Hi Heather, just discovered your podcast and blog. Really inspiring. Could I ask a question?
I have about £10k to invest and I’m considering three options. I’d really appreciate your help in deciding what to do.
Any advice would be hugely appreciated.
I apologise for the delayed response as I realise your question was time-sensitive but I was in project execution mode over the last two weeks.
I think this is an awesome question and I’ll tell you how I would go about thinking about this. Firstly, did you know that I too am a civil servant with access to the Alpha pension scheme? Let me know via the comments box if you did know. I have never mentioned it in any blog or podcast before but it is on my LinkedIn.
Given what you have said about when you could access your SIPP, I am guessing you are about 43 years old, i.e. you have 12 years to reach age 55 when you can access the SIPP and if your retirement age is 67 then you have 24 years until you can access your Alpha pension savings.
There are 4 keys things you might want to consider:
By portfolio effect I mean you should consider how the lump-sum is invested in the context of other sources of income you expect to have in retirement.
Firstly, I opted out of the Alpha pension scheme because my husband works for the NHS and has access to their defined benefit scheme and because we manage our household finances as a single unit, I felt we could take more risk. His NHS pension gives us a safety cushion and I went for the civil service partnership pension which works exactly like a SIPP in that what I get at retirement depends on the return. An added benefit is that I can access the money at age 55 rather than 67 if I want to although I doubt I would do that as I’d rather use up my ISA savings first.
Average stock market returns have historically been about 10%. This could be the same in the future or it could be different. There are no guarantees.
I am not sure what your passive investment portfolio is specifically invested in but I will assume it is a passive global fund and as you haven’t said it is in an ISA, I will assume it’s in a taxable investment account. The last time I looked for a reasonable return to use to model my future returns I found an article that suggested 9% gross and 6% net of inflation was reasonable. I prefer to use 7% gross and 4% net of inflation.
If we go for the 7% return in taxable brokerage account – i.e. ignore the SIPP option to begin with:
If you drew the money down according to the 4% rule which says that you should draw no more than 4% of an invested portfolio so that it doesn’t run out, then if you start to draw on this money from age 67 (same as when you would have access to your Alpha pension money) you would draw £2,028 in the first year of retirement (50,700 x 4%).
The following year when you are 68, you would draw £2,083 i.e. (50,700-2,028) x 1.07 x 4% - you draw slightly more because although the money has been drawn it is still invested and continues to grow at the average rate of 7%.
These are gross numbers – what about after inflation?
If you wanted to look at what you would be drawing after inflation, then in the equivalent of today’s money you would draw £1,024 (25,600 x 4%) and you would draw slightly more in real terms the following year.
You need to compare what this looks like against Alpha.
I know Alpha is inflation protected but I am not clear whether the £1k increase in Alpha payments that you mention is from today or whether it’s £1k from the age of 67 and growing from inflation at that point.
If it’s £1k and growing with inflation from today then at the age of 67 you would be getting £2,030 in real terms (1,000 x 1.03^24) whereas with the stock market investment you were getting only £1,024 in real terms – from this perspective Alpha is a no-brainer as it’s a guaranteed £2k per year until death rather than a probabilistic gross drawdown of £2k per annum.
I see the stock market as broadly providing some inflation protection given all companies increase the prices of their products over time.
If it’s the case that the increase in the Alpha pension is £1k at age 67 then growing by inflation from that point then the additional gross £1k in real terms after 24 years is only £490 (1,000) / (1.03^24) – in this case the stock market investment looks much more attractive.
If you go for Alpha with self and dependents then multiply the Alpha benefit by 90% to evaluate the impact.
If we go for the 7% in a SIPP account – then you get an immediate uplift because there is an immediate tax saving.
As a higher rate tax payer note that the SIPP provider would only claim tax relief at the basic rate of tax and you would need to claim additional tax relief via your self-assessment tax return or if you don’t do a tax return you would need to call HMRC to see if you could just do it by changing your tax code.
With the full tax relief £10k translates to £16,667 in your SIPP.
If you drew the money down according to the 4% rule, then if you start to draw on this money from age 67, you would draw £3,380 gross (84,530 x 4%) or about £1,700 in inflation adjusted terms and steadily growing.
From a returns perspective putting the money into a SIPP begins to look very attractive indeed. This brings us to the next consideration, horizon/flexibility.
HORIZON / FLEXIBILITY
With a SIPP you have access to the money from age 55. Unless you are 100% sure you don’t want to retire before age 67 or even to part-retire then you don’t need earlier access to the money.
With the money in a taxable brokerage account you can draw the full gross amount invested in one go, if you like. There would be tax to be paid but you would still have the full amount if you wanted it.
You can reduce the tax amount due from a full drawdown if you put half i.e. £5k into your own investment account and half into a spouse’s investment account. You can avoid tax completely by putting the full £10k into an ISA (the annual limit is £20k so you would be within that).
If you have all your assets in a defined benefit pension plan then your dependents don’t have access to those assets except to the extent defined by the plan. For Alpha, if you die before your spouse then I believe your spouse continues to get 37.5% of what you would have got and children only get a benefit if they are under 18 or under 23 and in full time education.
With a SIPP your family gets everything invested and under current tax law money sitting in a pension is protected from inheritance tax if you die before the age of 75 (this could change given the tax rules are constantly changing).
So, as basic example, if you died at the age of 67– in 24 years just before you could claim any pension, if your 10k had been invested in:
I apologise that this response is so full of numbers but this is essentially all the things you need to think about and the numbers are pretty important when we are thinking about pension and retirement options.
If having access to a few pots of money before the age of 67 is important to you or if passing on some cash to dependents matters, then Alpha is not attractive.
If you are risk averse and want to ensure you have a comfortable, guaranteed inflation-linked pension pot then plough the £10k into the Alpha pension plan as this would suit your risk tolerance better.
I hope this helps!
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Heather on Wealth
I enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™.