What is the best mix of cash, equities, or annuities in retirement?

[3CC]

I’d be grateful if anyone could give an opinion on the following.

I have been trying to figure out the best approach to investments during retirement. I have read about the bucket strategy including the post below and I have played with some figures. I tried a few different approaches and I reckon that, using the bucket strategy, I have about a 20% probability of running out of cash and ~ 65% chance of leaving a large amount unspent when I die which is not really what I want.

https://www.askaboutmoney.com/threads/thoughts-on-the-three-bucket-strategy.236445/

It’s just too hard to get a fixed income from an equity-based investment given the potential volatility.

So I am starting to think that the bucket strategy might not be the best fit for me.

Rather than think of expenditure in retirement in terms of slices of time (near, medium, and long term) as the bucket strategy does, I am thinking that it might be better to think of it in layers of expenditure for example (1) essential spending required to avoid poverty, (2) nice-to-have spending which will increase quality of life, and (3) frivolous spending on sports cars and yachts.

So maybe the best approach is to ensure that the essential spending is covered by fixed income sources such as state pension(s), defined benefit pensions and maybe an annuity if necessary. That will keep you off the bread line for the rest of your days.

If you still have some wealth after that, this could be allocated to quality-of-life spending. This could be made up of a mixture of an annuity and equities, depending on your risk tolerance. Maybe 50% annuity and 50% equities.

If you have anything left after that, you can afford to put that into equities. On average the returns will be better. You could get caught out, but even if you do, you will still live comfortably.

I think all this makes sense, but it would great to get the opinions of others as well.

Thanks…

 

[conor_mc]

Two Sides of FI did a good podcast on this with similar thoughts to your own re buckets of fixed/discretionary/frivolous spending. Two sides of FI

 

[Brendan Burgess]

Hi 3CC

I have a Key Post on it here - it's from 10 years ago and I will review it to see if anything has changed.

https://www.askaboutmoney.com/threads/i-am-65-–-where-should-i-invest-my-life-savings.185577/

Eamon Porter had an excellent article as well

Key Post - "Should the elderly be less conservative investors?"

There was an excellent article by Eamon Porter in the Sunday Times on this topic. As the ST is not available online, you can read a similar version on the author's blog https://www.aspire-wealth.com/about-aspire-wealth-management-dublin/

www.askaboutmoney.com

 

[conor_mc]

Somewhat in line with above, glidepath investing is about mitigating sequence of returns risk at its potentially most damaging point (early in retirement) whilst ensuring sufficient portfolio growth throughout retirement. To that end, we tend to think safe at retirement and stay “safe” when it seems at least for historic US-based cohorts, they would have done better by decreasing equity exposure prior to retirement but then subsequently increasing equity exposure after 10 or so years. Some great posts and tools to examine this on the EarlyRetirementNow blog.

 

[Brendan Burgess]

I have about a 20% probability of running out of cash and ~ 65% chance of leaving a large amount unspent when I die which is not really what I want.

Maybe do a Moneymakeover post and get the crowd wisdom?

What does running out of cash actually mean? You will have the OAP I presume? And if you own your own home, you will be able to get a lifetime mortgage.

Brendan

 

[Dr Strangelove]

Use of the tax-free lump sum is important too. Say you retire and 65 and take out €150k and renovate your house and buy a new car. You get to enjoy the benefits for a decade or more. This is a kind of investment return that doesn't fluctuate with the market.

What does running out of cash actually mean? You will have the OAP I presume? And if you own your own home, you will be able to get a lifetime mortgage.

You have to realistically profile your own expenditure as well which will decline over time. People lucky enough to live to their late 80s tend not to have much discretionary spending.

 

[SquirrelChaser]

When I retire I'll keep my AVCs/ARF 100% in an index tracker. Because in the long term that's always the best return. Annuities and bonds are a waste of cash in my opinion.

I plan to take the minimum 4% or 5% annually from my ARF. As it'll be 4/5% of the remaining balance it'll never run dry.

My lump sum will als go into an index tracker, maybe after i buy a new car and have a blowout holiday. My house is already renovated and my mortgage will be paid off years before I retire.

I consider my defined benefit & COAP pensions to be my fallback- they'll keep the wolf from the door and then some if my AVCs get shredded by the market.

 

[Brendan Burgess]

My lump sum will als go into an index tracker,

The problem with that is that direct ownership of shares is much more tax efficient if you expect to still have wealth when you die.

On death, the Capital Gains disappear. If you have a fund, it is likely that you will pay tax every 8 years and exit tax when you die.

 

[Bluefin]

Use of the tax-free lump sum is important too. Say you retire and 65 and take out €150k and renovate your house and buy a new car. You get to enjoy the benefits for a decade or more. This is a kind of investment return that doesn't fluctuate with the market.


You have to realistically profile your own expenditure as well which will decline over time. People lucky enough to live to their late 80s tend not to have much discretionary spending.

If at all possible I think people should aim to have this completed before they retire and maybe purchase a 2/3 year old car as well.
Then you can have lots of fun with your lump sum before time catches up.

 

[GSheehy]

The problem with that is that direct ownership of shares is much more tax efficient if you expect to still have wealth when you die.

SquirrelChaser doesn't strike me as someone who is currently saving for someone else's future.

On death, the Capital Gains disappear

...but CAT doesn't.

If you have a fund, it is likely that you will pay tax every 8 years and exit tax when you die.

...and you'll get a credit towards your CAT liability with the exit tax you've paid.

 

[SquirrelChaser]

The problem with that is that direct ownership of shares is much more tax efficient if you expect to still have wealth when you die.

On death, the Capital Gains disappear. If you have a fund, it is likely that you will pay tax every 8 years and exit tax when you die.

As far as I'm aware direct ownership of shares isn't an option through an ARF? And honestly even if it is I've no really of going to the hassle of replicating an index fund through direct share purchase, whether with my ARF or lump sum. An index tracker also has the benefit of minimising the required effort.

SquirrelChaser doesn't strike me as someone who is currently saving for someone else's future.

I have no intention of living poor so I can die rich for the benefit of my heirs. I would anyway hope that my dependents will be reasonably independent from me financially by the time I die. And if they're not largely financially independent from me when I die (assuming I reach the average age), realistically there's no amount of cash or assets they won't burn through in short order if I leave it to them as part of my estate.

There's a very strong argument that the most valuable financial legacy I can leave my dependents is an ability to manage and improve their own financial wellbeing.

So minimising the tax burden on my heirs isn't my highest priority, no!

 

[Brendan Burgess]

I have been trying to figure out the best approach to investments during retirement.

As far as I'm aware direct ownership of shares isn't an option through an ARF?

My lump sum will als go into an index tracker,

There would be no advantage in owning individual shares in an ARF.

But for your "lump sum" which I assume to be your 25% tax free and for the OP's question, the best approach is to own shares directly.

But in your case where you don't mind paying more tax than necessary, a unit-linked fund is fine.

Brendan

 

[Brendan Burgess]

you'll get a credit towards your CAT liability with the exit tax you've paid.

Most people pay no CAT so this will not be relevant.

I know that you can get a credit for the CGT paid on any CAT on a gift, but how does the exit tax work?

And presumably it's only the exit tax and not the tax paid every 8 years?

 

[3CC]

Hi Everyone,

Thanks for all that feedback. It took me a while to read through everything but it was very helpful.

I probably should have been clearer in my OP - I am asking a general question here rather than something which is specific to my own situation.

Systems like the bucket strategy seem to be popular probably because they are simple to understand. (The same could be said of life-styling.) But there is quite a bit of evidence that both of these approaches might not be optimal.

Is there an alternative system which would be easy to understand and would suit most people most of the time? For example:

• Figure out your essential income in retirement.
• If possible, make sure you can service that from defined benefit escalating sources (such as state pensions and annuities with escalation).
• After that, put aside whatever cash you intend to spend on one-off big items in the early years of retirement like that round the world trip. (TFLS from pensions can be a good way to do this.)
• The best thing to do with the rest of your wealth, if there is any, is to invest in equities. You can use this for discretionary expenditure whenever you want. Whatever you don’t spend will end up in your estate when you die.
• Note 1: If you are risk averse, just bump up the amount you want in essential income to your liking.
• Note 2: Get some advice if you don’t understand your income requirements or your emotional/financial tolerance for risk.
• Note 3: This applies to the usual retiree scenario. Retiring in your early – mid sixties, expecting to live into your 80s.

What do you think? Is this a good rule of thumb for most people or have I oversimplified things too much?

 

[GSheehy]

Most people pay no CAT so this will not be relevant.

Most people won't have share portfolios that they intend holding until after they die.

A seprate thread on 'The Potential Tax Implications of Saving/Investing for Someone Else's Future' would be interesting.

I know that you can get a credit for the CGT paid on any CAT on a gift, but how does the exit tax work?

And presumably it's only the exit tax and not the tax paid every 8 years?

There's a worked out example on the attached for the scenario that you describe on the last page.

But in your case where you don't mind paying more tax than necessary, a unit-linked fund is fine.

You have absolutely no idea what tax regime will apply to any savings/investment/pension product that SquirrelChaser may buy when they comes to retirememt age.

We now know that LAET/Exit Tax rates are on the way down. We now know that deemed disposal will probably be removed. We now know that there may be some facility to offset losses/gains on ETFs/Unit-Linked Funds.

On SquirrellChaser's pension, I would be confident (only because it makes so much sense) that they will be able to leave whatever portion of their TFC in the vested-PRSA/ARF that they want to and draw it down over period of years, as opposed to being forced to take it all out at 'retirement age'. A Vested-PRSA that would allow that would be a win for the provider, the customer and the Pensions Authority.

The ARF will probably become surplus to requirements for most people now that you can mature your PRSA and stay in a Vested PRSA as the costs of the Vested PRSAs have come down to such an extent that, in some cases, they are now less expensive than ARFs. Particularly for those who want index tracking funds only.

Sorry @3CC for taking it off topic but the cost of those equities you mention in the post-retirement product structure that folk may choose would probably be of relevance to many reading your thread. As would a future Vested PRSA with the above feature.

 

[Brendan Burgess]

Most people won't have share portfolios that they intend holding until after they die.

Sorry Ger.

This is a completely spurious argument that you are making.

Let's say someone has €200k to invest at age 65 - outside their pension. The OP seemed to be asking about investing outside their pension so the pension rules are irrelevant to where someone should invest their money outside their pension.
Let's say that they live to age 85.
If they invest that in directly owned shares and live within their income, they will probably have substantial capital gains when they die.
Those capital gains will disappear on death. Depending on their other assets and the number of beneficiaries, those beneficiaries may or may not have a CAT liability.

If they invest in a life product, they will have a tax liability every 8 years if the product rises in value.

Summary
1) Invest in a life product at age 65 and you will have a tax liability.
2) Invest in shares and your CGT liability will disappear on death.

Your beneficiaries may have a lower CAT liability on death if you invest in a life product, but that is because they are inheriting less.

 

[Brendan Burgess]

The legislation may indeed change, but it's better to plan on the basis of today's legislation.

I advocate for the removal of the expiry of Capital Gains on death.
I think that the 8 year rule for life funds is stupid.

 

[Brendan Burgess]

To save people trawling through that document, here is the example:

Credit against Inheritance Tax
Where Exit Tax is payable as a result of a claim on the death of a life assured, the amount of Exit Tax may be offset against any Inheritance Tax liability arising for the beneficiary of the plan on the plan proceeds.

It is important to note that the beneficiaries Inheritance Tax liability is calculated based on the value of the plan before Exit
Tax was deducted.

An example of how this works
On Joe Smart’s death his original investment of €100,000 in a Life Bond has achieved a gross investment return of 50%
i.e. gross value €150,000 leaving a net €129,500 after payment of €20,500 Exit Tax at 41%.

Let’s assume he leaves this investment to his daughter Lucy. Assuming Lucy has received additional inheritances and
therefore used up her tax free threshold the full value of the bond is liable to Inheritance Tax at 33%.

Lucy is deemed to have received a taxable inheritance of €150,000 from which €20,500, Exit Tax, has been deducted.
The Inheritance Tax liability is calculated based on the ‘gross value’ i.e. €150,000, on which the estimated Inheritance Tax
liability at 33% is €49,500. This amount can then be reduced by ‘offsetting’ the ‘Exit Tax’ of €20,500 (in this example)
which has been deducted.

 

[Brendan Burgess]

@GSheehy

It does not deal with the deemed disposal

Using the above example.
If Joe invests €100k in a life bond at age 60 and at age 68, it's worth €150k, he will have a deemed disposal and pay €20,500 tax.

If his net of €129,500 does not change in value over the next two years and he dies aged 70, can Lucy set the €20,500 against the CAT payable?

 

[Fortune]

@GSheehy

It does not deal with the deemed disposal

Using the above example.
If Joe invests €100k in a life bond at age 60 and at age 68, it's worth €150k, he will have a deemed disposal and pay €20,500 tax.

If his net of €129,500 does not change in value over the next two years and he dies aged 70, can Lucy set the €20,500 against the CAT payable?

And to slightly modify the example again, what if the value drops after deemed disposal exit tax is paid? How does the edit tax rebate feed into the CAT tax calculation?