Planning for Decumulation

This post is for the monthly challenge posed by indeedably at sovereign quest. I don’t normally take part in these monthly challenges, mostly due to time restraints,  but this is a subject I’ve been thinking about a lot recently as I am getting close to reaching my FI number. So here are my thoughts and plans.

The general premise is that to achieve FIRE you simply save 25x your annual expenses, then when you reach that target you can retire by withdrawing 4% of that figure in the first year, and adjust the initial withdrawal amount for inflation in subsequent years.

Most withdrawal strategies written about in the FIRE community are based upon the idea of drawing down on an investment portfolio, usually consisting of shares/funds, using a Safe Withdrawal Rate (SWR) ranging from 3% to 5%. These shares/funds can be held in a variety of tax wrappers to shield the gains and the subsequent income from tax, such as ISAs and SIPPs/Pensions.

However, most people own assets that contain a mix of cash, property (home and rental), equities, and pensions (DB, DC and State). So it can be quite complicated to formulate a withdrawal strategy that takes this all into account, optimising the assets whilst minimising risk and taxes.

Other factors also have to be taken into account along with SWRs, such as Sequence of Returns Risk. ERN’s SWR series here explains all of this in-depth.

Despite all the studies and theories about asset allocations, SWRs, SORRs etc. it is probably advisable to have some flexibility in your plan to be able to adapt to events outside of your control, which may involve a reduction of income in some circumstances.

What about my situation?

At first glance, it looks simple.

If you have read my monthly updates you will know that my FI number is £1.25m, to provide £50k per year at a 4% withdrawal rate. This would be ok if I had an equity portfolio of £1.25m, but I don’t. As touched on above I, like many people, have a mix of assets.

If my assets were only equity based I may have been tempted to follow something like a 3 bucket strategy here like Fritz at the retirement manifesto.

I suppose my plan is a sort of 2 bucket strategy as my main assets consist of property and pensions.

Bucket 1 – Income Bucket –  rental properties, DB pension and dividends to provide a basic income of £38.5k. My rental properties will net £25k/yr, DB pension £3.5k/yr, and dividends from my SIPP £10K/yr. The remaining £11.5k will be withdrawn from the tax-free lump sum initially taken from the SIPP, then the SIPP itself.

Bucket 2 – Growth Bucket – SIPP – Capital left to grow inside SIPP, held 100% in equities, drawn down as required for income in bucket 1. In years of great stock market performance we may take more from the SIPP instead of rental income from our company as a form of rebalancing and tax optimisation.

Using the above strategy I will initially use a 5% withdrawal rate from my SIPP. I have allowed for a high rate as the state pension will kick in after 12 years which will provide over £18k/yr for the two of us. Combined with rental income this is over £43k/yr.

I’m keeping my SIPP in 100% equities, so you may ask how am I going to deal with Sequence of Returns Risk. Firstly, I’m quite risk-tolerant to volatility, and secondly, I don’t plan to increase the initial withdrawal each year with inflation but will use a guardrail system where, based on the current year’s valuation, the withdrawal is adjusted up or down by 10% only if the current withdrawal rate has gone above or below the 5% withdrawal rate by 20%.

Tax – Initially we will pay very little tax as we have 2x the basic tax free allowance =£25k, plus the tax free lump sum from our SIPP, and any dividend allowances from money taken from our company (currently 2x £2k).

Back up plans – Although I count our home equity in our net worth my plan doesn’t require any withdrawal of equity or capital from our home. However, I do plan to downsize or sell at some point which will release some equity. We could also do this if we needed to if ‘Plan A’ didn’t work out.

Behavioural – I don’t anticipate any problems on this front as we both work for ourselves and are self-sufficient in many respects.  We don’t have any trouble filling our spare time out of work and we are looking forward to a less hectic existence.

Inheritance – I don’t incorporate any inheritance expectations into my plans, but we may receive one at some point. I constantly tell my parents to enjoy their money.

Legacy – I do want to pass some inheritance onto my kids and this plan allows for some capital to remain at the end, but I am hoping my guidance will make them self-sufficient in their own right.

Concluding, the plan will be refined over the next couple of years as, even though I am close to My FI number, I am planning to FIRE when I am 55 when I can access my SIPP, in just less than 5 years time.

Thanks for reading