acceptable to me. But that’s just me, I can’t decide that for anyone else.

I’ve always intended the HYP strategy to offer lifetime potential from age zero up. The dividends are reinvested if not required, thereby boosting the future income when it is required. There is no cost or problem in switching from reinvesting to withdrawing.

[Julie Coxon]

Thanks Stephen

I understand that you can’t give financial advice but it’s helpful to know that you don’t see an age limit on HYP strategy

I’d be interested to know from your other readers on the forum if any of them are successfully using dividends from HYP to provide pension income

Julie

[Stephen Bland]

Julie, I can tell you for certain that a lot of pensioners use their HYPs for income because that in fact that is the whole ultimate purpose for which I designed the strategy. Nothing that has occurred in the 16 years or so since I first launched the HYP approach publicly has changed my view on this and my own experience and that of a lot of HYPers of whom I’m aware support it.

No guarantees of course, equity investment attracts unavoidable risk and the question is exactly as you posed, can you live with that risk as it exists in the HYP strategy? If you can’t then don’t do it. But in that case make sure that anything else in which you invest isn’t just as risky or even more so. But it is highly likely in my opinion that a HYPer who has had a good experience with an HYP for some years pre-retirement, especially if that covers some inevitable and testing poor years, will be happy to continue with it post-retirement when the income needs to be drawn.

I stress that it was never my intention for HYPs to be used as some form of temporary investment with a definite view to eventually selling and reinvesting elsewhere. That in my view would be a really risky way to approach it! You may have noticed that I refer often to eternity holding, never selling. That was always part of the strategy from the outset. Hold forever, reinvest dividends until you need them and when you do, draw all or just partially as required. That’s the HYP way.

[Nigel Roberts]

Just to add to what Stephen has said with my own interpretation of this….

It’s an eternity portfolio – yes, and when you die what remains in the SIPP can now be left to the beneficiaries of your estate (now that you don’t have to buy an annuity)…. but that does not mean that it has to be…. Personally I don’t think there is anything wrong with drawing down on the capital as well as taking the dividends once you have retired…. If you are 70 and think you have 20 years left to live why not draw down up to 5% of the value of the fund each year plus dividends? But only if you need / want to actually spend the money? This can be reassessed as you go so that you don’t risk putting yourself in a difficult position if you live beyond 90……

[Vincent Haines]

Julie, I have recently begun to take some of my dividends as income to supplement my main – occupational – pension. Having the (hopefully) secure income gives me the confidence to accept the low-to-medium(?) risk that the HYP strategy carries. I am still reinvesting the majority of my dividends in order to support an increasing income as time goes on, and am comfortable with the idea of ‘drawing down’ some of the capital if necessary (but not yet!). Dont forget the State Pension too – although you might have to wait until youre about 80 to qualify (if it even still exists by then!). Good luck with whatever you decide.

[Stephen Bland]

Personally, I am against capital withdrawal from an HYP and it was definitely never part of the strategy as I intended it. Eternity means forever, as an absolute minimum holding period.

Here’s some reasons:

1 Most obvious is the fact that if you withdraw capital regularly you will experience an increasing decline in the HYP dividend income. Yes you will be topping that up with the capital withdrawals so the cash you take each year may be about the same, though only as long as it lasts, but that’s like eating bits of yourself because you’re a little hungry. It’s increasingly damaging, irreversible and ultimately fatal.

What will you do if it runs out? We’re talking of a situation where the investor felt the income to be insufficient in the first place, which is why it was augmented with capital withdrawals. Well, if it was insufficient to start with, it’s going to be enormously more insufficient when you have reduced it to nil.

2 You are reducing, possibly to nil if it goes on long enough, the capital that you may wish to leave in your will.

3 For me, though perhaps not everyone, there is an emotional objection to spending capital. My ideal is never to spend it and just live on income from various sources, including my HYP. It just feels right somehow. I know that, technically, this can be seen as illogical because money is “fungible”, (horrible word that sounds like some kind of mushroom) meaning that’s it all just money and that distinctions between capital and income can be seen as artificial. But that’s really academic, in the real world most of us do see a distinction and so does the law and accountancy rules.

So I view capital withdrawal as a last resort for an investor desperate for additional cash though I do appreciate that some HYPers may unfortunately be forced into this situation by circumstance. But I assume we’re not discussing those for whom compulsion exists because there is not much argument in such cases. It’s where you have discretion that there is room for discussion.

Finally Nigel said above

…If you are 70 and think you have 20 years left to live why not draw down up to 5% of the value of the fund each year plus dividends?…

This calculation is incorrect. If you withdraw 5% capital each year, plus dividends, then assuming the HYP yield is 4.5% this will last only about 14-15 years, not 20. The reason is that you have to withdraw increasing amounts of capital each year to make up the increasing shortfall in dividend income so as to deliver the same cash income. Like a repayment mortgage in reverse.

For example on a £100,000 portfolio, the dividends will be £4,500 and you take out £5,000 capital because the example assumes you need £9,500 income. In year two though, the dividends will be 4.5% of £95,000 being £4,275 so you need £5,225 of capital to make your required £9,500 and so on each year with increasing capital and reducing dividends. There are several assumptions here, such as the fixed dividend yield and capital value over the years, but on this basis the math says that 5% a year will not last 20 years, because it’s not just a simple interest calculation of 5% capital withdrawn each year gives you 20 years.

For it to work like that over 20 years, you would have to accept a declining income because year one would be £9,500 but year two would be £9,275 and so on. And that method can’t be appealing because presumably this poor HYPer is in dire need of all the £9,500 in the first place, so the last thing they want is that it declines inevitably each year.

And there are complications. In practice the capital and dividends will fluctuate year on year. No guarantees but even though they are both likely to increase long term, this does not happen in a smooth annual progression. Your initial demand of £9,500 income may have to increase with inflation and your circumstances. It really is quite a gamble on it all working out as hoped. Yet another reason to avoid this situation if at all possible.

[Nigel Roberts]

It is an interesting conundrum – and eternity HYP is forever isn’t it? Well yes, but much as we might hope unfortunately we don’t last forever so at some point it comes to a conclusion, natural or otherwise….

There is a lot to be said for leaving it all to your children or elsewhere, but that does not have to be the case and a careful and managed withdrawal of capital definitely could and would work for some people, my use of a 5% capital withdrawal was just plucking a figure from the air and I did qualify this by saying that you should do this only if you needed or wanted the money and it clearly has to be recognised as something that will increase the risk to future income by withdrawing too much and potentially leaving you in your old age in strained circumstances…. but of course this may be preferable to leaving yourself in strained circumstances when you are not quite so old when the money may be better used…..

Its all about situation and circumstance and everyone will be different!

[Stephen Bland]

Agreed Nigel, everyone’s circumstances are different of course.

One point on the math, I know that 5% capital withdrawal plus dividends was just an example but I wanted to show that the length of time available before it runs out is not simply 100/x years (where x is the annual percentage capital withdrawal) as you had assumed. It is considerably shorter because increasing amounts of capital have to be taken to compensate for the declining dividend income so as to deliver the same (or worse, a growing) total income. There are some crude assumptions in there but that was the basis upon which we were discussing the point.

My fundamental position on this and hence my general advice to readers as I’ve said is that capital withdrawal is to be avoided if at all possible. When advising TDL readers, I have to offer what I believe is the best course for the great majority, which means that this approach may not suit a few. That applies to almost all the advice I give on running HYPs, not just the question of spending the capital.

So, yes, I quite accept that some individual situations will sometimes force a sale of capital from an HYP but would hope that this applies to only a small minority of HYPers.

Also, readers should not start investing in HYPs with the intention from the outset of selling up at some stage, either wholly or gradually. If they are eventually forced to do so by circumstance then so be it, but it should not form part of the reasoning for investing with HYPs in the first place. I had the impression from your message and others that you were assuming from the start that you would be spending capital. I am definitely against that view of HYPing. As I’ve said, selling should be the last resort, not part of the plan.

I’ve been asked many times over the years whether HYPs were suitable for dividend reinvestors building up capital to be used eventually for some other purpose. The answer is always no, that attitude creates unnecessary risk and it is not how I intended the strategy to be used at all. The idea behind HYPs is to step outside the obsession with capital values that preoccupies most equity investors and concentrate on the income. To liberate people from thinking about how much capital they have made or hope to make in future and instead look just at the income.

Thinking about the capital drags us back to trading shares, the old viewpoint from which I am trying with HYPs to distance readers.

[Nigel Roberts]

Hi Stephen – yes – I think from your perspective this makes sense, but investing is an individual pursuit and your readers also have to take responsibility for how they invest and also how they eventually use the money. We all have to make our own decisions! Keep up the good work!

[Julie Coxon]

Thank you all for the replies. The debate and illustrations regarding drawn down of capital gives really useful food for thought and provides clarity on Stephens strategy.
Julie

[Jeffrey Beranek]

Just for for readers’ information, I manage investments for my children (7 & 9), myself and my wife (mid 40s) and my father (mid 70s). We all have a portion of our investments held using the TDL strategy. I’ve been investing in individual shares for about 6 years and TDL for about 4 years. I’ve also been investing in funds for about 20 years. I have a special reason for preferring individual shares. We are dual US/UK citizens and therefore holding collective investment funds outside a pension is complicated and tax inefficient. I am strongly in favour of low-cost global index trackers, but I reserve these for pensions (SIPPs). I personally feel the TDL strategy works well for all age groups as an income, or future income, strategy. I think if you feel you may need to draw on capital in the future (5+ years) you should probably use index trackers and not TDL. Any less than 5 years and you should stick with cash, or perhaps a portfolio of individual short-term corporate bonds (although these are certain not risk free). I guess the issue is, that not everyone will be lucky enough to be able to put away enough money to use the TDL strategy to exclusively fund their retirement needs (even after taking any state benefits into account). And even if they did, then it would entail leaving a serious chunk of change to their heirs (or charity) when they die, which may or may not be what they want to do.

One consolation is that the TDL, over time, does look a lot like a low-cost index tracker. Yes, it has a high-dividend focus, which you might zrgue increases the risk. But the ‘large cap’, ‘cash/profit rich’, ‘industry diversity’, ‘value’, ‘strategic ignorance’, and ‘hold for eternity’ characteristics could arguably make TDL less risky than just holding the whole market. If you limit the size of your trades (whilst including the cost of TDL) it could even end up cheaper to run than an income tracker fund. I also fundamentally believe in the principle of owning equity in companies that are willing to pay you dividends, rather than companies that just push for growth on the assumption that you might find someone to sell the shares to in the future at a higher price than you bought them. Look at the companies that are in TDL. They own, operate and employ a significant portion of everything you see around you as you walk down the street. Yes, they mostly big and boring, and don’t generate much excitement in the press – unless perhaps when one appears to misstep and their price gets hammered. You’ll also notice that most well-regarded income funds hold many of the same shares…

Back on topic, the generally recommended withdrawal rate for a defined benefit pension pot is actually less than what the TDL yield historically appears to have delivered anyway. That doesn’t mean TDL will always deliver, but personally I think the income strategy is likely to be less volatile then relying on capital growth to cover future withdrawal needs. You should always have an emergency cash buffer to smooth out (many) fluctuating income or spending needs. It may not be enough to deal with every crisis, but what are the alternatives? You could buy an annuity, but when and with what? You would still need a pot of cash, but the income would be much lower than the TDL and what if you need to buy an annuity just after a major market fall?

No one ever said the TDL was going to be easy. I still find it very challenging, especially when an individual share price take a hit. But I try to take enjoyment from getting a chance to buy a new allocation to a high-yielding sector that needs topping up and try to ignore price fluctuations. I also do my best to calculate the effective on-going yield as well as the after-inflation internal rate of return (where all dividends are currently reinvested). I am satisfied with where they are and I don’t currently have a better plan! It’s all part of what I call “the loneliness of the long-term investor”…

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