Defining the Benefit. When to take a Defined Benefit pension.

Timing risk and when to draw a Defined Contribution pension are well documented. I was fascinated to read RIT's recent post on this in which talks about SWR and links to a video which uses historical data to illustrate that when a pension "pot" is put into drawdown is a major factor in determining whether or not it will last and that no withdrawal rate (whether 4%, or even less) can be regarded as "absolutely" safe but must be assessed in the context of the "value" of the markets at the time the pension is taken.

I was fascinated, but in a detached kind of way, because this kind of deliberation about "when" has never been considered necessary for those of us lucky enough to have index-linked DB pensions. Received wisdom is simple - never take a DB pension before scheme payment age if at all possible, actuarial reduction is to be avoided at all costs. But I've been thinking about this recently and have come to the conclusion that deciding when to take a DB pension is not that simple after all. We may think that it is but that is only because, unlike with a DC pension, it is easy to count the cost of taking the pension early, when what we should actually be doing is making some effort to measure this cost against the benefit.

As an example my own figures come out like this: (I currently have £35,000 in my SIPP and was intending to boost this up to around £50,000, retire at 58 and defer my LGPS till 65).

• Pension if I take it at 65 - £9,300. Tax free lump sum -  £13,000. (When taken this this would be partly subject to 20% tax as I have a small amount of rental income, plus state pension would become payable at 66).

• Pension if I take it at 60 - £7020. Tax free lump sum - £11,500). (This would be taken tax free until 66 as I intend to pay myself just enough out of my SIPP to take me up to the PA).

As I would get the pension for 5 years longer if I take it at 60, I will start to go into a "loss" at age 75 when I will be £2,300 pa worse off. I would therefore be down by around £35,000 if I live to 90 and this loss would increase year on year. Sounds like a bad deal and I should not even be considering it as an option if I can avoid it?

But what this calculation doesn't take into account are the benefits attached to:

• Not having to stretch our finances to allow me to retire at 58 (in other words, the pressure is off as I already have enough in my SIPP. In fact I shouldn't put any more in there as I am already at the limit of what I can use tax efficiently should I decide to access my LGPS at 60)

• Being able to take advantage of a tax free lump sum of £8,500 from my SIPP at 58 which could be re-invested in my ISA, in whole or in part. The rest of my SIPP would adequately fund the two years before I taking my LGPS.

• Being able to access my LGPS tax free lump sum and AVCs at 60 instead of 65 (when my husband would be 71 and we may not be able to put it to such good use). My TFLS/AVC fund currently stands at around £16,000 but could be bumped up to £25,000 by paying what I was going to put into my SIPP for the next two years into my AVC instead. (It is a perk of the LGPS pre-2014 that the whole of the AVC fund can be used to boost the tax free lump sum - subject to certain upper limits that don't apply to me).

• A big part of my income between 60 and 65 would be index-linked and risk free (via the LGPS) rather than managed myself via my SIPP (and therefore subject to market risk or inflation risk if I move it down into cash).

All the above add up to a clear win, for me, to taking my pension early despite the 24% reduction. This win is personal and depends on my lifestyle and situation, what it actually costs in monetary terms is just one of the considerations. After thinking it all through I'm pretty sure which way to go and have revised my targets accordingly. In fact the only one that I haven't yet hit is the one that means I need to add another £1,000 pa to my LGPS pension and that is simple to satisfy  - I just need to keep working for another 2 years.  

On a more general note, if things stay as they are with DB pensions and public sector ones in particular - which is unlikely but does provide food for thought - then it seems probable that some sort of "retirement age" gap could grow up between those with DC pensions, who let the decision on when they want to retire drive their saving and investing plans because no-one can actually tell them in advance what will be the best time to go, and those on DB pensions who just "expect" to have to stay in work until they reach scheme retirement age (which is increasingly being brought in line with State Retirement Age). Of course, there is nothing to stop DB pensioners funding (slightly) early retirement but it does need the foresight to set up an additional personal pension, a fair excess of salary over needs and a willingness to confront the horned beast of actuarial reduction, and assess the benefits of taking a hit on total pension received, in the context of the whole retirement plan, rather than with "just don't do it" blinkers on.

Knowing the financial cost of something is an advantage, but it can be a brake in just the same way as not knowing can (and maybe even more so). When deciding when to take a pension we should all make sure we take due diligence with our cost/benefit analysis and never forget that the only thing we can really be sure of is the value of time.

March 2015 Update

Portfolio Update Here.

Overall it's been another good month. At one point I actually hit my current ISA target of £70,000. This has slipped slightly again now but hopefully it will soon be consistently hovering around the mark (until we have a significant market fall that is - when and if that will happen seems to be anyone's guess so it's not worth worrying about.) For the time being I am calculating my investments with Abundance along with my ISA for the sake of simplicity. Although the interest on Abundance is taxable the recent budget changes regarding the £1000 tax free allowance on the interest on savings mean I am very unlikely to ever actually pay any tax.

I paid a fair whack into my SIPP in March (£3,000) but I have been thinking about my strategy for my pensions recently and may well be revising it (yet again). More details to follow.

On my current calculations (and current market positions) I have less than £16,000 to go to be on track for retirement in exactly 2 years time. My SIPP is key to this and I do still feel a little vulnerable to a large market drop with this. However I am protected to some extent by the CIS FSAVC which shouldn't lose much value whatever happens (famous last words). I intend to drop down to a less volatile position with the rest once I have transferred in the FSAVC around Sept time.

Since I started taking an active interest in our savings and investments one year ago I calculate that their value has increased by around £28,000 due to concentrating on budgeting and investing as much of our income as possible (around £8,000 has been in investment profit). Not bad for a year's work :-)

My Portfolio

Going forward we won't be making anything like the same kind of gains as my husband will be retiring fully in June. Still it does feel as if the bulk of the work has been done.

What's it Worth? - Putting a Value on Bricks and Mortar.

A house, just like anything else, is only worth what someone will pay for it and I have been made painfully aware of this over the last week or so because I have been trying to arrange the transfer of my parents' equity release mortgage over to a cheaper provider, with a view to releasing them some more equity in the process.

The house was valued at £240,000 around 15 years ago. Putting this figure into the Lloyds House Price Calculator produces an estimated value of £540,000 so we did think there must still be a fair amount of equity available. The guy from the equity release advisory service I spoke to agreed and he arranged a provisional transfer agreement for them which would pay off their existing loan and give them access to another £75,000 worth of equity should they require it, along with reducing the interest rate they are paying from 7.9% to 6.2%. For a halcyon few days it looked as if all my parents' troubles were over and they would be able to relax and forget all about money. They are well past the point of wanting to spend on holidays and fast cars (they are both 80) but a new telly wouldn't go amiss and neither would not having to worry about the exorbitant fuel costs their rambling old house generates (they're currently paying £380 per month to Ecotricity - a long story).

But this was all dependant on the valuation and when this came back it was a total shock. The mortgage company valued the house at £200,000 (£250,000 when essential repairs are done). The house is over 300 hundred years old, a 4 bedroom detached with a large garden. Admittedly there is a lot that needs doing to it - new bathrooms, kitchen and central heating - but the general fabric and roof of the building are solid and the land alone must be worth more than that! The valuer wrote that the house is "in a rural location with few facilities" - true, which is why the other houses in the village have all been bought up and renovated by "Escape to the Countryers" with outdoor hot tubs and floodlit decking. The location is rural but the motorway is less than 5 mins away. Perfect for commuters.

You and I would find out roughly how much our house would sell for by looking at what the neighbour or people up the street got for theirs (or by getting Zoopla to work this out for us) but this does not work in my parents' case as there is very little data to give them a baseline. Houses in the area rarely come up for sale because there are so few of them and they tend to sell at auction when they do. That's the real difference. The auction environment determines "value" in quite a different way from the highstreet. Value becomes a far more fickle thing, dependent on the immediate play off between interested parties and therefore more attached to emotion, there is no clearcut "price".

To a large extent my parents see the value of their home in much the same way - priceless. They've lived there for the last 50 years and have never seriously contemplated leaving. As my Mum said when I last asked them if they would please(!) think about selling and moving to somewhere more comfortable, nearer the shops, easier to keep clean and heat, "No, We love it here and we won't be moving". The value of the house to them isn't quantifiable. It's just a real shame that, because he had to prioritise the need for a quick, risk-free sale and reliable price, the mortgage valuer saw things much the same way but from the opposite side of the scale and the two couldn't somehow meet in the middle.

So, we're back to where we were a couple of weeks ago. If we do take the recent valuation as accurate then I am pretty sure that the house will (hopefully) go into negative equity by the time they both die. Any equity release mortgage taken up in recent years does have a "no negative equity" clause but this is a very old agreement with a company who do not belong to the Equity Release Council - the situation isn't completely clear. In actuality it matters little as my parents have no other assets that could be thrown into the mix anyway.

It has been a difficult and painful experience because the perfect solution was flashed in front of us but then whipped away, and I do feel guilty about getting their hopes up only for them to be dashed back down again. I'm going to give myself a few days and then start thinking about "Plan B" - hopefully there is one.

Pension Fund Fury

I don't intend this post to be a defence or justification of public sector pensions nor an apology for the fact that both my husband and I are lucky enough to have one. I've been reading the MSE forums for long enough to grow a fairly thick skin about the predictable "gold plated public sector pension subsidised by the tax payer" stance taken by some posters on a regular basis (as an example latest rant here) , although I have found myself getting quite defensive at times when a seemingly innocent question about pension scheme rules will raise a hornets' nest of vitriol against the poster for happening to work in the public sector but not realising just how "lucky" they are. Of course there is a very valid point in there alongside all the "politics of envy" that gets displayed. (Please note - My tongue is pretty firmly in my cheek here as that particular phrase is very often used by exactly the same people but in quite a different context :-))

No truly, I do agree, public sector DB pensions are not sustainable and don't suit today's work patterns and life expectancy. However, the changing pension landscape will mean that public sector salaries will have to be raised to recruit and retain. For example my husband will retire from the Civil Service this year after doing 35 years during which he brought in tens of £millions of revenue. His final salary as a Higher Executive Officer was £32,000 and his pension is £12,000. He chose pension, job security and lower levels of stress (he's also had serious health problems in the past which might well have lost him his job in some parts of the private sector) but he did have to sacrifice salary. It was a choice, not luck.

But I digress and am in danger of doing exactly what I said I wasn't going to do so here is the real subject of this post: "A Pensions Patchwork" - BBC Radio 4. I was sent the link by a friend and have been feeling intermittently incensed ever since.

I don't expect anyone who isn't a member of the LGPS to have the staying power to listen to the whole 38 mins of the programme (although actually maybe you should as it turns out that it is your money that's getting wasted). But in case you're short on time here is the introduction:

"In Canada, everything is big - including powerful pension funds such as the Ontario Teachers fund which owns half of Birmingham airport and other large projects around the world. It's all a far cry from the British pension scene, where a hundred local government pension funds each run their own affairs separately and pay costly fees to City firms for investment advice. Many of them still have financial deficits. Taxpayers have been forced to pick up bills to pay off those shortfalls and already hard-pressed local services have been stretched further. Lesley Curwen investigates how these individual funds are run and asks whether we should have larger funds with cheaper costs - like Canada does. And she asks whether more councils should be using pension money to invest in housing and infrastructure as a way to boost their local economies?

And here are the main points I took away from the programme:

• The LGPS is a "fractured, cumbersome" structure which, although it is to all intents and purposes one occupational pension scheme, is divided up into over 100 funds each having its own admin function, infrastructure and fund managers. 

• On average the 89 funds in England and Wales are 21% underfunded which means there is a deficit of around £47 billion which can only get worse due to low interest rates and increasing life expectancy. The deficit has to be made up by the employer (ie the Local Authority and therefore the taxpayer).

• Local Authorities are already struggling with massive cuts to their budgets and this is yet another pressure on those budgets.The example of Birmingham City Council is given. The Council needs to make £101 million cuts due to loss of funding and it also owes the West Midlands pension fund £23 million to make up a deficit. The cuts will impact the flagship new library which is well used by tourists and locals alike. Weekly opening hours will be cut from 70 down to 40. 90 staff will be made redundant.

• The LGPS as a whole pays out a massive amount in fund management costs. A figure of £597 million is quoted for one year's costs and this figure does not include dealing costs which seem to be much higher than they need to be due to over trading by as much as 500%. Although there has been no detailed analysis made of the trading costs they could easily be adding another billion to fund management charges. 

• Councillors are often ill-equipped to made informed investment decisions so they rarely challenge or question fund managers about performance.

• John Clancy, a Birmingham councillor has studied the costs in more detail. He found that costs had gone up 20% in just one year although returns had halved. He discusses the issue further along with Michael Johnson from the Institute of Policy Studies in a blog post here

• Unison officials are also very concerned and agree with financial experts who advise that larger, regional funds should be created which can then employ their own fund managers instead of paying independent managers and "funding the buildings in Canary Wharfe" .

• The last words go to Michael Johnson who calls the LGPS a "national embarrassment" whose structure "acts to the detriment of members and taxpayers". Unfortunately he isn't hopeful of change any time soon because "the vested interests that oppose change... are very considerable....Imagine the screams of pain from the Investment Management Industry and bear in mind how political parties are funded in this country and draw your own conclusions".

This whole mess is made even more tragic given the fact that the majority of the members of the LGPS are fairly low paid workers (although there are some very highly paid managers at the top - in fact obscenely highly paid as ermines's recent post states). A typical pension for a fairly long serving worker is somewhere between £7,000 - £10,000 with a retirement age of 66. (My own will be around £9,000).

Despite public perception to the contrary, the true situation isn't a simple case of the typical local authority worker leeching the tax payer to fund her pension - that job is being done far more effectively (and cynically) by fund managers supplementing their already bloated salaries, aided and abetted by councillors making decisions on things of which they have very little knowledge.

Divesting and the Carbon Bubble

I was interested to read recently about Norway's largest sovereign wealth fund, the Government Pension Fund Global (apparently the world's richest fund) dropping some of its shares in fossil fuel funds.
This wasn't an "ethical" move, as such, but one that was driven by the belief that the fund was in danger of being invested in companies who would be unable to realise expected profits without breaching legislation outlawing the removal of the remaining fossil fuel reserves. This move is:

 "part of a fast-growing campaign...over $50bn in fossil fuel company stocks have been divested by 180 organisations on the basis that their business models are incompatible with the pledge by the world’s governments to tackle global warming. But the GPFG is the highest profile institution to divest to date."

However it still invests heavily in fossil fuels and has since reinvested some of those resources into oil and gas. The general trend, though, is encouraging and the pressure on large investment bodies to reassess and justify where they put their money is definitely growing.

Part of this pressure comes from warnings such as that made by Mark Carney (Bank of England governor) back in October that "most carbon fuel is unburnable". His argument is supported by evidence from studies into the concept of the Carbon Bubble which conclude that the shares of companies involved in fossil fuels are overvalued due to the fact that their value is calculated with the "assumption that all fossil fuel reserves will be available to be consumed". Whereas in fact:

"... A series of analyses have shown that only a quarter of known and exploitable fossil fuels can be burned if temperatures are to be kept below 2C, the internationally agreed danger limit. 

The divestment movement is growing in response to this realisation. Members of several large Danish pension funds are to be asked to vote on divestment and, closer to home Boris Johnson has been called on by the London Assembly to "change the city's investment policy to exclude fossil fuels."

Now, it will be no surprise to anyone out there that I am a Guardian reader but I make no apology for the number of references to the paper as a source for this post. The current editor (Alan Rusbridger) is stepping down over the Summer and, when looking back over his career he finds that he few regrets 

...  except this one: that we had not done justice to this huge, overshadowing, overwhelming issue of how climate change will probably, within the lifetime of our children, cause untold havoc and stress to our species. So, in the time left to me as editor, I thought I would try to harness the Guardian’s best resources to describe what is happening and what – if we do nothing – is almost certain to occur, a future that one distinguished scientist has termed as “incompatible with any reasonable characterisation of an organised, equitable and civilised global community”.

My last quote given below comes from a particularly powerful article which makes a key point by questioning the effectiveness of relying on broader reasons to persuade investors to divest due to one of the key characteristics of the typical investor -  how they are prone to isolate the process of investing from the actual purpose of money and the part it plays in their lives.

 "Indeed, investors often fetishise monetary returns without thinking about the world in which those monetary returns will have to be spent. This is partially due to misunderstanding the nature of money, which is best thought of not as an independent “thing”, but rather as a claim upon society. What is the point of amassing such monetary claims if the society in which I can use them in has become a lot less liveable?"

So many people worry about inheritance tax. They go through all sorts of loops to pass on their pensions and property and preserve their assets for their children without even acknowledging the truth that none of this will be of much help to those children in a world completely destabilised by climate change. Logic should now dictate the course of action to both institutions and individuals. No-one should need persuading any more. In the case of climate change I fear we have already got past the stage of fiddling our way through the burning and it's now just a matter of how much damage limitation we can plaster over the wound.

This particular issue is very close to my heart but the quote about the way that investors "fetishise" money also sparked my interest in a more general way. I see it in myself, the slavish obsession with tweaking spreadsheets, calculating strategies to claim back and avoid paying tax (incidentally something I'm beginning to feel more and more uncomfortable with - I have a feeling that I should be examining my own "fetishistic" behaviour in this particular arena and comparing it with the kind of world I actually want to live in), fiddling about trying obsessively to lower charges and generally spending lots of my valuable "free" time doing things that I have not "costed" against the returns.. maybe one for a later post.

Graphic via Wikipedia

The Mystique of the Market and the Common Man

I started this blog about a year ago now so I thought I'd take another look at the "theme" I chose when I did so - the idea that investing is a dark art accessible only to the select few. The slant I took was, of course, a little tongue-in-cheek, but there is a serious side to this issue. The proportion of the population who invest in the markets (other than in a "second hand way" via their pension funds - and in this case many people don't even realise this is what is happening) is very small.

The Stocks and Shares ISA, which is the most accessible and widely publicised route into investing, is still a very poor relation to the Cash ISA and this trend has changed very little despite the very poor returns of cash ISAs in recent years. Statistics show that Cash ISAs consistently form over 70% of the total takeup.¹
This disparity is also reflected in the PF blogscape and on sites such as MSE. There are still relatively few UK investment bloggers, and the majority of these are people who work, or have worked, in banking or financial institutions, so cannot consider themselves ordinary mortals :-). (The situation in the US seems to be a little different where Dividend Investing is more popular).

Despite the relative lack of involvement in investing in the UK there's certainly no lack of interest in money itself, evidenced by the vast amount of Budgeting, Saving and DebtFree blogging and forum participation going on.

Why should this be?

Looking back at my own journey I can understand the reticence people feel. For most of us money is hard earned and we are very loath to "play" with it. I believe that this is a pivotal point. Money, for the majority of people, is something that is tied tightly to work. We earn it. It is not something that can be grown. It really does not "grow on trees". However, the select few who grow up in a culture of inheritance see things from a very different point of view. For them what essentially makes money is money itself, compound interest is their biggest friend and volatility holds no real fear. There's a whole different mindset involved and it's one which it is difficult to introduce to people who actually need what they've got and would really struggle if it was lost.

Putting a little away in a savings account and watching it grow slowly is one thing, but tossing it into the seething cauldron of the stock market feels very much like losing control. In the eyes of the general public investing still has that impenetrable fence of, danger, magic, and privilege surrounding it. You need financial qualifications and "insider" knowledge to be able to invest, or you need to be able to pay someone who does. It's much safer to stay on the other side of that fence.

This apprehension is gradually being addressed by the increasing availability of advice and information on the Internet forums such as MSE, blogs such as Monevator, and the DIY platforms themselves. Helpful "Investing Made Easy" books are readily available and understandable. I have used of a lot of this material myself over the last year and I'm really grateful for the time taken by the authors and participants to help and inform. But all this help should be making more inroads than it is.

I suppose we could ask why does it matter? If the majority of people are not comfortable with investing then why should they be encouraged to do so. This might be a sensible response in a world where not so much lay at the door of the individual. In the days of the Defined Benefit pension and co-operative financial institutions such as Building Societies personal finance didn't need to be quite so personal. However many sensible people these days are not even including receiving a state pension in their financial planning. It seems that, (sadly in my opinion - and dangerously too) the state is "letting go" of its responsibility to be mindful of the financial well-being of all its citizens.

Earned wealth is dropping and "grown" wealth is growing. This makes it even more important that ordinary people (what used to equate to the working and lower middle class) start to see the benefit of investing their money. Maybe the newer types of "investment" that don't carry the old fear factor - things like peer-to-peer lending and crowd funding might be a less daunting way into the whole process for some people. Despite the fact that they are often inherently just as risky, they do seem more transparent than the whole cult of "Wealth Management", with its performance charts, asset allocation, diversification, ETFs, Bonds and a multitude of other incomprehensible terms, rules, calculations and acronyms.

All in all, I have had a very interesting year teaching myself the ways of the dark art. I have learnt a lot and although I know that I still have a lot to learn, I have found the whole process incredibly satisfying and engaging. What worries me is that most people don't have the time, inclination or interest to do the legwork, nor the money to pay someone else to do it for them. This fact will do nothing to halt the growing trend towards wealth inequality.



Investing still isn't simple enough, probably because it isn't in the interest of the industry to make it so. This is something we should all be concerned about.

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1 HM Revenue and Customs ISA Statistics^↩

February 2015 Update

February's update here

The markets have been kind this month so there is very little red in my portfolio. My biggest monthly addition continues to be £1000 into my SIPP which I will be making until my husband retires in July. I'm still working on my strategy for the SIPP after that, but as it is pretty pivotal to my being able to retire in two years' time, it's important that I get it right.

I've also started investing in "Abundance" this month which I'm hoping will be something I can add to when we have any spare cash. I like the way that chunks of capital are returned each year, as well as interest paid, as this suits my time scales for when I will need the money (and it also allows me to support clean energy production).

All in all, a quiet but productive month, just the way we like it :-)

Summary Feb 2015
Total Funds Outstanding £22,284.95