What to invest in after ISAs continued
In the last episode I covered what a collective investment was and how pooling your investment works and what unit linked or unitised investments were. I also mentioned that there were a whole host of investment products available. I am now going to try and simplify the choice for you.
You need to ask yourself what are you saving and investing for? Lets take it as read that you have your emergency fund set up and safely tucked away in a deposit account. Why are you saving and investing?
I believe there are two basic reasons,
1. Establishing a lump sum with which you are going to do something specific
2. Establishing future income security
In the first category are things like,
· Saving up for a big holiday
· Paying off your mortgage
· Buying a yacht/supercar/etc
· Funding school fees or university fees for your children/grandchildren
In the second category are,
· Retirement and pension planning
· Early retirement
· Reducing working hours
· Protecting against being made redundant, especially in the latter part of your career
· Improving your lifestyle in retirement
If any of the things you are saving for in the first list are things you are going to do when you stop working then put them in the second list.
You are now going to plan your savings/investments as, either retirement focused – that is normal, partial or early retirement, or capital expenditure needed before retirement.
We could label these as “very long term” and “not-so-long term financial objectives”. There are lots of people who save for the big capital expenditures, holidays, cars, boats and kick the retirement can down the road …until it is too late. There is a “live for today” driver that gets in the way of the sensible and not too burdensome retirement planning. So let me paint a picture for you of what retirement looks like if you save nothing and rely on the state.
According to the Office of National Statistics (ONS) the lowest income retired people in the bottom fifth in society spend on average £153 a week per person, that is £305 per week as a couple. In annual figures that is £7,956 and £15,912. So how much will the state give you?
From April 2020 pensioners retiring on the new state pension will receive £175.18 per week. So, on that basis you will be fine. However you will be only spending £11 a week on clothes, £10 a week on booze and less than £55 a week on food and those numbers are for a couple not an individual. There is a link on the transcript which will take you to the source of this information so you can have a look for yourself. Click on it and download the spreadsheet.
If you are earning the median UK income £29,400 a year, your weekly earnings after tax are £452.50 (and just marginally less if you live in Scotland). If you are spending all of that you are going to need to cut your outgoings in retirement by a massive £277.32 a week to live off the state pension of £175.18! That is a serious drop and one that you might well struggle to cope with if you have been used to spending everything you earn for over forty years.
Only those who are on very low incomes can realistically afford to retire and live off the state pension without dropping their living standards and even then it is a real, real struggle.
So sort your pension out before you start planning on driving your Maserati to Cannes to pick up your superyacht. For me you must sort out your retirement first but sadly too many people just don’t do it.
The next four bullet points may help to convince you of the importance.
1. The pot of money needed to fund a retirement income of £20,000 is £477,000 today
2. The average pension pot of people retiring in 2019 was £61,897
3. The average pension pot would provide £2,595 a year or about £50 a week
4. That leaves a shortfall of average pension income of £227 a week
I have not mentioned savings arising from stopping working such as travel costs, lunches and so on. However they will not make up anywhere near the level of shortfall you will face.
Where is the best place to save for retirement?
A pension plan.
Let me explain why.
1. You cannot touch it until you are 55
2. You receive tax relief on your contributions
3. The fund you invest in grows largely tax free
4. When you take benefits you can have 25% of the pot you have built up tax free
5. If you die under 75 the fund is payable tax free
6. If your employer pays in to a pension for you there is no benefit in kind tax
There are a few restrictions for high earners but I don’t intend to turn this podcast into a pension planning course. So, if you are a high earner, then see an adviser.
I think it is really important to understand what these features mean to you.
Not being able to touch your money till age 55 will stop you spending more effectively than anything else. If you cannot get it you cannot spend it!
If you are employed your employer may well offer a pension plan into which they pay for you. If they do it is one of the best returns you are ever going to get. So make sure you join it.
I have covered tax relief before but it bears repeating. For a basic rate tax payer it increases your contribution from say £100 to £125 for nothing. A full 25% return, day one with absolutely no risk. But what effect does that have over time?
£100 in a non-pension investment at 5% would produce £704 in 40 years. In a pension pot it will produce £880 – 25% more. But the investment growth is largely tax free so you will earn a higher rate of return. If you run that through assuming 6% instead of 5% you would have £1,285.
That’s 82.5% more money because you chose a pension instead of a non-pension investment.
But in reality you should be saving regularly not just putting in a one-off payment so here are the results for £50 a month plus a £100 lump sum.
· Non-pension investment £75,132
· Pension investment £121,095
And if you increase your monthly amount by 2% a year the figures are £99,938.95 and £157,626.
The two really important messages in this are that
1. The longer you save the better so start early. If you do accumulate that £157,626 and earn 6% return on it the following year it will be nearly £9,500 higher.
2. You should make a start! Right now! Even £50 a month can make a huge difference to your future wealth so get on with it.
I mentioned earlier that if you are employed and your employer offers a pension that you should join it. Let me emphasise why. If you employer matches your contribution of £50 in the example we just looked at then you will have over £315,000 in forty years.
There are a number of different pension plans to choose from and I have put a link on the transcript to the Money Advice Service for more information.
It is more important to get started than to sit and analyse the best pension option so don’t let yourself be put off by the options. Any pension is better than none!
That’s it for this episode. AS always if you like what you are hearing tell your friends and family. If not …tell me using the contact page at www.poundsshillingsandsense.com
Till next time, thanks for listening.