Pensions case study: how I manage my £1 million SIPP

Reaching retirement with a seven-figure pension pot is the holy grail for many of us. It would take either serious bad luck or catastrophic investment choices to run out of money in old age.

I recently chatted to an investor and ii customer who has not only achieved this lofty milestone but did so by his early 60s. As you may expect, a generous workplace pension helped him along the way, but this was complemented with some shrewd tax planning.

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We’ll come on to how the investor manages his retirement wealth shortly – both in terms of the income strategy he deploys and portfolio construction - but first let’s discuss how he got there.

‘I couldn’t have been less interested’

The investor was part of the generation when defined benefit (DB) pensions, which provide an inflation-proofed income for life at retirement based on your final salary and number of years’ service, were commonplace.

However, his employer’s DB scheme closed when he hit his mid-40s, and the cash equivalent value was switched to a defined contribution (DC) pension, where you save and invest for your future to accrue a pot of money.

Given DB pensions require far less maintenance than their DC counterparts, it’s understandable that it took the investor some time to properly engage with his long-term savings. He was well into mid-life before retirement planning found itself firmly on the agenda.

“When I hit age 50 in 2008, the year of the financial crisis, I remember the pension guy coming into our workplace, long-faced, telling us how disastrously our pensions were performing. I couldn’t have been less interested,” he says.

This sentiment will undoubtedly ring true with others. The pension industry frequently rams home the importance of getting to grips with retirement planning at the earliest age possible. But a combination of the complexity and the fact we have other things going on in our lives, means this doesn’t always happen.

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Still, fast forward five years and the investor’s focus had really sharpened up. Until this point, his main financial goal was to clear his mortgage, which he achieved by his mid-50s.

He says: “The first thing I did was think about when I wanted to retire and my 60th birthday seemed natural to me. Once I’d set a target retirement date and savings goal then it was about working out how to get there. That’s when I put together a spreadsheet.”

So, what savings strategy did the investor employ? A key reason why people choose pensions over other products, such as individual savings accounts (ISA), is the upfront tax breaks on offer.

Put simply, on any personal contributions you receive tax relief at your marginal rate (the rate of tax you pay on your next pound of earnings), which could be as much as 45% if you’re a big earner.

Making the most of this in the lead-up to retirement was front and centre for the investor.

“I really ramped up pensions savings from age 55 to 60, putting in everything I could to get 40% tax relief.”

The investor also directed further residual savings into an individual savings account (ISA) to supplement his pension pot and widen his retirement income choices.

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Needless to say, the plan worked. At age 61, he had accrued sufficient savings for a hard-stop retirement from his career in sales for a food manufacturer. His total pensions currently stand around the £1 million mark, comprising an interactive investor self-invested personal pension (SIPP), which he set up by transferring in from elsewhere, and three old workplace schemes.

“The process of transferring to ii was easy, but emotionally switching the pension was difficult. I switched to ii when I looked at all the charges I paid with my independent financial adviser firm. Over six years I paid more in charges than I got in growth.”

The investor is now age 64 – so can claim his state pension in 18 months’ time - and is married with one son. His wife is a few years younger and has a part-time job in the village where they live. She plans to retire soon.

The retirement income conundrum

Despite packing up work in rude financial health, the investor is faced with plenty of big financial decisions to achieve his retirement goals.

“Fortunately, I don’t have a lavish lifestyle,” he says. “I’m thinking about how long I’ll have an active life. How much money am I going to need when I’m in my 80s? The chances are I won’t be spending a lot.”

The changing landscape fuelled by pension freedoms, which has allowed savers to draw from their pensions however they wish, has resulted in the majority choosing to keep their money invested and take flexible income using drawdown. The alternative is to buy a guaranteed income for life via an annuity.

What approach does the investor currently take? Well, he draws £17,000 a year from his SIPP using uncrystallised funds pension lump sums (UFPLS).

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This enables you to access your pension savings without committing to either income drawdown or an annuity. The mechanics here are that 25% of any withdrawal is tax free, while the remaining 75% is added to other income and taxed at your marginal rate.

“I want to avoid paying higher rates of income tax, so will keep any pension withdrawals within the 20% tax band,” he says.

Using UFPLS does trigger the money purchase annual allowance (MPAA), which restricts annual tax-relievable contributions to £10,000. However, as the investor doesn’t have any plans to work again or wish to further boost his pension savings, this shouldn’t affect him.

Whether he will continue to use UFPLS for the long term is unclear. The investor says he will monitor his circumstances and make calls as and when. Either way, buying a guaranteed income with any portion of his pension savings is completely off the table.

“I don’t like annuities – someone’s making a profit out of them,” he says. “I want my wife and son to have a lump sum when I die so they will be looked after.”

Death benefits are a key reason why people choose drawdown over annuities. With the latter, there is usually no lump sums to pass down. On the flip side, drawdown can not only pass to a surviving spouse, but can also cascade down generations, supporting the retirement aspirations of any offspring.

Not putting all your eggs in one basket

So, what about his investment choices? In the lead up to retirement, he had most of his money in a mixed-asset fund but says he’s “not sure the risk and reward is in your favour”.

He adds: “That’s when I questioned why I would have lots of my money in such a fund.”

It’s fair to say the investor has a firm grasp of the importance of diversification - commonly described as not putting all your eggs in one basket.

This involves spreading your money across various asset classes, typically shares and bonds, in different parts of the world. The idea is that if one asset or region performs poorly, others will be there to prop them up.

There are multiple ways to achieve suitable diversification, and which assets you choose will depend on several factors. These include your attitude to risk, capacity to bear investment losses and whether you prefer a hands-on or hands-off approach to portfolio management.

The investor’s SIPP comprises 14 investments: a mixture of funds, investment trusts, trackers and single company shares, combining both active and passive strategies.

• HgCapital Trust (LSE:HGT)
• X Trackers Private Equity ETF
• Jupiter India I Acc
• VT Argonaut Absolute Return
• L&G FTSE 100 Tracker
• S&P 500 ETF
• Vanguard LifeStrategy 60% Equity
• Single stocks in Amazon (NASDAQ:AMZN), Walt Disney Co (NYSE:DIS), Citigroup Inc (NYSE:C), Rolls-Royce (LSE:RR.), Legal & General (LSE:LGEN), Microsoft (NASDAQ:MSFT) and Meta Platforms (NASDAQ:META)

“I think the decisions that I’ve made, particularly the private equity ones, are real diversification,” he says.

The investor’s equity holdings may stretch far and wide, but he equally wants to make sure he has sufficient cash savings should stock markets take a turn for the worst. This provides him with some much-treasured peace of mind.

“I feel it’s important to have cash to give me a safety blanket should investments head south, and cash is currently holding its own in real terms. If all my money was in the market, I’d be a bit more nervous.”

Turning back the clock

One may assume the investor wouldn’t change anything if he could turn back time given his healthy financial position. There is, however, one thing he would’ve liked to have done differently.

“I wish I had taken an active interest in investing when I was younger as the key to success is understanding the relationship between risk and reward. It’s a shame that I didn’t invest 30 years ago as think I would’ve had fun with it.”