Reply To: Consolidating personal pensions into a SIPP

Moderator

Personally, I am against capital withdrawal from an HYP and it was definitely never part of the strategy as I intended it. Eternity means forever, as an absolute minimum holding period.

Here’s some reasons:

1 Most obvious is the fact that if you withdraw capital regularly you will experience an increasing decline in the HYP dividend income. Yes you will be topping that up with the capital withdrawals so the cash you take each year may be about the same, though only as long as it lasts, but that’s like eating bits of yourself because you’re a little hungry. It’s increasingly damaging, irreversible and ultimately fatal.

What will you do if it runs out? We’re talking of a situation where the investor felt the income to be insufficient in the first place, which is why it was augmented with capital withdrawals. Well, if it was insufficient to start with, it’s going to be enormously more insufficient when you have reduced it to nil.

2 You are reducing, possibly to nil if it goes on long enough, the capital that you may wish to leave in your will.

3 For me, though perhaps not everyone, there is an emotional objection to spending capital. My ideal is never to spend it and just live on income from various sources, including my HYP. It just feels right somehow. I know that, technically, this can be seen as illogical because money is “fungible”, (horrible word that sounds like some kind of mushroom) meaning that’s it all just money and that distinctions between capital and income can be seen as artificial. But that’s really academic, in the real world most of us do see a distinction and so does the law and accountancy rules.

So I view capital withdrawal as a last resort for an investor desperate for additional cash though I do appreciate that some HYPers may unfortunately be forced into this situation by circumstance. But I assume we’re not discussing those for whom compulsion exists because there is not much argument in such cases. It’s where you have discretion that there is room for discussion.

Finally Nigel said above

…If you are 70 and think you have 20 years left to live why not draw down up to 5% of the value of the fund each year plus dividends?…

This calculation is incorrect. If you withdraw 5% capital each year, plus dividends, then assuming the HYP yield is 4.5% this will last only about 14-15 years, not 20. The reason is that you have to withdraw increasing amounts of capital each year to make up the increasing shortfall in dividend income so as to deliver the same cash income. Like a repayment mortgage in reverse.

For example on a £100,000 portfolio, the dividends will be £4,500 and you take out £5,000 capital because the example assumes you need £9,500 income. In year two though, the dividends will be 4.5% of £95,000 being £4,275 so you need £5,225 of capital to make your required £9,500 and so on each year with increasing capital and reducing dividends. There are several assumptions here, such as the fixed dividend yield and capital value over the years, but on this basis the math says that 5% a year will not last 20 years, because it’s not just a simple interest calculation of 5% capital withdrawn each year gives you 20 years.

For it to work like that over 20 years, you would have to accept a declining income because year one would be £9,500 but year two would be £9,275 and so on. And that method can’t be appealing because presumably this poor HYPer is in dire need of all the £9,500 in the first place, so the last thing they want is that it declines inevitably each year.

And there are complications. In practice the capital and dividends will fluctuate year on year. No guarantees but even though they are both likely to increase long term, this does not happen in a smooth annual progression. Your initial demand of £9,500 income may have to increase with inflation and your circumstances. It really is quite a gamble on it all working out as hoped. Yet another reason to avoid this situation if at all possible.