Stocks and Shares ISA Rules to Keep You Solvent in Retirement

A recent study by Morningstar, the investment research and management firm, offers up a statistic that may alarm many stocks and shares ISA and SIPP investors. Namely, that reaching retirement with a pension pot of £1 million means that guaranteeing it will last for a retirement of 30 years means drawing down no more than £19,000 per annum from it as an income.

While the stock market boom over the past several years may have significantly boosted the value of stocks and shares ISA and SIPPs across the UK, Morningstar warns that a side effect of recent gains means that ‘implied’ future returns are currently significantly worse than normal. In layman’s terms, Morningstar is saying that there is a high likelihood that a stock market downturn and a series of lean years may follow the recent rich pickings. This means that if the value of a pension portfolio drops significantly as the result of a market slump, drawing down a higher regular income than the recommended level could lead to irreparable damage to capital value.

The most common ‘rule of thumb’ often referred to with regard to pensions drawdown has been the ‘4%’ rule – taking an income of 4% of the value of a pension pot should be conservative enough for it to last for the duration of retirement. In 2016, Morningstar’s advice was that the ‘safe’ drawdown level for a pension fund 40% invested in the stock market was around 2.5%. Now, the new advice based on developments over the past year is that under 2017 conditions, that should be adjusted to between 1.9% and 2.2%.

The chances are that anyone who has earned enough over their working life to amass £1 million in pension savings will not particularly relish the prospect of living on £19,000-£20,000 plus their state pension. Richard Evans, personal finance editor at The Telegraph, believes that while pension investors do need to use some kind of framework to be aware of how much income it is safe to withdraw each month and year, a degree of flexibility is also required.

He offers two rules that can help mean stocks and shares ISA and SIPP holders are able to withdraw enough from their portfolio to live comfortably, while still maintaining strong capital value that will last into the future. The first rule is one advocated by Ken Fisher, a high-profile US investor and analyst and chairman of Fisher Investments. Fisher advises that investors keep 3 years-worth of cash separated from their pension pot and keep the rest invested, mainly in the stock market. The reasoning is that major market downturns tend to be relatively short lived, with markets bouncing back within 1 to 3 years. Holding cash means that this can be spent in the meanwhile, allowing the value of the investment portfolio to recover without suffering the erosion of drawdowns while markets are down. It also means the investor has some firepower to eventually invest at bargain prices while markets are down, boosting the portfolio on their way back up.

The second option suggested by Evans is that stocks and shares ISA and SIPP holders can invest all or a part of their holdings in ‘enhanced income funds’. Evans suggests that the innovative way these funds boost returns, by relinquishing the rights to part of the capital gains holdings may make in the future, is ‘relatively clean’ and doesn’t conceal any dark dangers investors should be overly concerned about. Enhanced income funds return around 7% a year, which would mean £70,000 income if the entirety of a £1 million portfolio were to be invested in them.