'Can we retire at 55 with a £150,000 income?'

To retire early you need to get several things right. You need meticulous planning, a solid investment strategy and enough income in the meantime to make sure you can afford your lifestyle and save. Jim and Helen have all three. But, given their ambitious pension aims, the couple want to make sure their plan makes sense.

The couple want to retire in just under 12 years' time, when Helen will be 55 and Jim 56. The duo earn £330,000 a year between them, mostly coming from Jim’s £270,000 salary. From this, they cover the mortgages on their £1.5mn home and a £430,000 holiday let, private school fees for their two children, saving into child trust funds (CTF) and putting £48,000 a year into their Isas and pensions.

They expect to maintain this until 2035–36, at which point the children, currently aged 14 and 11, will both have finished private school and university – all funded via the couple's income – the mortgage on the family home will have been paid off and there will be £90,000 debt left on the holiday let. With a healthy 5 per cent investment return, their current £330,000 individual savings accounts (Isas) will be worth £952,000 and the £284,000 pensions worth £786,000. Overall, their current £2.1mn wealth will be worth just over £4mn, setting themselves up nicely for a long retirement.

However, retiring early means funding yourself until state and workplace pensions kick in, and the couple has a lofty aim. They want between £100,000 and £150,000 a year but will be reliant on their savings for three to four years until Helen turns 60, when a £5,000 defined-benefit (DB) pension kicks in. When she turns 65, she receives another £30,000-a-year pension and both will receive the full state pension aged 68. 

Jim says: "Our portfolio will be over £4mn (including £2.3mn net in property) by the time we retire. I want to aim for around £150,000 in annual income, especially considering Helen’s DB pensions and the state pension. I appreciate we need to wait to get these so we need to think about how to get income beforehand.”

However, the risk of running down the invested assets is high. Assuming their income needs to grow by 2.5 per cent a year to cover inflation, a £150,000 income means they will have withdrawn more than £460,000 in the three years before any other income kicks in. The Isas and pensions would run dry in their mid-70s, even accounting for 5 per cent investment growth and their state and DB pensions rising by 2.5 per cent a year. A £100,000 income, by contrast, would mean they would still have money left by the time they reached 90. However, Jim says they would be open to selling the holiday let to cover any shortfall and expect the CTFs to help the children onto the housing ladder. The couple are yet to make any inheritance plans.

In terms of the portfolio, the bulk of the pension savings are covered by Jim’s workplace pension with Scottish Widows. Otherwise, it’s invested in individual stocks and a smattering of stock market funds. The Isas are more conservative with 43 per cent invested in bonds and cash and 17 per cent in infrastructure investment trusts, with the rest in shares. The couple want average growth of 5 per cent a year across the portfolios and do not want to lose more than 25 per cent in a given year.

Jim says: “I am medium risk but blend high-risk assets with bonds and cash. Overall, the risky assets should be offset by the low-risk ones. I try to invest for dividends and reinvest them each year and will put more cash into the iShares Core S&P 500 ETF (IDUS). I’d like to keep the number of company stocks low and focus more on ETFs and investment trusts, although I am looking at Microsoft (US:MSFT) and may add to Hollywood Bowl (BOWL).”

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

Laith Khalaf, head of investment analysis at AJ Bell, says:

You seem a little unsure about exactly how much income you will need in retirement. I don’t think that’s uncommon, and you’re ahead of the game by even addressing this question at this stage in your lives. At the moment your estimate is between £100,000 and £150,000. It’s probably worth digging down into this to get a better idea as the savings you need to put aside for these two goals will be considerably different.

You look in good shape financially but need to increase annual savings contributions where possible to make your £150,000 target without starting to draw down on your assets. Your £150,000 retirement income target actually looks more like £190,000 in 12 years, assuming 2 per cent inflation. Based on 5 per cent a year fund growth with your current pension and Isa assets and contributions, you’d be looking at an investment pot of around £1.8mn in 12 years, which at a 4 per cent yield would provide an income of £72,000 (including using your tax-free cash sums to generate income). 

Your holiday property is expected to add another £500,000 or so into the mix, which could produce a further £20,000 income at a 4 per cent yield (4 per cent is clearly an example yield but I think it’s a prudent rule of thumb to use across the portfolio). When state and defined-benefit pensions kick in later down the line, that should help make up some of the shortfall, but as things stand you may need to start drawing down your capital before those kick in. This needs to be done at some point, but it reduces the income-producing capacity of your portfolio in the long term, and given you’re retiring in your mid-fifties, and might need to draw on these assets for 40 years or longer, it’s not a good idea to start depleting capital right away.

Some of the extra savings might be automatic through wage rises boosting pension contributions. As I say, if you decide your income target is nearer £100,000, that shifts the dial in your favour considerably. You also need to take taxation into account. Isa income is free from tax, but pension and property income will be taxable, subject to whatever tax bands are in place when you hit retirement. You are also considering selling your holiday let, which could boost your financial resilience in that tricky period before pensions ride to the rescue. However, you could also continue to own your holiday let and draw an income from it. I think this is a decision you can leave to nearer the time to gauge the relative merits of keeping the money tied up in the property or pulling it out to invest elsewhere. Of course, this depends on whether you’re still using the property and the tax situation at the time. It’s a nice option to have in your back pocket.

You say you are medium risk and with around two-thirds of your portfolio in stocks that matches up – a rarity in these pages. It’s reasonable to expect an average return of 5 per cent over the long term with your holdings and annual drawdowns of less than 25 per cent. Although, of course, there are no guarantees.

Your investment portfolio looks sound, I would only question two things. You have around a quarter of your assets in one fund, the Scottish Widows Pension Portfolio 2, which is a significant chunk. In common with many pension funds, public information is not what you would call plentiful. While the fund factsheet says it is mainly passively managed, there does seem to be some active asset allocation going on, and if it’s actively managed in some way, that does raise the chance of underperformance. It’s worth reviewing how this fund works and potentially scaling back your exposure depending on what you discover.

You also hold Fidelity Enhanced Income, which I would normally expect to see in a portfolio trying to maximise income with less focus on total return. The strategy of this fund is to increase income by writing ‘covered call options’. These increase the income of the fund but can act as a constraint on growth. In recent years that might not have made a huge amount of difference given the poor gains seen from UK stocks, but in the longer term, it might prove more significant. Again one to review to make sure it’s performing the right role in your portfolio.

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Rob Morgan, chief analyst at Charles Stanley, says:

Your overall asset allocation – with the majority in stocks and a modicum of bonds – feels right. This is a long-term portfolio that will be added to over time, which helps iron out volatility. There’s a strong preference for stocks, with some core funds supported by individual companies. I would look to add to existing funds and build out new positions to improve diversification and allow fund managers, or simply following the broader market, to do more of the heavy lifting. Your overall strategy doesn’t require you to take a high level of stock-specific risk, so the closer you get towards drawing on your pots the more I would suggest migrating to a good selection of active and passive funds and dialling back punchy positions in individual stocks.

There is also a distinct ‘home bias’ to the UK to be aware of with the shares, although as you have already admitted you are expanding your horizons and adding more overseas positions and funds, and I would support this more diversified approach. Funds to help diversify include JOHCM Global Opportunities (GB00BJ5JMC04), BlackRock Global Unconstrained (GB00BFK3ML85) and Artemis Global Income (GB00B5ZX1M70).

Overall, you are in a strong financial position with debt well under control and the ability to fund an early retirement. While you have options, you will encounter some tax issues if you choose to sell your holiday home, as this will mean paying a significant capital gains tax bill, as well as income tax on any investment income generated from the reinvested money.

You could keep the holiday home, but will likely have to accept a lower income. Another consideration is that, if you are concerned with inheritance tax planning and passing on wealth efficiently to your children, you should build up as much as you can in pensions and release that last to fund retirement as pension funds fall outside of your estate.

There is a case for releasing money from the holiday home and using your Isa and and pension allowances until you retire, although care would need to be taken regarding the tapered annual allowance for Jim, given he is a high earner. This may not be necessary if you hit a consistent 5–6 per cent investment return and keep up contributions.

However, much depends on whether your target income is a nominal £100,000, or rather a figure that is equivalent to that in real terms once you retire. If we increase £100,000 in today’s terms to when you retire, it’s almost £150,000, which is less attainable. 

You would benefit from thinking about the order in which you take money from your Isas and pensions. When it comes to drawing money in retirement the Isas will be particularly useful for taking unlimited amounts tax-free, while the ability to take up to 25 per cent from personal pensions will also be important when it comes to devising the right decumulation strategy. 

It’s also possible that the rules might change between now and then, so although it looks as though you have sufficient resources to fund your plans, and a relatively undemanding target growth rate, the tax side of the equation will need some monitoring.