Can we buy a second property and generate our target retirement income?

James and his wife are age 57 and have grown-up children. They run their own businesses, and he earns around £42,000 and his wife earns around £15,000 a year, which covers their day-to-day expenses. Their home is valued at about £1.25m and has a mortgage of £10,000 remaining.

“We aim to wind down or stop working at age 60,” says James. “We wondered how much we could draw from our non-property assets while ensuring that we do not run out of money in retirement and maintaining some of their value? Ideally, we would like to have a joint income in retirement of £70,000 to £80,000 a year in today’s money, of which £50,000 to £70,000 a year comes from my assets, so that we can travel and have a very comfortable lifestyle.

“We would also like to move to a larger plot of land and self build a home or modify an existing property on it. We awould aim not to spend much more than the value of our current home on it.

“This may require drawing on our investments as we would like to keep our existing home or a smaller property in this area. We may want to return here, and it could provide rental income and something to leave to our family. But doing this would create a capital gain upon disposal of one of the properties and tax on the rental income – so is this the best way to use of our capital?

“I have a final salary pension which is due to pay out around £9,800 a year from age 60 and a lump sum of £27,000. I have started drawing a second final salary pension three years early, which pays £27,000 a year, due to the value of my pensions breaching the lifetime allowance. I have invested the lump sum I received with this pension in an individual savings account (Isa) and trading account, into which I also invest the payments from this pension. I will continue to do this for the next three years until I need this pension’s income.

“My pensions in total are worth around £1.37m. These include my self-invested personal pension (Sipp), which has a value of about £523,000 and continues to grow. I have not made any contributions to it for the past two years, but the investments have performed better than I expected.

“I plan to wind up my business at some point, which is currently valued at about £450,000. I plan to invest the proceeds, and draw their income but preserve their capital value.

“My wife has a final salary pension which will pay her about £11,000 a year from age 60 and another that should pay her about £1,700 a year. She has a defined contribution (DC) pension worth about £108,000 and a personal pension worth about £30,000 which she still contributes to.

“In what order would it be best to draw from our various accounts? Should we first draw from my Sipp, or take the income and capital from my trading account? Or should we draw on the Isas funded by my pension lump sums and sale of my business?

“I started my Sipp around 10 years ago and added direct shareholdings which seemed like good investments. I have had mixed results with these, but take a very long-term view and don’t like to crystallise losses. I have tried to diversify the fund holdings across markets and sectors, although am concerned that I have too many investments. 

“Due to the secure income we will get from defined benefit (DB) pensions, I plan to mainly keep my Sipp in equities rather than bond funds. 

“I have built up the Isas over a long period and invested them in funds that appealed to me at the time. I weed out and replace funds in these accounts, but have probably not cut the number of them enough. So I wondered what a simple, balanced and geographically diversified portfolio would look like? And should I have the same allocation in the Sipp, Isas and trading account?

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS’ CIRCUMSTANCES.

Chris Dillow, Investors’ Chronicle’s economist, says:

You should be able to achieve your personal income target. Given that your final salary pension income will be worth almost £37,000 a year, a total annual income of £50,000 to £70,000 a year means that you will need around £23,000 a year from your investments. This is equivalent to less than 3 per cent of it. But with average luck, equities should post a real return of over 4 per cent a year, so you should be able to take such a sum while leaving your capital more or less intact.

But this doesn’t allow for you to buy a plot of land. Doing this would result in a hit to your income as a consequence of taking out a mortgage or selling some of your investments.

And don’t assume that property will pay off better than equities in the future. Housing is more overvalued than equities and more vulnerable to rising interest rates.

You’re right not to want to switch into bonds. This isn’t because I’m pessimistic about their returns, but rather because your DB pensions are like bonds. They are, in effect, an income from a safe asset and, given low yields, a very large safe asset. The standard advice that we should switch out of equities as we get older is, for many people, plain wrong.

But you are over-diversified. When you diversify across funds, you don’t simply dilute the risk that a fund will underperform. You also dilute the possibility that it will outperform. So holding a basket of funds means that you have, in effect, a tracker fund. Except that it’s an expensive tracker and charges mount up. An extra half percentage point of management charges each year might not sound much. But it can easily add up over 10 years to over £7,000 for every £100,000 you invest. Are you aware of the ‘magic’ of compounding? Fund managers certainly are.

I’m not sure that you can justify such diversification by the risk that an asset manager will go bust. For one thing, your money should be ring-fenced. And if a major fund manager collapses it’ll be in circumstances in which you probably don’t want to be invested in equities.

You only need one fund to diversify well. A fund that tracks global equities is, in effect, a fund of all equity funds and well diversified.

That said, you might want other equity assets. You could add an emerging markets fund, or UK and eurozone funds, if you are worried that a global equities tracker is overweight in expensive US stocks. There’s also a case for private equity, because a lot of future growth might come unlisted companies, although fund manager risk is greater in this sector than with funds that invest in equities listed on public markets.

If you want to simplify your portfolios, ruthlessly cut losers. Sell anything of which the price is below its 10-month or 200-day moving average. This is a way of protecting your portfolio from adverse momentum effects.

Mark Giles, senior consultant – private clients and Samantha Owen, director at Becketts, say:

The details you have provided indicate that purchasing property would probably use up the vast majority, if not all, of your non-pension cash and investments. However, you could take out a buy-to-let mortgage which would free up other assets. You should get specialist advice on this.

You also need to consider the initial costs, stamp duty, legal fees, renovation and development costs, and there would be a period during which you get no rental income while the property works are finalised. There would also probably be income tax on the net rental income profit and capital gains tax if you sell the rental property before you die.

Whether you can generate your required level of income will largely depend on how much of your cash and investments you use to purchase property. You and your wife appear to have sufficient funds within Isas and trading accounts to generate the required income over the long term, especially as you will both receive state pensions in 2031. I think that you could achieve this without having to access your crystallised DC pensions.

Your total assets will probably provide the income and capital you require over the long term, but a second property purchase will have an impact on your planning requirements.

Your total pensions exceed the lifetime allowance. But your wife’s do not, which gives scope to access benefits without a lifetime allowance tax charge, although income tax is likely.

You will face a tax charge before or at age 75. Unless you have no other option, consider leaving benefits within your Sipp until you are nearer age 75, when your circumstances and options are clearer.

DC pensions’ value does not normally fall within your estate at death so, from an inheritance tax point of view, could be very efficient when trying to limit the tax liability on your own or your wife’s estates. It is important to ensure that all pensions have an up-to-date nomination form in place to ensure that their benefits pass to your intended beneficiaries. You and your wife should also check with your pension providers that your schemes offer the necessary flexibilities to allow you to plan properly in the future.

Make sure that your wills are up to date and reflect your current wishes. And, if you have not already done this, seek legal advice on Lasting Powers of Attorney.

It is possible to both simplify your holdings and have a diversified portfolio. Diversification is not just having many holdings, but also having manager, regional, sector and style diversification and – most importantly – asset class diversification.

With over 40 holdings in your Sipp alone, some positions may have some of the same exposures as each other, meaning that they are highly correlated.

By running your winners and not cutting the losers, you risk ‘portfolio drift’ and ending up with a riskier portfolio than you intend. It would be sensible to rebalance your portfolio from a risk perspective as it is mainly made up of equity investments. Although this should have served you well over the long term, it will have suffered sizeable falls in value at times. This can be tolerated in the accumulation stage of portfolios, but less so when you are drawing from them.

You could switch a portion of your investments into an actively managed multi-asset fund, of which the investment mandate is aligned to your objectives and risk profile. You could retain some direct shareholdings alongside this to trade as a hobby. Having some of your assets professionally managed would help to remove the emotion from investing. It is right to take a long-term view with equity investments, but also important to change things if they have been consistently underperforming or the justification for you originally investing in them no longer stands.