On Friday 16th March the Trump administration fired the Deputy FBI Director Andrew McCabe just 24 hours before he was due to take retirement with full benefits. Without entering into the rights or wrongs of the decision the fact is that by not fulfilling the complete 20 years to qualify for a full pension McCabe has lost his right to the benefit of that pension.
Few people are likely to face such a bombshell on the eve of their retirement but the incident is a wake-up call for us to review other threats to pensions and to understand why we cannot rely on a single source of income in retirement.
People living in their home countries have their own concerns when planning retirement. In the UK for example the state pension scheme is safe but not particularly generous. Company pensions schemes are in dire straits with the majority of them in deficit and failures are common, including some high profile ones recently such as BHS and Carillion. But there is a partial safety net in the UK in the form of a government-controlled Pensions Protection Scheme.
Where expatriates are concerned however there is virtually no protection against the failure of any financial product, including pension plans. Hence the need to have more than one source of income to combat the risk of a single source failing. Let’s a take a look at the various forms of pension that people rely on and how they could fail.
State schemes
If you are allowed to maintain a state scheme in your home country this is usually the most secure scheme you could have although it is unlikely to cover more than your most basic needs in retirement. And if you are British you need to keep in mind that once you take the pension it will be frozen at the same rate so long as you remain resident in Indonesia. There is a local group in Bali actively supporting a campaign to change this but it is an uphill battle.
Company pension schemes
If you are working in Bali your employer is unlikely to be funding a pension plan for you unless you work for one of the large hotel chains. You may however have a personal pension or two secured in your home country and related to former employment. The risk here is that they could fail if they relate to final salary, a formula doomed to failure due to changing demographics and years of low interest rates. As a result, companies like British Airways are burdened with massive pension obligations which also affect their bottom lines. New pension freedoms may make it possible to transfer to a private scheme but you could be faced with an immediate tax bill and need to take great care as to where the pension is moved.
Annuities
Annuities purchased from a respectable insurance company are basically safe. But they also require a large up-front payment if they are to produce a meaningful pension. To guarantee the pension insurance companies have to rely on long-duration bond purchases and at this point in time bond rates are very low. Also, the purchasing power of the pension will fall each year. If you live to 100 it is will be practically worthless. Furthermore, the annuity will die with you or your spouse, leaving nothing for your estate.
Private pensions
A pension plan taken out with an offshore company does not have the constraints of a state or company pension. In fact the market would shun such a constrained product as people like to spend their pension pots as they please.
A typical pension would take the form of a regular savings plan over a period of 10 to 25 years. An income can then be drawn from it at regular intervals. Potential pitfalls include market volatility, poor fund selection and a temptation to draw down too quickly. Also, failure to maintain the contract or early surrender can lead to heavy losses. Having said that, a regular savings plan, adhered to with self-discipline and invested carefully with regular reviews, is still one of the most effective ways to save for retirement.
Lump sum portfolio
For someone fortunate to be able to put a significant lump sum aside a simple way to plan for an income for life is to place it in a portfolio bond or similar product. The portfolio should be carefully constructed with a balanced mixture of funds in stocks, bonds, commodities, liquid alternatives and cash. Global stocks should form the bulk of the portfolio as they will provide growth. But there will also be volatility, hence the need for a holding of bonds and cash. Withdrawals would be taken from the cash portion.
A portfolio valued at $500,000 would provide an annual income of $25,000 based on an annual withdrawal of 5%. Actual returns will vary considerably but they should not affect the 5% withdrawal. If the portfolio can make an average gain of at least 5% per annum after charges then the capital should remain intact indefinitely. But don’t count on it. A prolonged recession could force a reduction in the withdrawal amount or a shrinking of the capital.
Another consideration affecting portfolio bonds is that of high charges. Cheaper alternatives now available consist of ‘mini-bonds’ restricted to a menu of 200-300 funds or non-life company ‘platforms’ which perform the same functions as portfolio bonds but with lower charges. If you are locked into a high-charging product it may be possible to switch to one of the cheaper ones.
Property portfolio
Some people have successfully built up property portfolios over the years and treat the income from the properties as a pension. Income may be erratic though and monitoring the properties together with legal and tax issues may be difficult in advancing years. If any loans are outstanding these could become problematic when interest rates rise. Property is usually a good long term investment but it may not be the most practical if income is the priority.
Running a successful business
Many expats in Bali are successful entrepreneurs. Some will have put all their capital into their business in addition to their efforts. If the income from the venture is a good one it could indeed provide for retirement. But this might require a continued hands-on approach which may or may not be practical in later years. Running a business can bring great rewards but there are always risks and nothing can be taken for granted. It would be wise to ensure some of your profits are diverted to a separate investment which may well benefit from a Trust arrangement to protect you from creditors should the business fail.
To sum up:
As we have seen, each type of pension has its attractions but also drawbacks and uncertainties so should not be relied upon on its own to provide for retirement. If you could build up your wealth via three or four of the options you should be in good shape to provide for the challenges that face old age.
Finally, don’t upset your boss just days before you qualify for a retirement pension! At least Mr. McCabe at 50 has a bit of time to start rebuilding a pension if he can find a new job.
Colin Bloodworth, Chartered Member of the Chartered Institute for Securities and Investment (UK), has spent over 20 years in Indonesia. He is based in Jakarta but visits Bali regularly. If you have any questions on this article or related topics you can contact him at colin.bloodworth@ppi-advisory.com or +62 21 2598 5087.
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Copyright © 2018 Colin Bloodworth