Should I switch some of my pension fund to cash as I approach retirement?

[Marc]

Sequence risk seems to be mostly problematic with falls in asset values occur at the start of drawdown.

If you retire into growth years, assuming you are spending less than observed growth your fund builds up a buffer, which protects against later falls.

Keeping this in mind things I have considered to protect against selling, especially during falls in the first 5 years.

Create a 'temporary' cash/bond buffer to cover some of the initial years spending. Spend that first. If times are good rest of fund grows. If times are bad you are not selling your falling equity (which increases bomb out risk/reduced future income). You do give up the expected equity returns of this buffer during the temporary period though.

Have another income source e.g. annuity, rent, job, state pension. We all need some minimal spending to not starve. The more of that which comes from another source, the more we can choose not to drawdown during falling markets. I think I include dividends here from shares that I would never sell, but I don't think either of ye clearly proved that. It's probably worth it's own thread.

Reduce lifestyle/withdraw less

@SPC100 has this about 100% accurate

there is cash drag from keeping a cash buffer so you are generally better off with short term fixed income.

Research by Eugene Fama at the University of Chicago and other respected academicians has shown that longer-term bonds historically have had wide variances in their rates of total return without sufficiently compensating investors with higher expected returns.[1] In terms of variability of total return, long-term bonds look more like stocks than shorter-term fixed-income vehicles such as Treasury bills.

In a PENSION you need a reliable short-term liquidity fund which provides a positive correlation with inflation and a premium over an equivalent cash deposit

In the more recent past this still works perfectly well

Picking up a nice consistent premium over cash and a hedge against inflation but without going nuts with risk, which is the primary objective

---

[1] For example, see Edward L. Martin, “Intermediate-Term Bonds,” AAII Journal, January 1991, pp. 13-16.

The only tweaks that improve portfolio survival are to rebalance every time you withdraw as that captures any mean reversion in asset classes.

there is also a tax optimisation aspect which is peculiar to the Irish tax code and counterintuitive but otherwise a near perfect answer.

it’s all in here

Demonstrating our value v8.0

Joomag digital interactive publication

joom.ag

 

[Gordon Gekko]

@SPC100there is cash drag from keeping a cash buffer so you are generally better off with short term fixed income

I don’t think this is accurate at all. The returns just aren’t there in fixed income. As an approach, it’s too overengineered. One can jump through a number of hoops to earn zero (or worse) in fixed income, or just keep the required amount aside in cash.

 

[Sarenco]

One can jump through a number of hoops to earn zero (or worse) in fixed income, or just keep the required amount aside in cash.

Institutional cash deposits are currently attracting an interest charge of around -0.60%, whereas the short bond fund cited by @Marc currently has a yield-to-maturity of around 0.13%, with an average duration of 3.82 years.

 

[Gordon Gekko]

Institutional cash deposits are currently attracting an interest charge of around -0.60%, whereas the short bond fund cited by @Marc currently has a yield-to-maturity of around 0.13%, with an average duration of 3.82 years.

With a capital value that can move around

 

[SPC100]

Hi Gordon. It was at this point I came unstuck the last time someone tried to persuade me of the reasonableness of what you're proposing.
Firstly, I'm not investing the €60k. I'm spending it! Secondly, even if I don't spend it all, I can always give some of it to the children and grandchildren. As I recall, between the other half and myself, we can gift each of them €6k a year tax-free - not that I would want to claim to be that generous with them! That immediately eliminates any problems of CAT and CGT!

@Gordon Gekko

Moderators, I think this stream of posts would be a good topic for a post on its own. Although it may only be applicable to a lucky minority.

If I expect (hope!) that my imputed distribution will be more than what I need, what should my strategy be for the exceed? I had initially assumed I would only take what I need and leave the rest in the fund. But in the fund, it suffers the annual tax on the imputed distribution. And potentially additionally marginal income tax if you need to withdraw for some large cost above the imputed distribution.

It's a good point that if you are very confident in fund longevity and your future needs, it may be better tax planning to withdraw all give to friends and family yearly up to tax free limit.

But maybe taking it out and investing outside of the fund would be better at least in some circumstances.

 

[Duke of Marmalade]

The ‘other’ €60k is now still in the ARF so it can grow tax-free.

The 60k will be subject to a deemed distribution of 6% p.a. taxed at full marginal rate. A bit of a stretch to describe this as tax free growth.
Maybe the CAT thing changes things but other than that I can see no sense in leaving the 60k in the ARF.

 

[Gordon Gekko]

I don’t think so, but I’m open to correction.

The €60k that’s left in the ARF can then grow for a year, at which time circa 3% of it will go in the form of the imputed distribution tax. But if the person is pursuing an all-equity approach (like Colm) it should still be growing over time. And importantly, it should be growing more than €60k that’s taken out and invested personally. Although, now that I think about it, is that the case? €60k invested personally would only be subject to 50% tax on dividends and CGT on realised uplift. How does that compare with 3% on everything?

 

[Duke of Marmalade]

I don’t think so, but I’m open to correction.

The €60k that’s left in the ARF can then grow for a year, at which time circa 3% of it will go in the form of the imputed distribution tax. But if the person is pursuing an all-equity approach (like Colm) it should still be growing over time. And importantly, it should be growing more than €60k that’s taken out and invested personally. Although, now that I think about it, is that the case? €60k invested personally would only be subject to 50% tax on dividends and CGT on realised uplift. How does that compare with 3% on everything?

I looked at this from the point of view of a child (over 21) of the ARF holder who expects to receive the full €60k and its growth as an inheritance. She also expects to pay the full 33% CAT if it is outside the ARF and 30% if it is inside the ARF.
Clearly if the ol' man were to be hit by a bus tomorrow she would marginally prefer that the 60k was left inside the ARF. But suppose she reckons on him surviving 20 years. Let us consider 6% annual growth. If it is inside the ARF it doesn't matter if it is made up of capital gains or income. The net inheritance is €72.1k.
If the money is outside the ARF it matters a lot whether the income comes by way of dividends or (unrealised) capital gains. It is is all income the net inheritance is €71.3k, slightly worse than the alternative. If it is 2% income and 4% unrealised capital gains the figure is €102.0k, clearly superior.

(I Googled the CAT interpretation and stand to be ejected.)

 

[SPC100]

Thanks for the further thoughts on this.

We also need to look at it from the point of view of the old healthy poor man who is wondering if he will outlast his fund and has some ability to control his spending needs.

A lot of outside of fund investments will probably suffer from the deemed disposal tax treatment.

edit: This complicates the decision on wheter to withdraw the full deemed distribution. It appears people here are currently leaning towards outside ARF.

 

[NoRegretsCoyote]

We also need to look at it from the point of view of the old healthy poor man who is wondering if he will outlast his fund and has some ability to control his spending needs.

What no one on this thread has talked about is that life expectancy itself is highly variable.

Take a 65-year old Irish male. The median life expectancy is 18, so living to 83. But there is a 10% chance he will die before he is 71, but a 10% chance he will live beyond 93.

Below is a chart I worked up from CSO life tables.

https://imgur.com/MZy8eVJ

Suppose you are very risk averse and want your fund to last until you are 95. This would mean very conservative withdrawals and/or vulnerability to a bad sequence of returns early on.

Everyone tends to dunk on annuities because they are so expensive. But they allow you to insure against living a very long life.

 

[Allpartied]

What no one on this thread has talked about is that life expectancy itself is highly variable.

Take a 65-year old Irish male. The median life expectancy is 18, so living to 83. But there is a 10% chance he will die before he is 71, but a 10% chance he will live beyond 93.

Below is a chart I worked up from CSO life tables.

https://imgur.com/MZy8eVJ

Suppose you are very risk averse and want your fund to last until you are 95. This would mean very conservative withdrawals and/or vulnerability to a bad sequence of returns early on.

Everyone tends to dunk on annuities because they are so expensive. But they allow you to insure against living a very long life.

Without wishing to get too morbid, the reality of living life in your 90's is not the same as living your life in your 60's, 70's or even early 80's.
To be brutally honest, you won't be able to do very much in your 90's, if you are lucky enough to live that long. Travelling, eating out, walking in Connemara, theatre trips, golfing, they require modest health, mobility and independence. So, my advice, would be to bulk up your income in the active years and not worry too much about those years spent sitting in a chair, looking out the window.
If you have family looking after you, it might be nice to give them a healthy check every month, but, hopefully, that won't be their main motivation.
Nursing home care is provided by the state, as will medical bills and, if we remain a civilised social democracy, there will be continuing assistance for you when you are elderly and infirm.

 

[Duke of Marmalade]

Everyone tends to dunk on annuities because they are so expensive. But they allow you to insure against living a very long life.

Only if it is inflation linked.
Inflation capped at 7.5% pension for 65 year old €1m is €22,000 p.a.

But even this is very misleading. A 95 year old's expense base is very, very different from a 65 year old's. Could be a lot smaller (no holidays etc.) or a lot larger (medical).
Fair Deal changes the metrics somewhat.

 

[Duke of Marmalade]

Without wishing to get too morbid, the reality of living life in your 90's is not the same as living your life in your 60's, 70's or even early 80's.
To be brutally honest, you won't be able to do very much in your 90's, if you are lucky enough to live that long. Travelling, eating out, walking in Connemara, theatre trips, golfing, they require modest health, mobility and independence. So, my advice, would be to bulk up your income in the active years and not worry too much about those years spent sitting in a chair, looking out the window.
If you have family looking after you, it might be nice to give them a healthy check every month, but, hopefully, that won't be their main motivation.
Nursing home care is provided by the state, as will medical bills and, if we remain a civilised social democracy, there will be continuing assistance for you when you are elderly and infirm.

Our posts crossed.

 

[SPC100]

What no one on this thread has talked about is that life expectancy itself is highly variable.

I agree one's life expectancy is a key variable.

I started a thread on the topic of predicted life expectancy a few days before this thread started. I agree it is a key variable. The strongest advice on that thread was i think to build a model from your own relations!

https://www.askaboutmoney.com/threads/life-expectancy-predictions-for-when-i-will-die.224178/

It might be good to duplicate your graph in that thread too!

I also agree it would be interesting to have stats on expected healthspan (part of life during which you are healthy)

I have read in the past that for healthy active people (runners), tend to have a healthspan which is a high percentage of their lifespan, i.e. if you are healthy and active you can expect to not have many years in ill health.

I think the stat came from a biblical sized book for runners; It was probably biased towards presenting benefits of running.

 

[Marc]

We use this one

Longevity calculator

How long might your client live (and therefore need an income) for?

www.justadviser.com

It allows a stab at current health impact on life expectancy based on current age

 

[AJAM]

The Vanguard Target Date series gradually moves you from Stocks to Bonds as you near retirement.
This is how they manage the derisking process.

TR Fund Asset Allocations - February 2021

​

Holding	2065	2060	2055	2050	2045	2040	2035	2030	2025	2020	2015	Income
	90.3​	90.3​	90.2​	90.6​	90.6​	83.2​	75.6​	68.1​	60.5​	50.4​	36.1​	30.4​
	9.7​	9.7​	9.8​	9.4​	9.4​	16.8​	24.4​	31.9​	39.5​	49.6​	63.9​	69.6​

They start at 90% stocks and only start to reduce that 20 years from retirement (2040 on the table).
At retirement they have roughly 50:50 Stock:Bonds (2020 in the table).
5 Years into retirement they have 35:64 Stock:Bonds (2015 in the table).
The minimum amount of stock, (even 25 years into retirement), that they have allocated to stocks is 30%.

That's the US one. The UK one moves from 80% stock to 30% stocks (Again 50:50 at retirement), so a little more conservative.

 

[time to plan]

The Vanguard Target Date series gradually moves you from Stocks to Bonds as you near retirement.
This is how they manage the derisking process.

TR Fund Asset Allocations - February 2021

​

Holding	2065	2060	2055	2050	2045	2040	2035	2030	2025	2020	2015	Income
	90.3​	90.3​	90.2​	90.6​	90.6​	83.2​	75.6​	68.1​	60.5​	50.4​	36.1​	30.4​
	9.7​	9.7​	9.8​	9.4​	9.4​	16.8​	24.4​	31.9​	39.5​	49.6​	63.9​	69.6​

They start at 90% stocks and only start to reduce that 20 years from retirement (2040 on the table).
At retirement they have roughly 50:50 Stock:Bonds (2020 in the table).
5 Years into retirement they have 35:64 Stock:Bonds (2015 in the table).
The minimum amount of stock, (even 25 years into retirement), that they have allocated to stocks is 30%.

That's the US one. The UK one moves from 80% stock to 30% stocks (Again 50:50 at retirement), so a little more conservative.

Let's say the scenario is that I have a state pension, a small defined benefit occupational pension, and then a 'pension fund'. Would we expect this to decrease the % of pension fund held in cash / bonds? Given that in this example 30% (say) of a reasonable estimate of annual pension income is already de-risked?

 

[NoRegretsCoyote]

Given that in this example 30% (say) of a reasonable estimate of annual pension income is already de-risked?

Some consumption is de-risked too. Most people enter retirement with a roof over their heads and mortgage paid off, so don't have to pay out of pocket for shelter. Once you hit 70 most people get medical card, household benefits package, bus pass, etc....

 

[SPC100]

Let's say the scenario is that I have a state pension, a small defined benefit occupational pension, and then a 'pension fund'. Would we expect this to decrease the % of pension fund held in cash / bonds? Given that in this example 30% (say) of a reasonable estimate of annual pension income is already de-risked?

Yes. You have more capacity to take risk. As you have some basic standard of living already guaranteed. Whether you want or need to take it is another question.

 

[Sarenco]

The Vanguard Target Date series gradually moves you from Stocks to Bonds as you near retirement.

The problem with target date funds is that they do not take account of assets held outside the fund.

For example, somebody with significant cash savings outside their pension may not have the same incentive to de-risk their pension fund as they approach retirement.