UK expat pensions simplified

Think about an alternative world for a moment. One where UK expat pensions take minutes to set up. Next to no work on your part. Are tax efficient. Don’t require you to hand over control of your money to anybody else and are likely to grow your wealth faster than the ones people get lumbered with when they live in the UK.

The fact of the matter is, this is a reality.

But aren’t pensions complicated? And isn’t this especially true for expats? And, don’t we need to pay lots of money to professionals to get the job done?

No. Nope. Negative!

Let’s get into it.

UK expat pensions vs their resident equivalents

Most UK pensions are just tax sheltered investments in shares and bonds. Most UK expat pensions are something similar, but with much higher fees, and much less tax sheltering!

That pops up two simple truths right there.

• Pensions are just investing
• Expats usually pay more for something inferior

But here’s the thing, thanks to a little thing called the ETF we can do it ourselves. In other words the days of having to waste our money on overpriced rubbish have long gone.

Instead, we can simply invest in shares and bonds ourselves.

Is investing complicated?

But isn’t investing complicated I here you ask?

Not really. You see, whist its true investing can be complicated. It’s equally true that it doesn’t need to be.

Anybody new to the space can be forgiven for thinking otherwise.

That’s because there’s a mega marketing machine helping to push complexity in finance. For the simple reason there’s no money in saying its so simple that you can do it yourself.

But the fact of the matter is this, the more complex an investment is, the less likely to be profitable it is.

At its best, you’ll be charged an arm and a leg for something mediocre, but at its worst, you’ll end up investing in a load of rubbish and loosing all your money.

But it doesn’t have to be like that.

Putting your own UK expat pension together with ETFs

Enter stage left, the index tracking ETF (Exchange Traded Fund).

Index tracking ETFs are a magical invention for everyone. They are even better for expats because they allow us invest and to construct our own pensions.

I could spend days waxing lyrical about index tracking ETFs. You can read a lot more about them here if you want, but here’s a quick summary of what makes them great for us.

• Great investment returns
• Tax efficient
• Simple
• Available to expats
• Hardly require any work on your part
• Leaves you in total control of your own money
• Can access your money very easily and quickly
• Extremely low cost

For sure there are other types of funds out there that offer pretty much all of the above, but its point four that really separates ETFs from any alternative for expats.

The clue is in the name, Exchange Traded Fund. The ‘Exchange Traded’ bit to be precise. That means just about anybody with an investment account can buy them.

And unlike days gone by, there are plenty of investment accounts open to UK expats. We’ve compared a few here if you don’t already have one, but here’s the headline:

Online investment platforms open to expats mean you can open an account simply and easily from wherever you are.

The minute you have one just choose some ETFs, add money and you are good to go.

Online investment accounts

With an online investment account, we can use index tracking ETFs to build a really strong investment portfolio to act as our pension.

So just to be clear. No we aren’t picking individual shares. We are just going to choose a handful of funds based on our current situation (explained in more detail a bit further on).

At most you’ll need three ETFs but lots of people do it with two and some people even get away with one. More on that later. Let’s assume three for now. One for shares. One for bonds, and one for cash.

Here’s a brief explanation of what’s inside each of our three ETFs.

Shares ETF

Shares are little pieces of businesses. Over time, they provide stellar investment returns. Though there’s no guarantee of a repeat, history suggests around 9%.

These days you don’t have to pick shares. You just pick an ETF that essentially contains all of them a.k.a. the global index tracking ETF.

When you invest in one of these you’ll own tiny pieces of all the global businesses that matter. And they’ll be working for you 24/7 across the globe.

When they make money, you’ll make money. Yes some of them will loose money, but others will more than make up for it. It’s all in the maths you see.

Whilst one share can only loose 100% of its value, that very same share also has the possibility of going up 1000s of percent.

In other words, you don’t need anywhere near as many good companies in your fund as bad ones to get decent investment returns.

Buy them all and you’ll do well and not have to think about it.

The only problem with shares is they have a nasty habit of crashing from time to time. And whilst they’ve always recovered to reach new highs and we’d also expect them to recover in the future that doesn’t mean you aren’t in for a roller coaster ride in the short term.

It also means investing in shares absolutely has to be long term and most people are going to need a little something to smooth out the ride. Hence, the need for some other funds.

• Example – Invesco FTSE All-World Accumulating

(N.B. You might be expecting to see Vanguard FTSE All World here and once up on a time it would have been, but this new fund from Invesco is a much cheaper version of the same thing. Sorry Vanguard!)

Bonds ETF

Bonds are loans. You lend your money to a company or government and they give you some interest payments for your trouble.

Bonds provide stability through income and generally not being quite as wild a ride as shares. They really are a massive topic, though. You can read more about them here, but here’s a few pointers.

First, as well as providing some much needed stability for shares, they also tend to do well when shares don’t, meaning the two of them work very well together.

The main problem with bond funds its a bit harder to choose one than with shares. Whilst we’ve already established we can just pick a fund that contains all the shares, there are some additional considerations with bonds.

In a nutshell there are three risks to understand. Duration, currency and default.

Duration is a measure of interest rate sensitivity on bond prices, but all we really need to know is this. The longer the duration the more volatile bonds are. And in turn the longer the duration the more risk of prices going down there is. (But we’d usually expect this to be a temporary affair).

Choosing bonds in a currency that you don’t use, opens you up to the risk of that currency weakening against yours and there’s always a possibility that a bond issuer (company or government) could default and not pay.

All things being equal:

• the shorter the duration the lower the risk.
• bonds in the currency you use (or will use in retirement) removes currency risk
• governments are better than companies and developed market governments (US, UK, Germany, Japan etc) are safer than developing country government bonds.

Again, read this for more details on all this, but for those very reasons I personally prefer short term UK government bonds.

Short term means the price is pretty stable. UK means I stick with pounds and don’t take on currency risk. (Whilst I don’t live there now I intend to in the future).

And UK government, meaning I’m just about as guaranteed as I’m ever going to be of getting my money back. (They own the printing machines!).

So the following is an example based on my own preferences. It also assumes I’m retiring back to the UK. If you plan on retiring elsewhere you might want to read this.

• Example – iShares UK Gilts 0-5 years

Cash ETF

Whilst extremely rare, the possibility of shares and bonds both having a bad year is real. In other words they could both temporarily loose value.

You never want to be in a position of having to sell them at a loss to meet some kind of financial emergency. A real pension company wouldn’t let you do it, so you shouldn’t.

As a result, it almost always pays to have some cash on hand for emergencies. Three months to one year’s worth of life expenses are popular ideas.

I’m sure it goes without saying that the more you have, the more secure you’ll be. But here’s the thing, the more cash you have, the more of your money is loosing out to inflation.

This is why savvy UK residents whack theirs in a high interest savings account, but that’s not often practical for expats.

Even if you can access a savings account, the interest rates are often low and the banks who provide them often charge you higher fees for other things.

Luckily there’s an excellent alternative to the savings account called the money market fund. You can read more about them here, but essentially, they are an excellent savings account alternative for expats.

In fact, they usually provide higher interest rates than savings accounts without having to lock your money away.

Again, you can read more on this here, but there is a small risk you might not be able to access your money market fund when you need to in times of severe market stress.

This means it’s probably prudent to keep a couple of weeks to a month’s worth of real cash on hand for such times.

• Example Lyxor Smart Overnight Return GBP

ETF tips

Here are a few pointers you should be aware of with ETFs.

OCF

First up is the ongoing charge (OCF). This is usually the biggest cost you’ll have in investing. On the face of it, the numbers are small, but that somewhat hides reality.

Say your OCF is 2%. That’s 2% of your total balance in that fund. So say you have £100K, that would be £2K you pay annually to the company running the fund.

It doesn’t sound like much until you understand that number comes off your return. Let me explain.

If your fund made 6% one year. 2 from 6 leaves you with just 4% ie 2/3rd of your money. You’ve paid a third to your fund company. Here’s why you don’t want to do that:

• £100K compounding at 6% annually over thirty years gives you £574K
• £100K compounding at 4% annually over thirty years gives you £324K

In this example it costs you £250K.

Luckily for us you can choose ETFs with very low OCFs.

For your information, the OCFs in the example ETFs listed above are all less than 0.16%. And I wouldn’t want to be paying anything above 0.30%.

ISIN code

ISIN codes look like this:

IE000716YHJ7

All ETFs have them. You’ll usually find them on fact sheets, which should be free to download from the provider’s website.

We are interested in the first couple of digits, in this case IE. This stands for Ireland and it means the fund is domiciled in Ireland.

Expats need to pay attention to Domicile for tax reasons. Usually, Ireland domiciled ETFs make most sense for UK expats.

ETFs domiciled in other jurisdictions such as the US, Europe and even the UK are nearly always less tax efficient. We’ve talked more about this here if you are interested.

And just in case you are thinking this is starting to sound complicated, don’t worry all the big ETF providers like iShares, Vanguard and Investco have Ireland domiciled funds. (Our three examples are all domiciled there).

Distributing vs Accumulating

A lot of ETFs come in distributing or accumulating versions. Distributing simply means the dividends get paid into your investment account. Accumulating means they get automatically reinvested into the fund.

As a result, accumulating options usually make sense for most people because it gives you one less thing to do.

Rebalancing our pension investments

OK so now we’ve opened our investment account and chosen our funds.

The question then becomes how to split money between funds.

And I have to admit, this is a big question. In fact, to answer it you’ll have to ask yourself three more:

• Have you got enough yet?
• Where are you on the risk scale?
• How long do you have?

All three of these are related to the fact that shares can drop in value pretty dramatically in the short term and even bonds aren’t immune to the odd plunge.

Have you got enough yet?

All things being equal the nearer you are to having enough the more bonds and cash you’ll usually want.

If you don’t know whether or not you have enough there’s a handy calculator here that can help.

Where are you on the risk scale?

All things being equal the less risk you want to take on the more bonds and cash you’ll usually want.

And take note: most people think they can handle more risk than they actually can.

The solution to this is to take a conservative approach. For most people that’s likely to be a better option for the simple reason that its easier to stick to.

I freely admit I’m on the low end of the risk scale. In other words I don’t like risking more money than I have to.

I certainly have more cash and bonds than somebody in my position should do but this means I don’t panic when the markets drop.

Panic selling in a market crash is just about the worst thing you can do. (Remember we expect a full recovery sometime in the future).

How long do you have?

All things being equal the less time you have the more bonds and cash you’ll usually want.

But bear in mind most people undercook this one.

They target a retirement age, but in most cases that’s not what we want to do, because we actually need to be investing well into retirement. After all, that’s what pension numbers are based upon.

So let’s say you are 50 and want to retire at 67. You don’t have 17 years in front of you, you have more like 40! And if you have kids that you want to inherit your money it doesn’t stop there!

Again, the key to all this being stock markets crash from time to time and can take a few years to recover and bond markets aren’t immune either. But they do recover.

It’s more a question of can you handle these temporary drops both financially and psychologically. If you can load up on shares. If you can’t load up on cash and bonds.

But just remember its the shares that give you the good returns. Most people usually need at least some portion of their investments in shares to reach their goals.

Splitting hairs

So back to the matter in hand of how to divide your money between three funds.

You should always begin with cash/money market funds. It’s this simple. You need enough to see you through an emergency such as loosing your job.

Now for sure some people’s jobs are less stable than others.

I’ve got friends that are forever between IT projects. Luckily they get paid so much, taking a year out here and there doesn’t impact them in the slightest.

Most of us don’t have that luxury.

You know what they say. Today’s jobs are tomorrows AI tasks.

However, safe you think your job is, nobody knows what the future holds. Having enough money to at least see you through your search for your next one is crucial in today’s ever changing world.

Some say three months of cash is sufficient.The majority seem to have settled on six months. Others prefer a year and you might be surprised by the the number of people that go for three years.

(Three years comes from the fact it took the financial markets about that long to recover in 2008. Next time it could be longer or shorter. Nobody knows).

I like the idea of six months, but at the very least, I think it makes sense to have at least three months living costs covered for when the proverbial really hits the fan.

Once that’s sorted you can move onto the split between shares and bonds.

Laggards and the art of rebalancing

This is another one that may need a bit of further reading.

In a nutshell, you choose your split and then stick to it.

There are plenty of rules of thumb on this.

The most common is your age in bonds. So say you are 30 you’d put 30% of your money in bonds and the rest in shares.

Others believe that’s outdated because we expect to live longer so you should subtract your age from 120 and put that percentage of your money in shares.

So in this case that would be 90% in shares and only 10% in bonds. There are also those who believe you should simply go 50/50 no matter your age.

The fact of the matter is, this is a big topic that you need to think about. We’ve gone into more depth on the subject here.

But I’ll just say this. If it all sounds too complicated and you can’t make your mind up, I’d just go 50/50.

You can always change your mind later.

In other words. Say I get paid £50K/year and that’s what I need to live off. I’d probably focus on filling up my money market fund before I did anything else.

I’d be looking to stick around £23K in my money market fund and keep £2K in real cash, then split any other money I had equally between my shares and bonds.

This may be a big lump sum that I already have or it may be regular payments from my salary or both.

If you are investing a regular amount just alternate between the two funds until theres a laggard at which point you simply add to that.

Usually the laggard will be your bond fund because shares tend to go up faster.

So say I add £1K to my shares in January and then £1K to bonds in February but in March because shares have gone up 10% I’ve now got more in shares than bonds, I’d just add fresh money to bonds again.

Now, I would be remiss if I didn’t point out the fact that not every expat has to rebalance.

Do I really need three funds?

And that’s thanks to a neat invention which I’ll call the all in one.

That’s just to say there are ETFs out there that contain both shares and bonds.

They come from Vanguard and are called Life Strategy. You can read more about them here if you are interested but the key being they make things easier because no rebalancing is required. It is done for you by the guys at Vanguard.

While there are competitors on the market they aren’t usually suitable for UK expats. This is because they either don’t contain what we want or they aren’t ETFs so we can’t get access to them.

In fact, the UK versions of Vanguard’s Lifestrategy don’t even come in ETF format.

So why mention them then?

Well, because European Lifestrategy funds are infact ETFs which means anybody and everybody has access.

Lifestrategy funds really are a neat option. They have all the advantages we’ve already talked about and more, but there’s a catch.

Before you rush off and invest, do know, they aren’t suitable for everyone.

And that’s because they are euro focused, which means they have currency risk for anybody who doesn’t use the euro (either now or in retirement).

Most expats will retire back in the UK. If that’s you and the euro weakened against the pound you could find yourself out of pocket. Lifestrategy wouldn’t be suitable for you.

However, if you currently live in Europe or you plan on retiring there, Lifestrategy could be the perfect engine for your UK expat pension.

It takes rebalancing out of your hands and firmly places it in the hands of the professionals leaving you to get on with the important things in life.

Because with a Lifestrategy fund, you simply add fresh money to one fund whenever you have it without even thinking about it.

UK expat pensions simplified – the bottom line

So there you have it. Who said UK expat pensions were complicated. All you need to do is this:

• Open an expat investment account
• Decide on your split between stocks and bonds
• Choose your ETFs
• Add fresh money whenever you have it
• And then sit back relax and enjoy your life.