So before we recommend going ‘all in’ with equities we must look the clients firmly in the eye and let them realise we know very little about what equity returns will be and that the only route to a certain return is in bonds. How important is certainty to them? How will they feel if they are nursing big losses?
Income drawdown is an increasingly hot, in demand topic as pension savers wrestle with incredibly low annuity rates.
Many see drawdown as a high-risk strategy, only suitable for those investing in equities and living off the natural yield of the portfolio. Equity income as a total solution is both tax-inefficient and a recipe for disaster for anyone looking for higher drawdown levels.
The hurdle investment rate for beating an annuity pay-out to age 100 is currently only 4 per cent to 5 per cent. This can be achieved with a very high degree of certainty by investing entirely in bonds giving the same level of security as an annuity with all the extra flexibility of drawdown.
As drawdown investors found out in 2009/10, 30 per cent to 40 per cent equity market falls play havoc with your Government Actuary’s Department-imposed income limits. So unless you can tolerate these kind of swings in your income, equities are best kept to a limited exposure in drawdown.
And the nail in the coffin – drawdown investors pay tax twice on equity dividends. This little discussed phenomenon is worth considering for those investors with the choice as to where to own equities and where to own bonds, be it personally, in an Isa or in a drawdown account.
In drawdown investors suffer both the withholding tax on equity dividends in the fund and then go on to pay their marginal rates of income tax on their drawdowns.
So even a basic rate tax payer ends up paying 36 per cent tax on equity dividends. Bonds pay interest gross to the fund so the investor just pays tax once.
FIVE TOP TIPS
So on the basis that some of your clients would ideally like some certainty of return from some of their invested money, how do you go about getting the best from bonds in 2014?
1. Buy direct
Consider buying individual bonds, not just funds. Only when you hold a bond directly do you get the certainty of the return to maturity. If you can buy a bond paying 4 per cent, say, over seven years to maturity, this return will be unaffected by interest rate rises, and rates will need to rise an awful lot over the next seven years before this return is worse than sitting in a cash deposit.
