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Money Makeover: ‘Can I live off my pension but still leave a £500k inheritance?’

Guy Kenyon - John Lawrence for The Telegraph
Guy Kenyon - John Lawrence for The Telegraph

The investing world has been turned on its head in the past week but, a collapsing pound or not, DIY savers need to stick to the course and plan for the future.

This is what Guy Kenyon, 66, from Nottinghamshire, intends to do. After a long career as an engineer he retired in 2011; he has built up a pension and used £80,000 from redundancy payments and an inheritance to save around £500,000. He has spent £100,000 on home repairs and now hopes to make that money back by investing, while also using the pot to fund his and his wife’s lifestyle and ultimately leaving around £500,000 to the family.

He said: “I don’t have children but I have five nieces and nephews – and I want the pension to hold as much value as possible for them.” In the meantime he has to cover living costs for him and his wife. He currently draws down £1,500 a month, which covers his day-to-day expenses plus £500 towards a new car and a cruise.

After they are paid off he hopes to reduce the monthly amount to £1,000 in around 18 months’ time. Like so many investors this year, Mr Kenyon has been disappointed by his returns.

“Of late it has not been doing well,” he said. “I think fossil fuels will be needed for some time so I wonder if I should invest more in energy.” The biggest holding in his portfolio is Terry Smith’s Fundsmith Equity fund. He also owns Smithson Investment Trust, Evenlode Global Income fund, CT UK Equity Alpha Income fund and two Vanguard LifeStrategy funds.

His pension is unchanged since he set it up and Mr Kenyon would like to review his holdings. Where should he invest his £400,000 now – and will he be able to make back his £100,000 considering how much he’s taking out?

Guy Kenyon - John Lawrence for The Telegraph
Guy Kenyon - John Lawrence for The Telegraph

Poppy Fox, investment manager at Quilter Cheviot

By taking out £1,500 a month Mr Kenyon is withdrawing at a rate of 4.5pc a year, which is relatively high given the volatile markets. He risks seeing his pension pot fall in value, not grow, if he does this.

Adjusting to £1,000 a month, or 3pc, would be more sustainable. However, it’s worth noting that, given how choppy markets are, that £400,000 starting figure could fall at any point. How long the pension has to last is difficult to calculate and it’s important to factor in market movements and Mr Kenyon’s life expectancy. That will naturally be a big influence on how much money will be left.

Having said that, using theoretical cash flow management and assuming his investments return 5pc a year after fees, the pot will support Mr Kenyon until he dies and allow him to pass on money to his nieces and nephews. His investments look suitable as long as he is comfortable with a fairly high level of risk.

Around 88pc of his pension is invested in stocks. While this should help to boost returns, usually at this stage of life investors take less risk because their ability to recover losses is lower as they have less time.

Mr Kenyon’s investments are reasonably well spread with global, British and European stocks. He has no specific US stock funds but does have a stake in that market through global funds.

To improve this spread, he could consider adding more exposure to the Far East, the emerging markets and Japan. It may also be useful to increase the number of funds to help improve diversification.

He could also consider having more bonds and “alternative” investments, such as property, hedge funds and infrastructure. These can provide a good income as well as capital gains, so could be beneficial.

George Davey, financial planner at Charles Stanley

It is encouraging to see that Mr Kenyon has built up a significant pension and is trying to leave as much as possible to his nephews and nieces. Pensions typically sit outside your estate for inheritance tax purposes and are an extremely tax-efficient way to leave a legacy.

The most important thing is to ensure he has completed the “expression of wish” document with his broker, Hargreaves Lansdown, to reflect his wishes about who should receive his pension assets. His objective is to grow the pension by £100,000 in the coming 20 years from a current value of £400,000 while also meeting his income needs.

This growth of 25pc, or 1.1pc a year, over the period does not sound daunting. However, when considered alongside the fact that he is drawing an income at the same time, the picture changes.

Taking out £18,000 a year represents withdrawals of 4.5pc based on the £400,000 fund value, meaning that returns net of inflation and fees would need to be 5.6pc a year for the next 18 months, falling to 4.1pc thereafter when he reduces his withdrawals. His income in isolation is sustainable.

The probability of a fund value of £500,000 in 20 years is much har­der to predict. Therefore I suggest that he focus on funds rather than directly held stocks.

Funds allow closer control of the risk being taken through diversification and ongoing management by a fund manager. If he wants to limit costs, an actively managed portfolio of tracker funds may be a good choice.

There are many good options, some with ethical and environmental preferences in mind. Reducing how much he takes out would also reduce the returns needed to get the pension pot back to £500,000. If he has any tax-free cash entitlement remaining, it may be worth drawing taxable income up to the personal allowance (£12,570 in the current tax year) and meeting the balance from tax-free withdrawals.

If he is able to optimise the tax efficiency of his pension income, the amount he needs to draw would in turn be reduced, again reducing the returns needed to meet all his objectives. Finally, and importantly, Mr Kenyon must prioritise his needs.

While the growth of his fund and eventual legacy being left to his nephews and nieces is a “nice to have”, meeting his income requirements should take precedence. He should not take any undue risks that leave him in danger of being without an income or unable to cope if his expenditure greatly increases, such as if he needed care in later life.

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