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How to generate an income from your savings

With the right mix of assets you can make 7% a year over the long term, says Mike Deverell of Equilibrium Asset Management.

 

Say you receive a total return of 8% in a year and require 5% a year to fund your income. Does it make any difference whether you take this from income or capital?

In fact, for non-pension portfolios there is a real tax benefit to taking regular capital withdrawals. You can make capital gains of up to £10,600 in a year without paying capital gains tax.

Say you had a portfolio of £300,000 and made a return of 10%. The gain is £30,000 on the total portfolio; however, you only pay tax on gains you crystallise. For example, if you encashed £110,000, you have only crystallised a capital gain of £10,000.

It is therefore possible to take a very high level of regular capital withdrawals without having to pay tax.

Sustainable return

A sensible mix of the above asset classes should be able to generate a total return of over 7% a year on average over the long term.

This level of return should be enough to produce a decent income from a mix of yield and capital, and protect against inflation.

Equilibrium Asset Management features in Adviser Finder

The opinions expressed in this article are those of the author and do not constitute advice.

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32 comments so far. Why not have your say?

Hugo First

Aug 07, 2012 at 06:14

A sensible and balanced article.

It may be worth pointing out, as the article is not clear, that the 7% return quoted as a reasonable target is presumably the "nominal" or "cash" rate of return. The "real" rate of return would be 7% less the expected rate of inflation. Shares and funds invested in shares provide some protection against inflation as company profits, and hence dividends, are expected to grow over time.

If long-run inflation is 2.5% per year, then your 7% nominal return might become 4.5% "real" return. Of course, inflation has been higher than this recently, so real returns have been even lower.

This shows the importance of paying attention to costs. If you are only expecting to earn 4.5% real return, then costs become very important. That low cost tracker fund with costs of 0.3 % to 0.5% per annum, suddenly looks attractive compared to an actively managed fund where costs may be 1.5% - 2.0% per annum or more. The active fund manager has to really outperform his index to justify his costs. Very few actually manage it over an extended period, and in 30 years' investing I have not found any reliable way to predict which funds will perform in the future.

Finally, in the example on taking capital gains as income, it may be worth pointing out that, of the £110,000 encashed, you would of course take £10,000 net as income (potentially free of income and capital gains tax), and reinvest the remaining £100,000 back into the portfolio.

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alan franklin

Aug 07, 2012 at 07:37

An annuity is like a tax on the lazy or ill-advised: you would have to be very silly indeed to voluntarily buy one of these heaps of financial garbage.

I am angry that, when I reach 77, the government - in its typical arrogant, ill-informed way - is likely to force me to buy one of these surefire ways to get little or no return.

I sincerely hope to deplete as much as possible of our own- self administered - pension plan long before then.

I have managed our own private company pension for many years, with great success, and have drawn down the legal maximum plus paid myself the max allowed for management.

Currently our annual dividend return averages well over five per cent overall, despite some dogs like Lloyds Bank in the portfolio (thanks Gordon "braindead" Brown.) This is not counting capital gain, which is also considerable. For example, I bought Britvic and BAE at recent lows and they have risen a lot. But I only go for top dividend stocks, to gain both ways.

The way to a good retirement income is fairly simple (Although of retirement age I am far from "retired" although mostly work voluntarily now.)

Diversify. Build up your private pension but, if possible, also buy some property. I would also have a percentage of your money in gold, which is cerytain to rise a lot over a year or two as governments continue to foul up the world economy. Also buy stocks outside your pension scheme, which is far too strictly controlled for my liking.

If you can buy some Canadian stocks as this will be one of the countries least affected by the coming troubles. Today I am buying BCE -Bell Canada-on a yield of five per cent.

This is not a time to take risks as I am anticipating wars and financial mayhem, so I wouldn't be risking big debt at this time - we pulled out of a property deal last week as people were overbidding. I would also not touch insurance companies at any price, with wars looming.

However, most people who are prepared to research, which has never been easier, can run their own pensions and prepare well for their older years provided they are prudent.

No need whatsoever for expensive middle men.

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Chris Dickson

Aug 07, 2012 at 08:36

If you invest in a company through Zopa or Fundingcircle, and the company qualifies for SEIS, which is very likely, you will make a 50 % ( of your investment ) saving on your Income Tax, and a 28 % saving against a Capital Gain. However, you only have until April 2013 to find a company that needs your money.

My new idea does - any takers ?

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James Muir

Aug 07, 2012 at 08:55

This is a good article as are all the initial comments. I have a SIPP and will be starting to draw down income probably from next year. Alan Franklin's comments are especially appropriate for me. You mention how you self-manage your draw-down and "pay myself the legal maximum allowed for management". I'm not aware of that possibility. What is the legal maximum?

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Hotrod

Aug 07, 2012 at 09:42

The examples described in this article appears to me to be an attempt to stretch the cloth to make the suit that you want.

Personally I prefer to organise my finances on a simplier model.

How many readers have £300,000 of investments which they could readily access? I suspect, not very many, and even if they do, they would most likely of built up this capital over many years.

If the capital gain has been compounded for twenty years at 5%, it would represent a 100% gain.

In which case £110,000 divided by 2 = £55,000 minus £10,600 = £44,400 subject to CGT @ flat rate of 18% = £7,992 tax to pay.

So you would now have invested capital of £190,000 plus £102,008 in cash.

In these uncertain times it could be argued that this would represent a sensible split to protect ones capital against market crashes, but I cannot see any sense in making such a move to gain advantage from an income perspective, unless years of life left are so short that you intend to "blow" the whole lot!

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The ssinnic

Aug 07, 2012 at 10:17

@james muir

Yes what is it? Is it another "bankers dodgey trick"?

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JMM

Aug 07, 2012 at 10:33

alan franklin 'An annuity is like a tax on the lazy or ill-advised: you would have to be very silly indeed to voluntarily buy one of these heaps of financial garbage.'

Totally agree until the rules are changed why save anything in a pension wrapper, if you are capable of managing you own money then a self invested ISA can build a remarkable pension pot whith no restrictions on what you can do with your money in retirement and no income tax or capital gains tax to worry about. Why go for the lure of tax relief on pension contributions when you are going to be taxed on income from your pension in retirement when you can least afford it.

I do think its about time our dear Chancellor woke up to the power of funds saved in ISA's and allowed switch back into cash ISA's when savers need a safer home for their money or at least part of it. Think what that could do for freeing up funds the banks could then lend to British small business.

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The ssinnic

Aug 07, 2012 at 12:27

@JMM

Well said JMM... this is the most important post ever made on this board! Unfortunately the politicians are (ill)advised by Old Etonians at the Treasury who don't need silly things like pensions so the perpetuity of the ridiculous will continue for ever and ever Amen!

Can anyone let me know how I can charge my SIPP a fee for running it? I am seriously intrigued by this.

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C Robertson

Aug 07, 2012 at 13:35

This is an interesting article but rarely do we learn about how final salary schemes work out. I worked with a leading firm of chartered accountants for over 30 years and on retiring in 1990 I drew down a lump sum. The balance was supplemented by £30,000 I contributed over the years by AVCs. I had been given to expect that the pension would be uprated by RPIs but since 1997 the pension has been vitually static apart from a lump sum augmentation four years ago. Over the previous seven years the pension increase totalled only £114! Pensions for post-1997 retirees only have been RPI uplifted. I have criticised the inequitable distributions by the Scheme but the firm has not replied to this. What is the experience of others to first-salary schemes in operation?

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Jazz52

Aug 07, 2012 at 16:05

Hotrod has rather missed the point of compounding. Capital compounding annually at 5% would increase by 100% after just over14 years and because of the magic of compounding would have grown by 165% after 20.

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DIY

Aug 07, 2012 at 16:17

Yes indeed, well said JMM and Ssinnic, but let's be cautious about trumpeting the massive merits of ISAs. With more people catching on we can bet that Ed Balls or A.N.Other will tax and/or limit and/or abolish them first chance he gets!

Yes, pensions are a scam. Any money left once you die, and the balance gets taxed at 55% when passed on to your heirs. That is over and above the income tax already paid on pension money drawn whilst you are still breathing. And we think the Banks are bad . . . . . . . . .

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Jonathan

Aug 07, 2012 at 16:49

"How to generate an income from your savings" -> "The drawdown option"

So basically spend it! Not exactly rocket science but at the moment it seems one only methods without managers taking a large cut and no risk of loss.

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The ssinnic

Aug 07, 2012 at 16:53

@Alan Franklin

Sounds as if BAerospace is a share for you! Are Krupps still on the go?

Wars are generally good for the Stockmarket.

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Hotrod

Aug 07, 2012 at 17:06

@Jazz52

I fully understand your computation, but the figures I mentioned were intended as a simple illustration of capital growth discounted back twenty years.

I doubt very much whether anyone's investments would have followed such a consistent pattern over twenty years. In the lean years the investor would have had to accept no growth at all or endure a loss, but if he continued to invest at the same rate his investment capital would increase more rapidly when markets recovered.

The actual computation is different for everyone because it depends on one's attitude to risk, and the investment decisions one makes during rising and falling markets.

Five years of steadily increasing growth can be wiped out in hours when markets crash, likewise fortunes have been made by pumping money into the upwave. Judging when to sell out will always be the most difficult question.

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BONZO

Aug 07, 2012 at 18:30

RE PROPERTY

STD LIFE PROPERTY INVESTMENT TRUST YIELD + 7%. HAVE HELD OVER SOME YEARS AND OBTAINED ACCEPTABLE CAP GROWTH AS WELL

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Mike Deverell

Aug 09, 2012 at 10:00

Thanks for all the feedback and the comments.

It seems there is a real negativity on this forum towards pensions, much of which is unfounded.

There seems to be a real misunderstanding of the pension rules and the benefits, so I’d like to make a few points.

There is no longer the compulsion to buy an annuity at age 75. Drawdown can continue after age 75, and can even continue being paid to a spouse on death. The main difference post 75 is that the amount you can take is reviewed annually.

New “flexible drawdown” rules actually allow you to draw as much as you like from your pension PROVIDED you have £20,000 of secured income from elsewhere. This includes your state pension, so if you have a state pension of say £9,500 and an occupational pension of £10,500, then you could qualify for flexible drawdown. This means you could draw out your whole fund if you wanted, although it would be taxable.

Pensions are a vital long term savings vehicle because of the tax relief. For a basic rate taxpayer, every £4,000 you put in your pension is immediately turned into £5,000. Compound growth on this over the long term makes a huge difference compared with investing in an ISA.

It is true that you then have to pay tax on your pension income, but 25% of your fund can be taken tax free. You can even phase this so as not to take it all at once.

I don’t believe that paying yourself to manage your pension would work, unless you happened to be FSA authorised and can charge yourself an advice fee! I expect this would be classed as an unauthorised withdrawal and subject to a big penalty, so I would advise readers to be very careful.

These rules can be complex and I would suggest readers seek professional advice. Citywire’s adviser finder can help you find a well-qualified, fee based (not commission) pension planner.

Hotrod, regarding my CGT calculations... I am suggesting that a good piece of planning is to make sure you use your CGT allowance every year. Even if you do not use it to provide an “income”, you could sell enough shares to fund your ISA allowance every year. By using at least part of your allowance each year, you should avoid a large tax bill in the long term.

Bonzo – property has indeed made some great returns in the past. I personally believe that it may be a difficult period in the future.

With reference to the Standard Life Property Investment Trust you mention, I notice that the share price has risen by 19% over the past 12 months. However, the NAV (the actual value of the properties) has fallen by 3.1%. This perhaps illustrates why I have concerns about the underlying asset class, which ultimately will drive this fund’s performance.

I hope some of these comments are helpful.

Mike Deverell (author of article)

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The ssinnic

Aug 09, 2012 at 10:15

@Mike Deverell

Thanks Mike , but I would like you to clarify this for me please:

In your paragrapg 5 you state "...draw as much as you like....."

I have a SIPP worth £1M. I realise I can take £250K tax free. Are you saying I can now take the other £750K as a pension (less Inc Tax)...so if a basic taxpayer @20% say, can I take the net £600K out in one go..assuming my other income is £20K secured. And if so that's the end of it..I would be no longer swubject to these stupid rules. If so I can't believe it!!!

But I hope you're right!

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Jonathan

Aug 09, 2012 at 10:21

@Mike Deverell

How do you get a state pension of £9,500?

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Jonathan

Aug 09, 2012 at 10:29

The ssinnic,

you can take £600k out in one go but you would have to pay more than 20% tax on it, it would be classed as income.

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Mike Deverell

Aug 09, 2012 at 10:32

ssinic - provided you qualify, yes you can take the whole fund.

However, if taking £750k all at once, this is classed as income and so you will be paying 50% tax on a large chunk of it! You could however do it in stages over a few years to keep tax down.

See http://www.pensionsadvisoryservice.org.uk/annuities-and-income-drawdown/flexible-drawdown for a simple overview of the rules.

Jonanthan - a state pension of that level is quite typical for someone with entitlement to SERPS / S2P on top of the basic state pension. If you are coming up to state pension age, I suggest you obtain a personal estimate of what you will receive.

This link tells you how to get a forecast:

http://www.direct.gov.uk/en/Pensionsandretirementplanning/StatePension/StatePensionforecast/DG_10014008

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The ssinnic

Aug 09, 2012 at 18:31

@Mike Deverell

Thanks for that. I did wonder about the tax position but as you mention, staggering might be the answer.

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Dislexic Landlord

Aug 12, 2012 at 08:50

I do now invest in an Isa elf select and im very new at doing it Im 53 and saveing the max every year in companys that are good yeilds Vodaphone and alike but Im not sure im makeing a mastake to be very honest

In the NE I but 2 or 3 bed flats the cost around 50k to 55K just showing and example I would like to know others thoughts

Option 1 invest in Isa £11200 income dividend hopefully 5% £560 tax free worth to a 40% tax payer £784

Option 2 on a typical BTL investment

Purchase Price £55000

Deposit 30 % £16500 plus costs

Mortgage £38500 6% fixed rate 10 years capital and repayment £251.00

Rental income £475 (and rents do increase over the years)

Profit £224.00 per month Profit Per Year £2688

I know there are other costs which are all tax deducatable Repairs ,management ,voids ect ect

Ive made a very nice liveing buying property like this one above but is it sencable to put all the eggs in one basket

But being honest I think property is a better bet especialy in todays market maybe I should hold off investing in ISA

The price of property will increase again and when the yeilds on purchases are low agin the ISA may well be usefull but at presnt im not conviced

I would like others opinions on the above

What should I do which one should i use to produce Income

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banjofred

Aug 12, 2012 at 09:33

What I fail to understand - we know we are being robbed by an endless stream of self-serving politicians (and I suspect more likely the whitehall establishment which is ongoing).

We know they take from cradle to grave and beyond, and saving is pointless as theywill grab it..

They implement policy after policy which is no good for the people.

Yet, despite the fact that there are 56 million of us and probably 2000 or less of them (650 mps, plus Lords, plus senior police, establishment royals etc MI5 etc etc,

why oh why do we allow them power over us??

As time goes on I understand this less and less. We have th epower to send emails to MPs,MEPS very easily. we can group and bombard them with our demands. They would find it very hard to ignore a million or more people knocking on there door.

BUT

even on the most important of issues yo might get say 100000 people going for one of those "we will talk about it in parliament then ignore it" debates.

The number of people pestering their MP or MEP probably runs to hundreds.

I can understadn the French Revolution, the USA one against us, the Russian one, and recent Arab Spring events. Eventually the people rise up and act, and the rulers swing from a lamp-post.

In Britain we are too laid back, disinterested, too generous in spirit to those who shaft us, whether the government, the EU robbers, or the incoming hordes who want to dip their bread in our gravy.

Fine you say, it is better than murder and mayhem. But surely there is a middle way without the revolution of taking control of the puppet masters in London.

Dont read the Daily Mail and fume, get on and find MP email (easy) and send them regular demands.

Pensions are just one issue... Gordon Brown (and Ed Balls waiting in the wings for next time) robbed us blind as the red plot is to support the charvers who will vote for them.

This talk of the Tories looking after their own - my God I wish they would. They just also look for ways to rob the middle classes.

Why not email your MP today, then your MEP and persuade some others to do the same.

As you say if they cancel Annuities and simply give us our meny to squander at will whilst we are still on the planet, the economy would boom.

Power to the People !!

and free banjos to all

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barry slater

Aug 12, 2012 at 11:24

7 % wonderfu l!!! Hows this then, a challenge for the experts. Take my dosh make 7 % and I'll keep five % and you can have 2%.

But you have to promise me 5% no less... as part of our contract.

No one has ever taken me up on this sort of deal...makes you wonder if its easier to write hypothetical articles for a living...as opposed to actually having confidence enough to do it .

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banjofred

Aug 12, 2012 at 11:53

you make an interesting point there Barry.

If any of these Fund Managers had the courage of their convictions they could set feeds on results, and we would all be happy to pay.

for example I am paying Troy Trojan a flipping expensive half a percent in and half a percent out, plus 1.5% which inlcudes HL backhander of half a percent. BUT I dont mind cos its made me 12% plus and keeps making more every rmonth.

similarly I am a bit dodgy about hidden fees in HL Multi manager as its a fund of funds,BUT its doing well and i am 10% up so I DONT MIND PAYING.

Conversely the robbin lot at Smith & Williamson Global Gold & Resources Income Shares have a TER of 1.85%, and have lost me 33% thanks very much. They even managee to fall when the rest of the market and gold is going up. I have yet to bale out but will do so.

I think a fair fee would be:

return 0 or less - a fee of 0.10%

return 0.1 - 5% - a fee of 0.5%

return 5.1 to 10% - a fee of say 1%

return 10.1 or more - a fee of 1.5%

Surely the way things are now with many bailing out into Trackers or Vantage etc, the money in funds will fall and they will have to consider better fees. alsoe the baksheesh backhands of 0.5% to HL etc will surely cease.

The crazy thing is if you go direct to say Invesco Perpetual they will charge you 5% to get in, if you buy the same though say HL, they wont,

Like everything else the market will find its own level. As long as us mugs are willing to pay these fees, and IFA trail "commission" they will rip us off for the money.

Bearing in mind I go through HL, can anyone suggest any hot funds with low charges and decent returns (in 3 months not 3 years, time is not on my side at 62) as i am heavily back to cash and looking for new ideas when the next market plunge occurs?.

banjo

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Jonathan

Aug 12, 2012 at 11:59

barry slate

Yes, the statement: "A sensible mix of the above asset classes should be able to generate a total return of over 7% a year on average over the long term."

Is an archaic mantra that we used to be told about how our investments would grow. The pensions industry and asset managers used to tell us how our assets should grow at 7% if invested and we all were going to end up rich by investing in their funds. The reality in recent years has been very different, sometimes negative, but nearly always less than inflation. The pensions industry has been told to stop using figures like this and asset managers should be told the same thing. The sad truth is that 66% of all managed funds perform worse than the equivalent tracker fund. Fund managers make their money from taking a percentage of peoples investment. So their main task is getting as much of your money in their fund as possible so you get spouting rubbish and falsehoods like this spouted all the time.

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banjofred

Aug 12, 2012 at 12:03

oh another thing. I currenlty have part of my SIPP in drawdown and plan to put the rest in drawdown in 2013

take my 25% Tax free and bleed as much as poss out of the rest till I pop my clogs.

A present i take nothing from drawdown as i am higher rate texpayer, so they take 40% of what i have saved for 30+ years, ta very much.

I realise theywill still take 20% when i retire, but can see point of starting to draw out drawdown this year.

Or am i wrong - should i be starting and paying the tax?

As i reach the age (62) where an an alarming number of peers, famous people and not so famous are snuffing it, and so many getting cancer etc., and every time I see someone younger than 62 dying, and read th eobits (not many last long into their 70s) - i start to wonder. Why continue to try to maximise this pot, (its just a game really isnt it, like betting on roulette), why not grab all i can NOW, squander it famously, and if then unlucky enough to last longer with various conditions, depend on the state as all these millions of leeches do.

Tell me I am wrong and should keep at it.....

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Tony Peterson

Aug 12, 2012 at 12:57

Alan Franklin's opening shot is perfect - a new take on a "lottery being a tax on people who are bad at mathematics".

I concur with many contributors on the future risks to people foolish enough to save in pension funds or turn them into annuities.

My own direct equity portfolio grew to provide me with at least ten times more income than the small pension I enjoy from a stupid investment in the 1990s. And with less by way of contributions.

My consistent advice now to all the unretired is to acquire your own income producing assets so that they are under your own control and forget about our corrupt financial services industry, and the tax breaks that are a form of confidence trickery.

On one day (Friday 3rd) my savings grew by more than all the cash I once earned for 8.3 years of comprehensive teaching, years in which I had progressed from the bottom to the top of teachers' pay scales.

Equities, at present, in my view, are the only place to be.

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Anonymous 1 needed this 'off the record'

Aug 12, 2012 at 18:58

Dont you pay any income tax on blue sky £224 profit? and you are not comparing like with like . What about £16500 invested in ISA with 6% income no tax invested in 60% bonds =£990 pa in first year. Then you invest £250 per month in IT fund or shares i.e. £3000 PA and reinvested in ISA if you wish, you can do the calculations.

Or you could invest in a SIPP if you are a 40% tax payer you are on a winner. Property is not expected to do very well over the next Ten years, and i think your calculations are Blue Sky.

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A Vent

Aug 12, 2012 at 21:36

Do not touch pensions, sipps or anything not in your name.

what is not in your name is not yours

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mr trick

Aug 13, 2012 at 11:13

If I take a draw down pension with my SIPP and die after say 10 years, for how long can my surviving wife continue to draw money?

I take it that when she passes away, the money going into my estate will be taxed at 55% and then a further 40% death duties ??

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Brian Richards

Aug 13, 2012 at 14:44

Mr Trick,

I believe the spouse can continue to take payments for as long as funds are available . However drawdown rules change at 75, and it would probably be more advantageous to take a annuity at this age ( ie you or the spouse) .After both deaths I think you are correct with the tax assumptions if still in drawdown.

I think it is better to have both routes for saving IE SIPP and ISA and deplete the SIPP before ISA funds if you want to leave an inheritance to your children.

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