Hosts Merryn Somerset Webb and John Stepek speak with Bloomberg Opinion columnist Stuart Trow, author of “The Bluffer’s Guide to Economics,” about pension drawdown, which is a way to access your pension income when you retire while leaving the rest invested. Trow tackles how it works and offers suggestions on how best to manage it.
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Bloomberg Audio Studios, podcasts, radio news, Merin Talks Money listeners, I have exciting news. I have launched a weekly Merin Talks Money newsletter. The first edition came out last Saturday. Are very in depth, well, maybe not as in depth as some of you might like. Look at the Bitcoin melt up, all the great insights in even better humor than you get here on the podcast. Hard to believe, I know, but it is true. The newsletter is for Bloomberg subscribers only, so be sure to sign up at bloomberg dot com slash Newsletters or check out the link in the show notes. Welcome to Merin Talks Your Money, the Pirsonal Finance edition of Merin Talks Money and these bonus podcasts and they are a bonus. We talk about the best strategies for making the most of your money. I'm Merrin Somesetweb and with me Senior Border and Money Just Still author John's Depic.
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Well, do you know what it gets me? A lot of engagement on Twitter. People keep saying to me, you only post about bitcoin, so you get engagement, and you know what, it's true because it's kind of fun. Anyway, this week we're not going to be talking about bitcoin, well, not on this bit of the pod anyway. We are answering another question about pensions, and I don't say another with exhaustion. I know it's very important and it's something that John and I get questions about all the time, and we want to make absolutely sure that when it comes to your time to dealing with your pension, you know exactly what to do. So this is the question that John and I get asked, possibly the most apart from should I buy bitcoin? But we're not touching that today. Here it is how does pension draw down actually work? You know, we hear a lot about pension draw down about how are we going to take care of our own money and our run up for a time, and that's our accumulation phase. Then we get to our decumulation phase. How on earth does that actually work? And how best can we manage it? Now? John and I of course are brilliant and all sorts of things, hugely knowledgeable, but on this we have had to pull in an expert, so here we have Stuart Trousse Stewart. Thank you so much for joining us. Stuart is the co host of Money, Money, Money on Switch Radio and author of the Bluffer's Guide to Economics. Although of course he had not a bluffer, he is an expert. He was previously a strategist at the European Bank for Reconstruction and Development. He's also e columnist for Bloomberg Opinions to do It. Welcome and thank you. Right, okay, so let's just get right in there. How does pension draw down actually work?
The difficulty with pension draw down from an ordinary retire or prospective retires perspective is that basically all the risk is down to you, so you, you know, unlike having a final salary pension where the money just turns up in your out every month, so nice. You've kind of got to engineer how the money is withdrawn from your pot and ideally that you don't outlast your pot. That means you take on a lot of risks. So you take on the longevity risks simply that you last longer than your money does. The inflation risk. You've got to have a strategy for investing the money you don't need immediately. You know, the bottom line is you've got to decide on an appropriate level of draw down from your fund. So the way you can handle it is the classic thing is people some people take their twenty five percent of their pot tax free as a lumps arm to go and buy a yacht or a Lamborghini or holiday of a lifetime or more sort of more boringly, to sort of pay off mortgages than anything outstanding they've got prior to retirement, and then they put the rest of their pot into what's called draw down, and they decide on a sustainable rate of draw down, ideally with the help of a financial advisor. But a lot of people don't take that route. Some rules of thumb perhaps we can discuss later to as a guide of what's a sustainable rate. But there is one other strategy that combines the tax free cash and drawing down a regular income, because you can, instead of taking your twenty five percent tax free cash all in one go, you can take twenty five percent of each monthly draw down free of tax, and that allows you to take a much bigger income without running into sort of making yourself a forty percent tax payer and retierance stuff like that. And you know, obviously that's a big challenge in the way of the budget as well. You know, given the inheritance tax now applies to pensions, you want to be able to draw as much as you can from your pension if you've been fortunate enough to build up a big pot without paying forty forty five percent to withdraw it.
Yeah, but the challenge, there's jud so so many places to go here. But let's star. Yeah, let's start with that inheritance tax point and whether you should take out the twenty five percent. It's not always twenty five percent any more, is it as capped? But that large tax free amount that you can take out immediately. Now, let's say, let's just say that you hit whatever it is you can start withdrawing from your pension. It's fifty five for some and then going up to fifty six, right, and then is it going to fifty seven like that? Yes, So it depends on which age you can take it. But you get to that age and you do not take out the twenty five percent, you decide to take twenty five percent of every income payment going forward as your tax free amount. If you get hit by a bus tomorrow, everything in your pension now becomes IHT liable, Whereas if you took the whole twenty five percent out at once and gave it to your children, then you would have avoided that bit of inheritance tax.
Yeah, and I think you've you've just hit the nail on the head there actually, because if you simply take the twenty five percent tax free cash and leave it in your bank account, you know, economically, that doesn't change anything. But if you gift it, then yes, absolutely that's a game check. So you know, say you're talking about a million pound pot. You can take two hundred and fifty thousand pound out of that and gifted away, and your inheritance taxes is calculated on the remaining seven hundred and fifty thousand.
You know, that is subject I just want to say quickly before I'm just saying that that is subject to the seven year uld. Did you get run over by a bus tomorrow, you're still subject to problem. Get away from buses, stay away.
Yeah, no, no, yeah, you're absolutely right. That at least starts the process rolling. And you know, and to some extent, the tax free cash is is kind of more complicated as well, because that's not inheritable, do you know what I mean? A lot of tax allowances, especially between husband and wife, are inheritable, but your spouse or whoever you leave it to doesn't inherit your right to tax free cash. So that's what slightly changes the dynamic a bit, you know, And in some ways it's better to inherit a million pound in ices from somebody, although you lose the tax wrapper. You have to take that in cash unless you're a spouse, so you know, you could see you're already it gets really complicated because you've got a whole load of choices that most people just don't want to have. You know, the sort of pension freedoms ten years or so ago gave people a lot of freedom that they didn't really want to want to have.
Oh that's sad, okay, right, Let's assume here we've decided we've decided not to take the twenty five percent up front. We've decided to leave it in the account, and we've decided that every month when we draw our income, twenty five percent of it will be the tax free part. Or I'm saying twenty five percent is shorthand by the way, we do know it's capped. We're just saying twenty five percent. Yes, the majority of people, it will remain twenty five percent. That sounds like admin. Hell, how do you do that? You simply say your provider do this for me? Or is there some kind of admin that you're required to do to make this happen?
Yes, there is that been required to make that happen. But actually most pension providers will be able to set you up. So say, for example, you decide to take twenty five percent of each monthly payment free of tax, you can you can arrange for that to be paid regularly into your bank account with minimal interference. A problem comes when they have to decide what to sell from within your pension pot to provide you with a liquidity, so you can't completely get away from the problem. But most people can set it up so that they receive a regular amount into their bank account. The question is is whether that's too much now run out of money or too little and now pot will build up and up and up and now get hit with inheritance tax when they eventually die.
But when you say they, you're referring to the provider. But let's say, for example, that you hold your SIP on a DIY platform, so maybe you all language landsown or I or something like that. How does it work. Then when you say they have to decide what to sell to create the liquidity and these circumstances, you have to do that yourself. So it's hard work.
You're exactly right, and you know, I mean, this is a conversation I have with a lot of people, is that we may all, you know today, we may all feel on top of our powers, and you know, on top of our game and stuff like that, our appetite for complexity, you know, in our late seventies and eighties is going to be significantly diminished, even if we've got mental capacity. So you know, this is one of the problems with things like draw down. There's a lot of flexibility, a lot of freedoms to do stuff, but most people don't want those freedoms. So you can have it set up so you get the regular income. You can do the regular income even if you've taken all your tax free cash. It's just you can have a bigger income without paying a huge amount of tax. If you take a quarter of each monthly.
Payment so it might make sense then, I mean in the accumulation phase obviously, you know, if you're diying in the accumulation is complicated. You've given eyels all the time, be careful of your investments, et cetera, but you don't have the same type of maths to do so. For most people, is it fair to say that it would make sense, if you've diyed through accumul perhaps to hand it over to a platform that will do the money management for you in the decumulation phase.
Yeah, no, no, I think there's a case to be made for doing that. Another way people handle the complexity as well, is that the early years of retirement tend to be pretty expensive. In fact, spending in retirement tend to be a bit of a u shape. But you, I don't know, You still might have children on the balance sheet, and you might want to sort of buy yourself a little present for a lifetime working or something like that, or the holiday and what have it, whatever, whatever the cause, you spend quite a bit in the early years of retirement, and then you get to the stage where hopefully you're sort of still fairly fit, but your appetite for sort of trekking in the Himalayas or what have you, is not quite what it was when you were in your twenties, so you're spending goes down a bit. And then obviously the final years it's a bit of a lottery. You've got care and stuff like that. So what some people do is that they spend sort of in a more discretionary manner in the early part of retirement, and then when they start to get a clear idea of what their fixed expenses are, then some people buy an annuity to cover just those fixed expenses and then and you know, the rest of the pot is available to be drawn down if they need more money than that. But that's kind of a nice way giving yourself some certainty at a time when you're you're you're craving a lack of complexity in your life.
Okay, that makes it. That makes a lot of sense. That's a really useful thought. The idea that your retirement, your retirement spending is is you shaped. So let's say, let's say, John, this is the last question I'm going to ask, and I'm handing over to you at the long list of questions I know you have about this. You don't, of course, you do, of course you. So let's talk about how we actually invest. So let's say that I am going to stay DIY at least maybe for the first ten years of my retirement. Maybe I'm only in my late thefties, and I'm pretty sure that I can do this my out for the next fifteen years or so. Do I just go out and buy a pile of equity income funds or equity income investment trusts or is that the wrong approach and I should just go straight into bonds and hold a pall of boring bonds forever. Not the bonds are always boring.
There's so much to unpicking that, you know. It's a basic principle of investment. The amounts of risk you take is proportionate to your time horizon. So you know, if you're setting you know, if you're saving a lump some I don't know, to pay off for mortgage by a flat something like that in the next few months, you obviously don't want to take the risk of the market crashes and halves your capital, so you take zero risk your cash or short dated bonds. But as your time horizon lengthens, and especially once it gets past five years, which at least some of your pension pot will be designed to last for then it's appropriate to take more risk. And the question is how you take the risk with a pension Because you don't have to pay capital gains tax and stuff like that, you don't actually need to have income generating sets in that you can draw down on the capital gain. So you know, it's the old thing between being indifferent between an income and a capital gain. You know, if your wealth is risen by ten percent, it doesn't matter whether you've got ten percent of dividends or your the value of your assets gone up by ten percent. So to that extent, you don't necessarily have to restrict yourself to equity income funds on the one hand, And then you talked about bonds, and the natural thing is that as people get older, they de risk their portfolios. They have bigger holdings of bonds. But there's a massive difference between holding a bond, an individual bond, and holding a bond fund because the only way you get the good bits of bonds, you know, the fact that you know what you're going to get when they mature, and the regular income along the way is if you hold individual bonds to maturity if you buy a bond fund, you know, you're just as subject to the arbitrary movements and markets as an equity fund would be, you know, and people found that to their huge cost in say twenty twenty two, when inflation took off, interest rates took off, and bond funds got absolutely crucified. And so it really depends what you're going for. If you've still got an appetite for complexity, then you organize your bonds. You've got them running off at a regular period, creating a stream of coupon income and final redemption, so you can actually plan what's going on. You can't do the same with a bond fund. It's simply just another asset class that's subject to market movements.
Okay, so going into bonds by yourself it's also very hard work.
Yeah, No, it's very labor intensive. You're doing what a defined benefit pension fund manager would be doing, matching their assets and liabilities, and you having a nice ladder of bonds maturing at regular intervals, and you can have a spreadsheet or I'm sure there's more sort of exotic software, but from an individual investors' perspective, they can see where their incomes coming in each month, and they can engineer it so they get exactly what they want. And you know, they can even do fancy things by outside pension wrappers, by sort of buying low coupon bonds. So some of the return is in the form of capital gains. But do you know what I mean, you know, yeah, exactly, you're optimizing all the tools you've got at your disposal. Is it is mind blowing.
So that there's a reason why people do this professionally, right.
Yeah, oh, definitely, very much so, you know, but the issue between the difference between bonds and bond funds is a crucial one that you know, even a lot of financial advisors don't seem to grasp.
And I think that's really interesting point that Manas kind of brought up. Is there difference between the accumulation and the decumulation fees. I mean, ultimately, accumulation can be quite easy if you really wanted to, then you can just stick your money monthly basis, save every month, stick and track your funds whatever. But you know, you start in your twenties, you get forty fifty years before you're retired, you can keep your portfolio being virtually the same kind of you know, between eighty and one hundred percent equities, probably for at least the first twenty years, probably for the first thirty if you want, and then you don't have to worry too much. But is this becoming very obvious from the conversation. The bit after that is actually really complicated because suddenly your time horizon completely narrows. You're suddenly trying to balance. It's not about saving as much as you possibly can. It's about trying to make sure that you use up as much of the port as you can before you die. Yeah, and you just don't know obviously, you don't know when you're going to die. You don't know what your rate of return is going to be on the stuff that's still in your portfolio. You only have a I mean, you barely know what your spending is going to be. And one thing I've noticed whenever I talk to the retired people is they are astonished by how much they spend, even though I mean, yeah, it's the U shaped thing, definitely, but it's also it's a bit like, you know, they're always complaining about how they don't have any time now that they've retired. And then also you know, they don't have any money either, or rather they spend more than they expect. I mean, so from that point of view, do you think there's a good case for even if you've been an independent investor, you're for your accumulation phase of opening an advisor, And if so, what other kinds of things you should look for in a wealth manager and maybe how much should you be expecting they pay for that? I know those are all those are both pretty tricky questions, but I mean, if you've got a rough view on your thinking there.
You're exactly right, because you know, accumulation is completely different from decumulation, and there are all sorts of issues. You know, it's you've got pound cost averaging on the way in for accumulation that works in your favorite you know, very briefly, that's basically, the weaker the market is, the more your regular monthly contributions buy, the more units in funds. The mirror image of that is there when markets are really strong, you're buying fewer units, so on average, you're buying each unit at a lower price than you might otherwise have done. It's smooth things out and protects you against falls. And in fact, if you're really young as big stock market form might actually be a really good thing because you're going to put more in in future than you've done today. So that's the accumulation phage, and that's pound cost averaging. What we've just been talking about, what you've been asking about, is pound cost ravaging. And this is probably where you need the help because because basically, if the stock market, if the stock market falls sharply and you're just about to sort of you know, if you're say taking your annual income in one go, you know, just to sort of make the for the purpose of illustration, you're going to have to sell a lot more units in your pension fund to make however much you want to draw down from your fund. And that's where the professional advice can really help, because if you can take some of the pressure off your pension fund when stock markets are really weak, give them time to recover as they usually do, that will give you your fund a lot more resilience, and it's worth paying extra for that. The problem is is that basically, rather than simply giving you the advice setting you up with a sustainable plan and letting you get on with it, that financial advisors will want it to bring all your assets under management and charge you a fee appropriately, And that's a large part of the reason why, you know, people who haven't got enough assets don't interest financial advisors because two percent of nothing is still nothing, whereas people who've got very substantial assets, perhaps people who've used pensions of as wealth management in estate management tools, might have many millions in there, and two percent of that is a very substantial amount of mine, and probably considerably more than the advice they get is worth. So you do get caught in that situation. But if you derive quite a bit of consumer sort of joy, if you like, from having all this worry taken away from you, you know, it's difficult to put a price on that, especially if you're buying peace of mind by getting advice. You can also get free advice as well, you know, pension wise, there are you know that the take up of these services has been extremely disappointing from a government's perspective, and financial advisors are always quick to point out that the take up is quite low. But you know, you can have a free conversation about precisely these sort of issues with somebody who knows how everything works, and conhaps sort of sanity check what your plans are and make a few useful comments on that.
The all the other thing I was going to ask about boys annuities and their rule and all this, and know that it can have briefly meant. But again, one of the reasons the pensions freedom came along in the first place is because people got annoyed about having to annuitize and obviously buy an annuity portshole down, et cetera, et cetera.
And then they were so partly irritated not just by the annuities themselves, but by being ripped off by the annuity providers because they were obliged to buy annuity. So it was partly the system and partly the fact because they were obliged to do it and they almost always brought them from the same the provider that they'd been previously, they were almost inevitably ripped off. So that was a big part of the problem. Sorry to interrupt, No, I didn't you get that?
Yeah, yeah, because I remember we always used to write a shop.
Up around, shop around, but nobody did. They got these letters and and you know it said take care. They ticked there and that was that maddening.
But yeah, no, I mean, obviously, then annuities became extremely poor, of how you because of the low interest rate environment, but that has changed now, so in terms of the role of an annuity and checking that you're getting a good value innuity, if you get any thoughts or kind of rules of thumb for going about doing.
That, right, Yeah, No, no, definitely, because I mean, obviously, you know, annuities tend not to, even in good times, tend not to pass on a huge amount because you know, basically you lose your entire pension pot and you get an income that's only slightly better than you might do from fixed income products as well. But you know, setting that aside, the change is inheritance in inheritance tax will definitely cause more people to err towards inuities now, because you know, if you're going to lose forty percent of your pot, you might as well sort of get yourself a guaranteed income and get away from a lot of the problems. We've just been talking about about complexity in older age, and you can get around that to an extent. You know, we talked about hybrid anuities where you arenuitized enough of your pot to guarantee your fixed expenditure and stuff like that. There are also medical conditions as well. You know, this is shopping around not just to get a better standard rate, but a lot of people will be able to get if they've got slightly high blood pressure, you know, they're taking medication for that that. You know, it doesn't have to be sort of a death store or anything like that. They'll be able to get a better annuity rate for that as well. So it's well worth shopping around there. And then going forward, you know, the whole change in the environment whereby pensions aren't wealth planning instruments will change the sort of the way in which people look at drawing incomes down from pensions, and that's a huge new area where where work has been done but little progress may whereas now this is heavily incentivized progress because for example, you know, if you lose a big part of your pot on death, there is an argument for collectivizing death risk a little bit like life insurance in reverse. So that if for sort of an actuary or something like that, or you know, a pensions administrator looked at the whole fund for say particular yes, say for Bloomberg for example, and decide right in retirement. We can pay this rate largely because some people will die early, some people will dilate, and you collectivize that risk especially Yes, yeah, no, I mean you know, I mean, obviously there are details to to sort out there, and you'd want to improve confidence in pensions and administration, which is pretty low at the moment. But I would imagine that that is a way things are going to go, because it's you know, people want will want better incomes that than are available from annuities. Yet they are attracted to the certainty and sort of you know, maybe there's a trade off between certainty and sort of higher incomes there.
All right, I think we better, we better come to a closer everyone might as you get bored of pensions, which occasionally does happen. I had one, not for us, not for us, But I gathered there are other people who lose interest minutes. Final question. There are we gather, or I gather from reading the newspapers at the weekend, quite a lot of people who took their twenty five percent or not twenty five percent. But when you know what you can get a short hand for out of their pension in advance of the budget. Yes, and now regret it and would like to put it back, and several of the newspaper Q and A Money things I read over the weekend suggested that that is possible because of the thirty day cooling off period. If you only took it out just before the budget, you can go, actually, I've changed my mind and you can put it back. Is that correct?
That's absolutely correct. Basically, whether you should regret in inverted commas taking your tax free cash largely depends on what you do with it. So if it's just sitting in your bank account, you've lost the tax wrapper for it, the you know, the ability for those funds to grow capital gains, so you'd probably be better off putting it back using the cooling off period. But again, you know, if you're sort of trying to do this as part of your estate planning, drawing the tax free cash and gifting it and taking your seven year rule chances, it's probably still the main strategy. So it depends what your motivation for taking the money out in the first place was, what the best strategy is for now. You know, if you were just taking it out and parking it in a bank account, you might as well put it.
Back and of course, the other thing say is that you know, just because you didn't change the rules in that budget doesn't mean she isn't going to change the rules.
Yeah, no, no, I think sort of going forward, it is perhaps a little less likely because she's kind of acknowledged the tax free cash thing as a thing. But you're absolutely right, you know. I mean, basically, if you take forty billion out of the economy, growth isn't going to exceed expectations. Wandering out of my lane here, that's all right.
Just in case there is anybody out there who did take the money out and is thinking about putting it back, do be very very careful because you don't want to full foul of any of the rules. We're not allowed to put much in after you've taken some out, because you could end up with a really nasty tax charge if you get that wrong. So if you're going to do it, take advice, make sure you get it right, and I think stats it. Unless anyone has anything else super interesting today about pensions, Nope, we good guests.
Right.
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