To include the State Pension or to ignore the State Pension, that is the question…when you’re retirement planning.
 
If you’re a millennial (born between 1981 and 1996) or later, I’ve come to a bold conclusion: it’s best to assume you won’t receive a State Pension, when you’re planning how much to save for retirement.  Let me explain why…
 
While it's likely that some form of State Pension will persist, I believe there’s a good chance that it will become much less generous or that the state retirement age will increase even further. It is also possible that it will become means-tested so only the least well-off will receive it. Because the UK population is ageing and, as a result, the cost of the State Pension is increasing, one or all of these possibilities is almost inevitable.
 
With an ageing population, a conundrum arises: an increasing number of people require care in their later years, while the workforce available to support them through tax contributions continues to dwindle. And, as State Pensions rely on current tax collections – that is, taxes collected from today’s workers are used to pay today’s pensioners, fewer workers will shoulder the burden of supporting a larger and growing retired population. So pensions will be less generous unless something changes.
  
How has retirement and the State Pension evolved over time?
 
Retirement is still a rather new concept. In the past the average person worked until they physically couldn't anymore; if they were lucky, their family looked after them in old age otherwise they faced serious financial struggles (this is how it still works for many in developing economies).
 
In the UK, the introduction of the means-tested 'Old Age Pension' in 1909 marked a big turning point, providing a modest income to people aged 70+ with an income below £21 a year. The pension payable to a single person of 25p a month is roughly equivalent to about £157/month today (if we account for inflation and the increase in average earnings over time) – very much in line with the current Basic State Pension of £156.20.
 
But...average life expectancy in the UK was about 50 in 1909 so, most people did not reach the state retirement age.

This initial State Pension didn’t require any contributions to be made in order to be entitled to it; a contributory State Pension scheme only came about in 1925 for manual workers and others earning £250 a year or less (equivalent to £12,500 in 2023 prices).
 
It wasn’t until after the Second World War, in 1946, when the ‘Welfare State’ was created, that a contributory State Pension applied for all people.
 
From 1946 until 1980 people with higher average earnings enjoyed a higher State Pension, however, linking State Pensions to earnings was abolished in 1980. Personally, I think the new flat rate for all is much fairer.
 
The State Pension has become less generous over time and may need to become less generous still
 
In terms of what the money you receive can purchase, the State Pension seems to have not changed too much since 1909  - it’s just as generous or not so generous, depending on your view, as it ever was. What has changed since the introduction of the Welfare State is the bar you need to meet in order to get a State Pension.

Whereas women used to start receiving their State Pension at 60 and men at 65, now, both men and women get it at 65 for the older generation and that’s rising to 68 for my generation.
 
In addition, while someone used to need just 30 qualifying years of National Insurance contributions or credits to get the full basic State Pension, a total of 35 years is now needed and, to get anything at all, at least 10 years of National Insurance contributions or credits is required. These changes reflect the challenges governments face in balancing the needs of retirees with the available resources.
 
To maintain the purchasing power of pensioners, the Government has maintained a 'triple lock' since 2010; under this mechanism the basic State Pension is increased each year by either average wage increases, average price increases (i.e. inflation) or 2.5%, whichever is higher.
 
Despite all this, to continue to be able to take care of those that need it most, more may need to be done. There is only so much that can be done to raise the qualifying age or the number of years of contributions; at some point, it may become necessary to start cutting out those that don’t really need the State Pension given their other sources of income. And if I’m honest, I wouldn’t be upset if this is where we end up because if the government can balance its books it can stop progressively increasing taxes (including through fiscal drag).
 
What does the State Pension currently cost?
 
Consider this: in the 2023-24 fiscal year, an estimated £124.3 billion (10.5% of public spending) is projected to be spent on State Pensions. This figure, equivalent to approximately £4,400 per household, highlights the scale of financial commitment required, particularly when you realise that UK median household disposable income (that’s income after tax) is only about £32,300.

Just to give you an idea of how mind-blowing this statistic is, in my native Malawi, the government's budget for the whole year for absolutely everything is £450 per household (UK: £42,000). And, the average Malawian household is 4.3 people compared to just 2.4 people in the UK.
 
And what’s going on with population projections?
 
Without an increase in immigration, the UK’s natural population is projected to start declining by 2025 … that’s in two years; a lot sooner than was expected based on estimates made in 2018; at that point we didn’t expect the natural population to start declining until 2043.
 
So, what’s the long and short of it?
 
There’s no two ways about it, to sustain the current generosity of State Pension in the context of an ageing population, some difficult decisions will have to be made. Sustaining the system will require adjustments such as raising the retirement age further (it’s difficult to imagine, I know) or reassessing eligibility criteria. In the short-term increased immigration may help to boost tax receipts but it’s unlikely to be a long-term solution.
 
Some thorny questions will need to be addressed on how to balance fairness and affordability when it comes to State Pensions.

Having enjoyed a sneak peak into the state of our public finances, it seems sensible that if you’re planning how much to save for retirement, as we did last week, especially if you’d like to retire early, then the best approach is to view the State Pension as a bonus. It will be awesome to get it but if you find that you’re not entitled to it, then by saving as though it won’t be there, the retirement you would like to have won’t be scuppered.
 
References
 
How much would the original old age pension be worth today?
Basic state pension rates, Royal London
Why should I pay national insurance once I've paid enough for a state pension? Steve Webb (former pensions minister)
A brief guide to the public finances, OBR
Average household income, UK: financial year ending 2022, ONS
UK natural population set to start to decline by 2025, FT
Government expenditure on state pension in the United Kingdom from 1948/49+, Statista

You can listen to this episode on YouTube.

Retirement is a dream shared by many of us, but achieving it requires careful planning and early action. In this article, we’ll delve into the world of retirement savings and reveal exactly how much you need to save each month to retire comfortably. So, if you're aiming for financial independence but are possibly thinking it’s a pipe dream, buckle up and discover the key to retiring early!
 
Understanding the two pension types – DC and DB pensions
 
Before we jump into the numbers, let's familiarize ourselves with the two primary types of pensions: Nowadays, most people have "defined contribution" (or DC) pensions, where the amount you and your employer contribute determines your retirement income. The risk lies with you, because your return, i.e. the pot of cash you’ll have at retirement, depends on the performance of the stock market.
 
Previously, "defined benefit" (or DB) pensions were more common, guaranteeing a pension until death based on your final or average salary and the years of service. However, DB schemes have mostly been phased out and won’t be covered in this article.
 
If you have a DC pension, if the stock market performs poorly you’ll either have to work longer or plan for a leaner retirement. Defined contribution schemes are sometimes called ‘money purchase’ schemes or self-invested personal pensions (SIPPs). They are similar to what Americans call 401K plans.
 
How do you calculate your retirement "pot"?
 
To estimate the size of the retirement fund you'll need, we can employ a simple rule of thumb. Multiply your desired annual retirement income by 25, and voila! You have worked out roughly how much you should aim to accumulate. But why 25?
 
This is based on the ‘4% rule’ – a widely accepted guideline that suggests that withdrawing 4% of your invested pot annually, ensures your money lasts. Research has shown that even after three decades, your investments tend to grow due to average growth rates of a diversified investment fund surpassing the 4% withdrawal rate.
 
{If the nerd in you wants to get into the maths: 4% = 4/100 and 100/4 = 25; … you don’t need to understand the maths, though, just use the rule}
 
Estimating your retirement expenses – how much will you need to spend in retirement?
 
Now, let's discuss the various lifestyle options and corresponding expenses you might encounter during retirement: according to research conducted by Loughborough University and the Pensions and Lifetime Savings Association, we can categorise retirement lifestyles into three levels: minimum living standard, moderate lifestyle, and comfortable lifestyle. To account for inflation experienced since these studies were done, I’ve increased the figures by 20%.
 
To maintain a minimum living standard, a single retiree requires an annual income of £12,240, while a couple would need £18,840. For a moderate lifestyle, the figures rise to £24,240 for a single person and £34,920 for a couple. Lastly, to enjoy a comfortable retirement, aim for an income of £39,600 if you're single or £57,000 for a couple.

(source: moneyfacts.co.uk; and increased by 20%)
 
What are these different lifestyles assuming?

​A minimum living standard assumes a single retiree spends £46 per week on a food shop, has a one-week holiday and a long weekend in the UK each year, does not own a car and spends £555 a year on clothing and footwear.
With a moderate lifestyle, our single retiree spends £55 on food each week, enjoys two weeks in Europe and a long weekend in the UK each year, and spends £900 on clothing and footwear each year.
With a comfortable lifestyle, the single retiree spends £67 per week on their food shop, enjoys three weeks in Europe every year and spends £1,200-£1,800 on clothing and footwear each year.
 
Calculating your investment targets
 
Using the 4% rule and these lifestyle figures, we can estimate the amount you need to save for retirement. Here's a breakdown based on your desired lifestyle and whether you're single or part of a couple:

I know that these numbers look huge. But keep listening, I’ll show you that you can achieve them much more easily than you think.
 
Getting started: how much to save each month
 
Now, let's explore the exciting part—how much you need to save each month to reach your retirement goals.
 
Assuming you're a basic rate taxpayer, investing in a global passive fund with an average annual growth rate of 7% (we’ll discuss whether this is a reasonable assumption in a future post), aiming for the ‘comfortable’ lifestyle (i.e. £990k if single; £1.425m for couples) and ignoring the state pension (I’ll explain why in the next article) and employer contributions these are the monthly amounts you need to put into a pension account based on your starting age (rounded to the nearest 5):

Each month until you’re 68 you need to save:

What the table shows is that the younger you start saving and the longer you save for, the less you need to set aside each month.
 
Factors that can offset the numbers
 
Don't worry if these saving targets seem daunting because there are several factors that can actually work in your favour, offsetting even the larger amounts you need to save if you start late. Let's take a look at these positive factors:

• If you're employed (i.e. rather than self-employed), chances are your employer will also contribute to your pension fund, on top of your own contributions. Many employers even offer a ‘matching’ programme, where they match a percentage of your contributions. For example, if you contribute 3%, your employer will also contribute 3%. Contact your HR department to learn how your company’s policy works.
• The state pension can also help offset the amount you need to save. However, whether or not you should include the state pension in your basic calculation for your target pension pot is open to debate.
• Any gifts or inheritances super charge your journey to retirement. However, research suggests that the average Briton doesn’t get an inheritance until about the age of 61. If you’re very fortunate, you may receive a gift or inheritance from your grandparents – although at that stage you will more than likely need to invest it in a home, putting a portion into a pension would supercharge its growth. Here’s how the magic of compounding works:
  • Imagine receiving a £10,000 gift at the age of 28 and investing it in a diversified global passive equity fund. By the time you turn 68, without any additional contributions, that initial amount would grow to an impressive £163,000, assuming a 7% return. Similarly, if you had £50,000 at age 22 and let it grow with the same assumptions, it would multiply to an astonishing £1.2 million by the time you're 68.
• Lastly, if you're a 40% taxpayer, the tax savings on your pension contributions are even greater. Contributions to your pension are made before taxes are calculated, so saving becomes more efficient. This means you need to save even less to achieve the same effect as someone in the 20% tax bracket.

 
In conclusion, securing a comfortable retirement requires forward thinking. If you didn't have this information when you started working, don't worry—now you do! There's no time like the present to start saving for your future. And here's a bonus: you can share this valuable knowledge with your children, ensuring they don't make the same mistake that many others do—starting too late. With the right strategies and a proactive approach, you can pave the way for a financially secure and fulfilling retirement. Your future is in your hands.
 
References
What Is the 4% Rule for Withdrawals in Retirement and How Much Can You Spend?
Q&A: How much do I need to save for a comfortable retirement?
Pensioners need a £33,000 a year income to enjoy a comfortable retirement
Fidelity Retirement calculator
How to get the £260,000 pension pot needed for a comfortable retirement - and why it might not be as hard as it sounds
Dave Ramsey investment calculator (ignore the $sign)
Fidelity.co.uk retirement calculator
​

You can listen to this episode on YouTube.

Have you heard about the FIRE movement? It's an acronym for Financial Independence Retire Early. While many people interpret it literally, there's more to this movement than meets the eye. In this post, we'll delve into what FIRE truly means, dispel some common misconceptions, and explore the different aspects of achieving financial independence (or FI) and retiring early. So, let's get started!

Understanding what FIRE is and what it is not

Contrary to popular belief, the FIRE movement is not a cult or a race to become a millionaire overnight.
​
FIRE is also not about living close to the poverty line so that you can save every penny possible – in the process depriving your family of positive life experiences such as holidays. This latter interpretation is from a podcast run by one of the mainstream broadsheet newspapers!

FIRE is about gaining control over your financial life and having the freedom to choose how you spend your time without worrying about money. Many attribute the beginnings of the FIRE movement to Vicki Robin and Joe Dominguez’s 1992 book, ‘Your Money or Your Life’.

Let's break down FIRE into its key components: financial independence, retiring ‘early’, and what retirement means in this context.

FINANCIAL INDEPENDENCE (FI) - what is FI?

Financial independence is the foundation of the FIRE movement. Inevitably, you have to gain some FI before you can enjoy any of the benefits of ‘retiring early’. At its core, FI means having enough passive income from investments to cover your living expenses. However, it's important to note that there are different levels of financial independence.

Regular FI – what does ‘regular’ financial independence look like?

Regular financial independence ensures that your passive income can sustain your pre-retirement standard of living. This includes basic necessities such as utilities, transportation, food, clothing, and some travel. While many people in the UK aim to pay off their mortgages before retiring early, it's not a strict requirement.

Lean FI – what does ‘lean’ financial independence look like?

Lean financial independence focuses on covering only the essential expenses like utilities, food, transportation, and basic rental accommodation – perhaps, in a housing association or choosing to purchase the most affordable property available in an out-of-town area where property prices are much lower.

Those targeting lean FI may choose not to have children or plan to retire to low cost-of-living countries in Asia or Eastern Europe (popular destinations include Thailand, Malaysia and Turkey).

A just-getting-by type of FI, like this, is not most people’s idea of financial independence but it suits some minimalists. For instance, Jacob Lund Fisker, author of ‘Early Retirement Extreme’ needed only $7,000 a year to live and that meant he was FI at 30 and retired at 33! And if you think that wouldn't be possible in the UK, a very close friend of mine has lived on a similar amount for the 18 years since we graduated from uni...we'll cover their story in a future post.

If Lean FI is the goal then you may plan to earn some money from temporary or part-time jobs when you retire to cover luxuries such as a special holiday; this version of Lean FI is called ‘Barista FIRE’.

Fat FI – what does ‘fat’ financial independence look like?

On the other end of the spectrum is fat financial independence. It represents a comfortable retirement with all necessities and desired luxuries covered. Fat FI allows for frequent holidays, dining out, a nice house, and a generous budget for food and clothing. Downsizing is probably not on the cards for FAT FI-ers.

EARLY – what does retiring early mean?

The "Early" in FIRE refers to retiring earlier than traditional retirement ages. The timeframe for early retirement varies depending on personal goals and circumstances.

As soon as possible

For some, ‘early’ means ‘as soon as possible’. Some people join the workforce with the clear objective of achieving financial independence as quickly as possible, ideally within 10 to 15 years. To achieve this, they actively pursue high-paying careers and dedicate themselves to saving and investing.

Timing with family goals

Others discover the FIRE movement later in life or choose to align their retirement plans with family goals. For example, they might aim to retire when their last child enters university. This could be around the age of 50 or 55. In the context of a UK state retirement age currently set at 68 for millennials – and which could rise to 70 or older by the time we actually get there – 50 is ‘well’ early.

Retirement can end up being a mini-retirement

While the extremely early retirees in their 30s and 40s grab most of the headlines, some may retire in their 30s or 40s but go back to ‘traditional work’ after a few years in which case the first retirement ends up only being a mini-retirement – a fantastic opportunity to do something different for a few years.

How soon you want to retire informs the type of financial independence you go for. The ‘leaner’ your lifestyle, the quicker you can achieve FI. It also informs the type of career you go for: you might choose a career in finance or high tech over public service, for example, to maximise your saving potential.

RETIRE – what does 'retire' mean to those on FIRE?

Retiring early doesn't necessarily mean quitting work entirely. Some individuals choose to work part-time in the same career or switch to more fulfilling, passion-driven careers that may not pay as well.

Others pursue non-earning hobbies, engage in charitable work, or spend quality time with their children while they're young.

And others identify with the FIRE movement and want FI for the peace of mind and flexibility it offers, but haven’t decided what ‘ ‘retire early’ means for them yet.

In conclusion, the FIRE movement has revolutionized the way we perceive financial independence and early retirement. It's about breaking free from the constraints of a traditional career and embracing a life filled with possibilities. Whether you aim for regular, lean, or fat financial independence, the goal remains the same—to achieve a level of passive income that affords you the freedom to live life on your terms.

In my next post, we'll delve into the exciting topic of how much you need to save to embark on your ‘retirement’ journey. So, stay tuned as we uncover the secrets to financial freedom and pave the way to a future filled with endless opportunities.
​
​References:

• FIRE explained
• Early Retirement Extreme – Jacob Lund Fisker
• The 6 Kinds of FIRE: Which One Are You?
• What Is Lean FIRE? The Minimalist’s Way To Retire Early
• What Is Fat FIRE? The Best Early Retirement Lifestyle
• Cheapest Places to Live

.I always say that if you get nothing else right in your financial life, at least own where you live outright by the time you hit retirement and ideally much earlier. Well that’s not quite right, the other thing you need to make sure of, is that you qualify for the full UK state pension.
 
Currently, when I am 68, for so long as I have 35 qualifying years, I will get £185/week in state pension until my dying day. That’s about £800/month or £9,620/year. This is not an insignificant amount and if you live with someone, i.e. your partner, a sibling or friend, it’s double that as you would each qualify separately.
 
My calculations suggest that if you’re living on your own, that amount of state pension would at least cover all basic utilities (water, energy, council tax) and food.
 
You can check how many qualifying years you have and whether you can boost them at gov.uk/check-state-pension.
 
If you’re self-employed, to qualify for the full state pension later on, make sure you’re signed up to pay Class 2 national insurance and if there are any gaps in your national insurance record, pay for them asap as you can only fill gaps going back 6 years:
gov.uk/national-insurance/national-insurance-classes
 
As the state pension is unlikely to be enough, it’s helpful to contribute towards a personal pension (aka a self-invested personal pension or SIPP) as pension contributions get tax relief such taht every £240/month contribution equates to £300/month into your pension pot.
 
Based on a 7% gross growth rate of your pension pot (and keeping in mind the historic average return of the S&P 500 is 10%)

• if you contribute £240 into your SIPP from age 20, you would have £1.6m at age 65.
• if you contribute £240 into your SIPP from age 25, you would have £1.1m at age 65.
• if you contribute £240 into your SIPP from age 30, you would have £790k at age 65.
• if you contribute £240 into your SIPP from age 40, you would have £370k at age 65.
• if you contribute £240 into your SIPP from age 50, you would have £155k at age 65.

 
If you want to play around with how much you should expect to spend in retirement, here are a few other helpful blogs:

• Pensioners need £60 a week more to live on, YourMoney.com
• Cost of retirement mapped, FT
• Your average energy bill by house size and usage, British Gas
• How much is the average water bill per month?, MoneyHelper.org
• Tax on your private pension contributions, .Gov

Hey heather, thanks for your podcast, I find it incredibly useful because it's UK specific and everything else I find seems to be geared towards the US.

Anyhow, my name's Dee, I'm in my 50s and have been a military stay-at-home mum all my adult life although I went to university. Being a military wife has exposed me to so many countries and cultures which I love but you do sometimes encounter traumatic things so it's nice to settle in the UK.

My family currently rents and all our adult children live at home including one that is dependent.

We'd like to get on the property ladder but have been struggling with when and whether to do it. In the past I've left all the money stuff to my husband but now that the children are older I'd also like to start earning an income and I've been considering investment property. I want to gain some financial independence and I'd love to be able to help the children out financially.

I am so ready to make up for the time I spent raising children. I don't know if it was stupid not to use my degree sooner but I guess better late than never.

Keep helping with your posts! Thanks.

Hi D,
 
Thank you for this question that covers a very wide range of things. I am also very sorry that you have experienced something traumatic. Your life choices are not stupid, many women find themselves in circumstances that mean they have to stay at home with the kids for whatever reason so your question may well resonate with lots of other mums.
 
Being in my mid to late 30s, you will forgive me for providing what might sound like a slightly optimistic review of your situation.
 
Your question as it is framed requires me to speak to:
1.Providing for your children particularly the dependent child with medical needs;
2.Buying property as a home;
3.Buying property as an investment;
4.Earning an income for yourself;
 
PROVIDING FOR YOUR CHILDREN
By letting your adult children to stay at home rent free you are doing plenty. That alone should allow them to save for their own property deposits and is a financial boost many people including myself did not have. If I could have lived at home rent, free, that would have had me on the property ladder a lot sooner.
 
The other thing you could do is direct them to read the type of personal finance books that will give them ideas for how they can be financially responsible so that you don’t need to worry about them. I recommend The Richest Man in Babylon and The Millionaire Next Door as good starting points.
 
Does your child with medical needs financial support from you as well as general support for all their living? I won’t touch too much upon this except to say that make sure that you are accessing all the state benefits you can for the child’s support including the carer’s allowance if it is applicable.
 
BUYING A HOME
 
Firstly, as far as the UK is concerned I always advise that, if you get nothing else right, at least buy your own home.
 
From your message, it’s not clear whether or not you and your husband discuss finances but I am guessing that this may not be the case. Firstly, I would try to get the two of you on the same page. Working as a team when it comes to building wealth can really supercharge your financial health.
 
The UK property market is completely different to the US property market in so many ways so I’d be a little careful before taking advice on property from US authors and podcasters (lots of property advice on the internet tends to be US-focused that’s why I bring this up). To begin with the population density of the UK is 281 per Km2 (727 people per mi2); population density in the United States is 36 per Km2 (94 people per mi2). What does this mean? It means that UK property in many areas doesn’t see price crashes (too many people, too little land) and there is a propensity for house prices to be sticky upwards.
 
In addition, because US mortgages are fixed for the full term of 25 years whereas UK fixed terms are only for 3, 5, 7 or 10 years, interest rates are much lower in the UK compared to the US (almost half). The result of this is that very often the interest you pay on your mortgage is much much lower than rent. As an example, I live on a street where the rents range from £1,200 to £1,500, however, the interest we pay on our mortgage is just £350 (it was a 25% deposit mortgage). The full monthly mortgage payment is almost £1,000 but everything above the interest of £350 is money that will come back to us if we sell our home.
 
So, provided you can get a good deposit together, you will save a lot of money by buying a home rather than renting. In the long run owning where you live will give you a lot of security including the psychological comfort it provides.
 
At 50-something, you are not too old to get a mortgage and may even be able to get a mortgage of 20+ years, however, if you owned property abroad and sold it when you left then it’s worth buying the home outright.
 
State pension
 
Another thing to consider with regard to your financial security is that even the full UK state pension only pays £175/week per person (about £759/month) this would be double for a couple. If you live in a home that’s been completely paid off, no mortgage, then you can survive on the state pension relatively comfortably.
 
However, as you have lived abroad for many years you need to contact HMRC to see how many qualifying years you have. Your UK State Pension will be based on your UK National Insurance record. You need 10 years of UK National Insurance contributions to be eligible for any amount of the new State Pension and for people my age 35 years of credit are needed to get the full entitlement, you may be in the generation that only needs 30 years of credit.
 
You may be able to use time spent abroad to make up the 10 qualifying years. This is most likely if you’ve lived or worked in:

• The European Economic Area;
• Gibraltar;
• Switzerland; and
• certain countries that have a social security agreement with the UK.

 
I would contact HMRC as soon as possible (link above) and ask what you need to do or pay to increase your entitlement to the UK state pension.
 
You may get National Insurance credits if you cannot work - for example because of illness or disability, or if you’re a carer or you’re unemployed.
 
You might also be able to pay voluntary National Insurance contributions if you’re not in one of these groups but want to increase your State Pension amount.
 
BUYING AN INVESTMENT PROPERTY
 
I recently read David Tarn’s “The Complete No-Nonsense Guide to Becoming a UK Property Investor: The 1-2-3 on Property Investing” and found it useful on the topic. The author is based in the North of England where property is much cheaper. He is into buying property and letting out the whole house to a single group like a family – so, standard single let properties.
 
In addition, I would recommend The Inside Property Investing podcast. There are over 300 episodes, if you binge listen to the episodes that appear interesting, you will move up the knowledge curve rapidly. The ‘Inside Property Investing’ podcasters are themselves heavily into High Multiple Occupancy properties (this is when you let a single property out to 3 or more unrelated people like students or professionals). However, the beauty of the podcast is that they regularly interview people on the show that follow a variety of different property investment strategies.
 
Don’t pay for any overly expensive property course before you’ve gained all the knowledge that is available for free or almost free – a friend of mine recently paid £24,000 for a property course, she went 50-50 with her daughter and even had to put some of the cost on a credit card! You’ve been warned.
 
For the basics on property investing I have a course up on Udemy for under £50. This will give you all the basic knowledge you need about the property buying process in the UK.
 
EARNING
 
There are many jobs out there. If you just want to boost your confidence and get some money rolling in there are plenty of jobs out there provided you are not too picky about the pay as long as you get your foot in the door. If you want to build a work life for yourself have a look on jobs boards at what’s going and start applying. If you want to build a career within a specific field related to your field of study consider taking a course to freshen up your skills.
 
I have no idea what your salary expectations are but median UK income for 2020 is 30,800 according to the ONS. After tax that would bring home just over £2,000/month; if due to covid etc you secured a job with a salary of £24,000/year, that’s still £1,600/month which definitely isn’t shabby especially if your husband earns too. A GQ article gives an interesting breakdown on age, occupation and the covid-19 pandemic’s impact on earnings.
 
 
I hope this helps. Far from thinking you are too old. I am feeling soooo excited for you. This is a fresh start and even over a 15 year period you can build an amazing life and financial cushion.
 
Good luck.

Hi Heather

I’m really enjoying your podcasts and have already given a 5 star rating.

I am 57 and plan to retire at 60 so love your retirement items.

When talking about 4% draw down for retirement income, it’s never clear if the figures are before or after tax. For example 4% of £1m is £40k, but after tax this could be nearer £30k.

If you then get a state pension of say £9k, the figure before tax is £49k, but after tax it is nearer £35k.

So when you talk about money needed in retirement, do you mean before or after tax?

Thanks,

David

David, thanks so much for the review! I definitely appreciate it.
 
First things first, David I am sorry that it’s taken me ages to get a blog post done on this, however, I did respond to your question directly within 24 hours of you asking it so I hope that will make up for the late blog post response to your question which you asked me roughly 3 months ago and 4 months ago by the time this airs on The Money Spot podcast.
 
Turning to the 4% rule…
 
For those that have not ever heard of it, the 4% rule states that if you don’t want your pot of invested retirement funds to run out before you die, the maximum you can take from that pot each year is 4%.
 
This means that if you want an annual income of 40,000 from your retirement pot, you need to save one million (GBP, USD, EUR) – I believe the study was done using American stock market performance but if you invest in a global portfolio it will be heavily weighted towards the US so you can use the 4% rule as the best proxy we have on what a reasonable withdrawal rate is.
 
To answer, David’s question, the 4% drawdown is gross and you would have to pay tax after that.
 
So, if you have £1,000,000 (for simplicity) in your pension pot in a given year, you would draw £40,000 and pay the tax on that.
 
If you are based in the UK, you cannot throw the gross amount drawn from your SIPP or other taxable investment account into listentotaxman.com to get a calculation of your after-tax income because your drawings from your investments are chargeable to capital gains tax so you don’t pay income tax on them but capital gains tax. Capital gains tax rates are different. In 2020, assuming 50% of the £40,000 you draw is capital gains, then your net income after tax would be calculated as follows:

 
Not taxable:                                  £20,000 (this is the portion you actually saved)
Taxable:                                          £20,000 (the capital gain)
Deduct capital gains tax allowance:               (12,300)
Taxable:                                            £7,700
 
This taxable amount all falls into the basic rate band for 2020/21 so you’d pay tax of 10% on it, i.e. £770. If you had a portion in the higher rate tax band even that is only taxable at a rate of 20%.
 
So, out of the £40,000 the net amount received would be £39,230.
 
This is a huge different to what you would have paid if this was income of £40,000 as the net income would have amounted to £30,841. That’s a difference of £8,389 – wow! People on work place pension will be taxed in that way because the DB pension counts as income, you can’t separate it into capital and capital gain.
 
 
If you are UK based and have reached your state retirement age then you would have an annual state pension. This is taxable to income tax and you can throw the total annual state pension amount that you receive into listentotaxman.com to figure out how much you will receive after tax.
 
State pension is taxable if all your sources of income sum exceed the threshold needed to pay tax.
 
That annual state pension is just over £9,000 so if that’s your only source of retirement income you wouldn’t pay any tax because it’s below the personal allowance of £12,500 – however, if this is you, you probably wouldn’t be the type of person that listens to personal finance podcasts - #JustSaying.
 
A few BIG things to remember though:
 
ISAs
 
If your retirement income is all in your ISA then it is all tax free; not tax needs to be paid.
 
Capital gains tax allowance
 
Current tax rules allow you to have a tax free allowance on capital gains in addition to the tax-free personal allowance SO your tax bill may be much less than you think because your state pension and any other pension income may fall into the regular income bucket and this enjoy a separate tax free allowance.
 
For 2020 the Capital Gains tax-free allowance is £12,300. I don’t know if this will be available when I retire, there’s talk of eradicating it to raise more tax…
 
Early retirement
 
Those that retire very early, and I’d classify anything before 55 as early may be overdrawing if they draw 4% because the study of the 4% rule was based on a 30-year retirement.
 
David, you’re probably okay given you’re 57.
 
Sequence of returns risk
 
Sequence of returns risk analyses the order in which your investment returns occur.
 
If a high proportion of negative returns occur in the beginning years of your retirement, these negative returns will have a lasting negative effect  on the balance of your investment portfolio and the amount of income you can withdraw over your lifetime is reduced. This is sequence of returns risk. However, if you have a few years of good returns when you retire and negative returns only occur later, say in the middle of retirement, then there’s a lasting positive impact.
 
If this happened to me, I would probably stop drawing income from my retirement pot for 2 or 3 years and live off non-stock market income, e.g. if you have  cash pot set aside, I’d deplete that first; or I’d consider getting a part-time job; or for those fortunate enough to have rental income, you can live on that and give your investment portfolio time to recover.
 
I think that’s all the main stuff. To summarise:

1. The 4% rule is gross so tax needs to be deducted after you draw 4% from your investment portfolio.
2. No tax is due if all your investments are held in an ISA;
3. Even if the retirement investments are in taxable brokerage account, you have a healthy Capital Gains tax-free allowance of £12,300.
4. The 4% rule may not work if you retire early because it wasn’t tested on long retirements.
5. Finally, sequence of returns risk means that if stock market returns are poor in the first few years of your retirement, the value of the income you can draw during your retirement years is reduced.

 
I hope this answers all your questions and I additionally hope that I threw in a few thoughts that you hadn’t considered.


Heather 
p.s. subscribe to my podcast and ask me any money question, HERE - do it now!

Hi Heather

When is a good time to draw equity from your house: when I retire which is in about 5 years or before?

​Mary

Hi Mary
 
Thanks for this question because it really got me scratching my head.
 
I was initially quite flummoxed when I received the question because as a proponent of the FIRE movement (Financial Independence Retire Early) the whole premise of my money management toolkit is to get out of debt including mortgage debt completely and NEVER go back. However, I am going to park this way of thinking and answer your question in the most unbiased fashion that I can and I will also ask you a few probing questions so you can figure out whether this is what you want to do.
 
FIRSTLY, what do you plan to do with the money? Do you want to use the money for general living or to make a significant purchase or investment?
 
Generally, I think in most cases it is not a good idea to get into debt during retirement as it may cause undue stress if you run into any unexpected financial problems.
 
OPTION 1: Take equity out and pay off the debt or interest during retirement
 
I don’t know the value of your home or any other numbers, however, if you take equity out of your house that money will be charged interest and if you enter into a standard mortgage contract, you will have to pay the interest and possibly repayments from the month after you take that equity out.
 
From my follow up email to you I gathered you have a pension that will come in when you retire. I am assuming this is a “defined benefit” pension so it’ll be paid to you from retirement until you die.
 
By taking on debt you will have a reduced income. So, if your pension is income amount to 2,500 per month and if you take out equity requiring 500 in monthly payments you will lose 20% of your pension straight off the bat to debt payments. How will this affect your standard of living?
 
OPTION 2: Take equity out and pay all the interest off when you die
 
If you are over 55, which I assume you are, you can also get a mortgage that doesn’t require interest payments to be made until you died.

• Equity release through a "lifetime mortgage"

If you’re over 55 you can take equity out of your home at a fixed or capped interest rate. A lifetime mortgage allows you to take money out of your property a bit at a time up to an agreed amount and interest is charged on the total amount you have taken, rather than the whole amount available.
 
Depending on the terms you may be allowed to repay some or all of the amount borrowed. Otherwise, with a lifetime mortgage all the interest would be accumulated and paid on your death.

• Equity release through a "home reversion plan"

Under a home reversion plan you sell a stake in your home at below market value to a bank.
 
So if your home is worth 100,000 you might sell a 40% stake to the bank for a 20,000 lump sum. When you die, the bank gets 40% of whatever the house is worth at the point. So if you die 20 years later and your home is worth 300,000 the bank get 40% of 300,000 which is 120,000 for the 20,000 that they lent to you.
 
If you died the very next year and your house has stayed the same in value then the bank gets 40,000 for the 20,000 that they lent to you. Even if your house falls in value the bank is still likely to come out ahead because they take a huge hair cut off the value of the house.
 
The reason these mortgages are only offered to people over a given age is to minimise the chance of the bank losing its money, for example, because accumulated interest exceeds the value of the house on a lifetime mortgage.
 
To safeguard the bank further, they keep the amount of equity that can be released quite low; the younger you are, the lower the allowed equity release. So, a 55 year old might be restricted to releasing no more than 20% but a 75 year old might be allowed to release 30-40%. I am making numbers up here because the reality is that more conservative banks will have lower limits and banks that are more risk tolerant allow a bigger release of equity.
 
It all sounds great on first inspection but banks have received a lot of bad press regarding equity release schemes because in the fine print they have stuff like, you don’t need to repay the interest PROVIDED you live in the house so if you need to move home, even into a care home or to a more accessible home because you develop mobility issues, all that money comes due and you would be forced to sell your house and pay the bank.
 
There are likely to be other catches too because banks are in this to make money so if you go for an equity release scheme of any nature you should have a lawyer or financial advisor look at the terms and conditions diligently for you so you know exactly what you are getting yourself into.
 
The bank might get a guarantee that you will never owe more than the value of your home but this means that you could owe the full value of your home to the bank. If you release equity at age 55 and live until 95 there is every chance that interest can accumulate to the point of exceeding the home value.
 
It’s nice to get a tax free lump sum via an equity release but in doing so you may reduce your entitlement to means-tested state benefits, now or in the future so you need to think about this angle too.
 
I don’t know how well I am doing with the unbiased view thing here as you can probably tell that I think releasing equity is a high risk game and it frankly, freaks me out.
 
If you don’t have any kids or charities/causes that you’d like to leave an inheritance to and you’re certain you will be physically fit enough to live in your home until the day you die then perhaps the risk of releasing equity could be worth it.
 
Another form of equity release is to downsize your home, i.e. you sell an expensive home and buy a cheaper home and live off the difference, this way you release equity but don’t incur any debt in the process.
 
COST OF EQUITY RELEASE
 
According to moneysaving expert.com, a lifetime mortgage equity release typically has an interest rate of c.5%, but some rates are under 3%.
 
This is a lot higher than rates on regular mortgages. E.g. With a 40% deposit you can now get a 5 year fixed rate mortgage of just under 1.4%, just to give you an idea.
 
If you release equity at a rate of 5% then the amount you owe would double every 14 years (see my article on the rule of 72); so if, say, you borrow 20,000 on a 120,000 home, if you  live until 74 you’d owe around £40,000, live until 88 and you’d owe £80,000 and live until 102 and you’d owe 160,000.
 
As well as the cost of the interest, don’t forget that you'll have to pay arrangement fees when you take out the mortgage and in the UK these range from £1,500-£3,000 depending on the mortgage deal and including things like solicitors and surveys.
 
 
ALTERNATIVE
 
As you have 5 years until retirement, you could try to boost your savings over the five years so that rather than borrow money you’ve saved for it. If you don’t feel you earn enough to save the amount you want you can look at things like renting rooms in your home via AirBnB or by getting a more full time lodger.
 
I would personally find it very scary to go into retirement with debt because the need to keep with payments or even the knowledge that I don’t actually own my home but if you are more comfortable with the idea then this won’t be a consideration for you.
 
My biggest advice would be get professional advice before you take this massive step and do whatever you can to avoid having to do it. A debt-free retirement is a peaceful retirement.
 
Much love and thanks for being a long-time follower. See the linked article on equity release on the moneysavingexpert.com website.
 
Heather x

p.s. subscribe to my podcast and ask me any money question, HERE - do it now!

Hi Heather, just discovered your podcast and blog. Really inspiring. Could I ask a question?

I have about £10k to invest and I’m considering three options. I’d really appreciate your help in deciding what to do.

1. Add to my passive investment portfolio which is spread across equities and bonds. It’s down about 8% since Feb. I’m not planning to access this for 7 to 10 years. I could put it in now as a lump sum or drip feed 2.5k every week for the next month. I see the advantage as cheaper units and likely long term growth. The disadvantage obviously is that the market could drop significantly again. I know it’s dangerous to try to time the market.
2. Invest in my SIPP which has similar funds but will lock my money in for the next 12 years. As a higher rate tax-payer I know there are significant benefits.
3. Buy added Civil Service defined benefit Alpha pension. A 10k lump sump would buy approximately £1k self added pension or £900 self and dependent pension. The defined benefit looks attractive but again the money would likely be locked in until I turn 67.

Any advice would be hugely appreciated.

Many thanks
Nik M

Hi Nik
 
I apologise for the delayed response as I realise your question was time-sensitive but I was in project execution mode over the last two weeks.
 
I think this is an awesome question and I’ll tell you how I would go about thinking about this. Firstly, did you know that I too am a civil servant with access to the Alpha pension scheme? Let me know via the comments box if you did know. I have never mentioned it in any blog or podcast before but it is on my LinkedIn.
 
Given what you have said about when you could access your SIPP, I am guessing you are about 43 years old, i.e. you have 12 years to reach age 55 when you can access the SIPP and if your retirement age is 67 then you have 24 years until you can access your Alpha pension savings.
 
There are 4 keys things you might want to consider:

1. Portfolio effect;
2. The return;
3. When you might want to access the money, i.e. horizon/flexibility; and
4. Inheritance.

Anyone reading this that has a 'defined benefit' workplace pension (e.g. NHS workers) can apply the principles that I outline here to evaluate their own options for investing a lump sum of money.
 
PORTFOLIO EFFECT
 
By portfolio effect I mean you should consider how the lump-sum is invested in the context of other sources of income you expect to have in retirement.
 
Firstly, I opted out of the Alpha pension scheme because my husband works for the NHS and has access to their defined benefit scheme and because we manage our household finances as a single unit, I felt we could take more risk. His NHS pension gives us a safety cushion and I went for the civil service partnership pension which works exactly like a SIPP in that what I get at retirement depends on the return. An added benefit is that I can access the money at age 55 rather than 67 if I want to although I doubt I would do that as I’d rather use up my ISA savings first.
 
THE RETURNS
 
Average stock market returns have historically been about 10%. This could be the same in the future or it could be different. There are no guarantees.
 
I am not sure what your passive investment portfolio is specifically invested in but I will assume it is a passive global fund and as you haven’t said it is in an ISA, I will assume it’s in a taxable investment account. The last time I looked for a reasonable return to use to model my future returns I found an article that suggested 9% gross and 6% net of inflation was reasonable. I prefer to use 7% gross and 4% net of inflation.
 
If we go for the 7% return in taxable brokerage account – i.e. ignore the SIPP option to begin with:

• then when you are 55, £10k could be worth £22,500 (10k x 1.07^(12 years)) or about £16,000 after inflation; and
• when you are 67, £10k could be worth 50,700 or about £25,600 after inflation.

 
If you drew the money down according to the 4% rule which says that you should draw no more than 4% of an invested portfolio so that it doesn’t run out, then if you start to draw on this money from age 67 (same as when you would have access to your Alpha pension money) you would draw £2,028 in the first year of retirement (50,700 x 4%).
 
The following year when you are 68, you would draw £2,083 i.e. (50,700-2,028) x 1.07 x 4% - you draw slightly more because although the money has been drawn it is still invested and continues to grow at the average rate of 7%.
 
These are gross numbers – what about after inflation?
 
If you wanted to look at what you would be drawing after inflation, then in the equivalent of today’s money you would draw £1,024 (25,600 x 4%) and you would draw slightly more in real terms the following year.
 
You need to compare what this looks like against Alpha.
 
I know Alpha is inflation protected but I am not clear whether the £1k increase in Alpha payments that you mention is from today or whether it’s £1k from the age of 67 and growing from inflation at that point.
 
If it’s £1k and growing with inflation from today then at the age of 67 you would be getting £2,030 in real terms (1,000 x 1.03^24) whereas with the stock market investment you were getting only £1,024 in real terms – from this perspective Alpha is a no-brainer as it’s a guaranteed £2k per year until death rather than a probabilistic gross drawdown of £2k per annum.
 
I see the stock market as broadly providing some inflation protection given all companies increase the prices of their products over time.
 
If it’s the case that the increase in the Alpha pension is £1k at age 67 then growing by inflation from that point then the additional gross £1k in real terms after 24 years is only £490 (1,000) / (1.03^24) – in this case the stock market investment looks much more attractive.
 
If you go for Alpha with self and dependents then multiply the Alpha benefit by 90% to evaluate the impact.
 
If we go for the 7% in a SIPP account – then you get an immediate uplift because there is an immediate tax saving.
 
As a higher rate tax payer note that the SIPP provider would only claim tax relief at the basic rate of tax and you would need to claim additional tax relief via your self-assessment tax return or if you don’t do a tax return you would need to call HMRC to see if you could just do it by changing your tax code.
 
With the full tax relief £10k translates to £16,667 in your SIPP.

• then when you are 55, £16.7k could be worth £37,530 (16.7k x 1.07^(12 years)) or about £26,680 after inflation; and
• when you are 67, £16.7k could be worth £84,530 or about £42,720 after inflation.

 
If you drew the money down according to the 4% rule, then if you start to draw on this money from age 67, you would draw £3,380 gross (84,530 x 4%) or about £1,700 in inflation adjusted terms and steadily growing.
 
From a returns perspective putting the money into a SIPP begins to look very attractive indeed. This brings us to the next consideration, horizon/flexibility.

HORIZON / FLEXIBILITY
 
With a SIPP you have access to the money from age 55. Unless you are 100% sure you don’t want to retire before age 67 or even to part-retire then you don’t need earlier access to the money.
 
With the money in a taxable brokerage account you can draw the full gross amount invested in one go, if you like. There would be tax to be paid but you would still have the full amount if you wanted it.
 
You can reduce the tax amount due from a full drawdown if you put half i.e. £5k into your own investment account and half into a spouse’s investment account. You can avoid tax completely by putting the full £10k into an ISA (the annual limit is £20k so you would be within that).
 
INHERITANCE
 
If you have all your assets in a defined benefit pension plan then your dependents don’t have access to those assets except to the extent defined by the plan. For Alpha, if you die before your spouse then I believe your spouse continues to get 37.5% of what you would have got and children only get a benefit if they are under 18 or under 23 and in full time education.
 
With a SIPP your family gets everything invested and under current tax law money sitting in a pension is protected from inheritance tax if you die before the age of 75 (this could change given the tax rules are constantly changing).
 
So, as basic example, if you died at the age of 67– in 24 years just before you could claim any pension, if your 10k had been invested in:

• an ISA or taxable brokerage then your spouse would have £50,700 gross;
• a SIPP would mean your spouse would have £84,530
• the Alpha scheme would leave your spouse with  £760/year if the Alpha contribution starts inflating from now or £375 if the £1k increase in your Alpha is as at the age of 67.

 
I apologise that this response is so full of numbers but this is essentially all the things you need to think about and the numbers are pretty important when we are thinking about pension and retirement options.
 
IN SUMMARY
 
If having access to a few pots of money before the age of 67 is important to you or if passing on some cash to dependents matters, then Alpha is not attractive.
 
If you are risk averse and want to ensure you have a comfortable, guaranteed inflation-linked pension pot then plough the £10k into the Alpha pension plan as this would suit your risk tolerance better.
 
I hope this helps!
Heather

If you have any personal finance questions send them to [ME] – I respond to all emails but there can be a lag of a few weeks between me getting a question and responding to it as I try to give very comprehensive responses. 

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Hi Heather,
 
Thank you so much for launching your podcast. I am really enjoying all your advice.
 
My name’s Vivienne. I’m single and in my late 60s. I receive the state pension and find that I struggle to make ends meet – my saving grace is that I own my home outright but I don’t have any other investments outside of that. Although I would like to work because I get lonely sometimes, I lack the energy I used to have in my younger days and certainly I find a full day’s work very exhausting nowadays. Is there anything you can think of that can help me boost my income?
 
Thanks

​Thanks for this question Vivienne.
 
Given you are not working, I won’t give you advice about saving and investing at this stage as I normally would.
 
I’m sorry you get lonely – loneliness is a rising issue in Britain and not only amongst older people – in 2016/17 Younger adults aged 16 to 24 years reported feeling lonely more often than those in older age groups according to the Office of National Statistics.
 
I have two income boosting suggestions for you that could help boost your income and reduce your loneliness too.
 
In the past, I have also given people advice about boosting their income by monetising any skills they might have on freelance sites like fiverr.com or upwork.com or by tutoring via websites like tutorful. However, I am going to suggest something totally different to you, perhaps even radical: have you considered taking in a lodger or renting out any spare rooms you might have on airbnb.com?
 
You could do this even if you didn’t own your home as long as you get permission from your landlord to sublet.
 
There are pros and cons with each option.
 
Option 1: LODGER
 
If you take in a lodger, you will have someone living in your home on a full time basis and you will probably have to give up some of your space in places like the kitchen to them. You will also need to be comfortable with that person using your appliances and white goods.
 
Are you happy for someone to share your hob, your fridge space, your washing machine and your living space that closely.
 
Taking a lodger in could flip you from being lonely to being frustrated very quickly if that person has very different habits and a very different lifestyle to you.
 
Instead of a full-time professional lodger perhaps you could take in a more transient lodger like a student. Some students, especially international students don’t see university as one long party and may well be studious, well-behaved and easy to live with.
 
If the person comes from Europe, they are also likely to go back home regularly leaving you to enjoy your living space on your own terms during such periods.
 
The government allows you to earn up to £7,500 a year tax free by letting a room in your home. This amounts to £625/month, all tax free.
 
Given that the state pension currently sits at c.£8,800 a year, you would almost be doubling your income if achieved this amount. If you have a generous spare room with an ensuite you might well be able to charge this kind of rent. Or if you have two spare rooms you can get a couple of lodgers.
 
You could also exclusively look for someone that is retired with the objective of keeping each other company in retirement. The type of person you decide to let a room to is entirely up to you.
 
One downside is that you might find a lodger who keeps too much to themselves and isn’t interested in bonding with you which might make you feel even more lonely. This brings me to option 2.
 
Option 2: AirBnB
 
Have you considered renting any spare rooms out on AirBnB? If you have the energy to change sheets and provide a breakfast this can be a fantastic little earner especially if you live in a popular city.
 
However, even if you are in a quieter city it is certainly something that is well worth trying.
 
A major advantage of letting rooms out on AirBnB is that you will retain full control over your home and kitchen space. When you are not home, for instance, if you are on holiday or visiting friends and family you won’t be leaving the house to a lodger which may offer you some peace of mind.
 
Just as importantly, during times when you expect visitors such as at Christmas you can have the house free of AirBnB guests.
 
A key advantage of AirBnb over a lodger is that you will get exposure to many different types of people with many curious about you and your city – based on them having to rent an AirBnB you can assume that most won’t be as familiar with your local area as you are and you can enjoy telling them about it and where to visit.
 
Personally, if I were in your shoes, I think I would go for the AirBnB option but you should decide based on your own personality and preferences. For instance, you might find the perfect lodger for you – someone who is perhaps older and not transient and even wants to spend time with you.
 
When I was single, once I bought a house, I always had a lodger for two reasons: firstly, I didn’t like the person I was becoming when I lived alone – I was becoming very rigid and set in my ways; secondly, I needed the extra money because my first mortgage was expensive and the monthly income boost made a big difference to me. I was also very likely to always find lodgers that I had things in common with so we could do some things together.
 
Just as with getting a lodger, you can rent rooms out on AirBnB and not have to pay tax until you are earning over £7,500.
 
I hope this is helpful. Outside of this there are the more obvious things like getting a part-time job or baby sitting when you have the energy and inclination to do that kind of thing.
 
I hope this helps you thinks more broadly about how you can boost your income and get some companionship at the same time.
 
If you are enjoying listening to my podcast, please give me a 5* rating wherever you listen to podcasts. If I don’t yet deserve your 5*, please let me know how I can earn it.
 
I hope this helps!
Heather

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Hi Heather,
 
My name’s Linda. I would like to have a comfortable retirement but I am not sure how much money I need to have saved up in order to achieve this goal. I am not particularly extravagant but I do want to be able to afford at least two holidays a year. I additionally don’t have access to a fixed workplace pension so I need to live within the means of my own investments and the state pension. How should I go about working this out?
 
Thanks

Thanks for this question Linda.
 
There are a few ways to think about this.
 
Firstly, when do you want to retire? The reason that this matters is that your state pension will only kick in at the state retirement age so if you retire earlier than this you will need to make up the difference from your own investments.
 
You also need to consider your living situation during retirement. If you are likely to be married or in a relationship then you would have two state pensions coming into the household but not double the costs – for instance, utility bills don’t double with double the number of occupants in a home.
 
You would also need to factor in that, even if you are in a relationship, one person will probably outlive the other and at that point one source of pension income may be lost.
 
TWO WAYS TO GET AN INCOME IN RETIREMENT FROM A SAVED LUMP SUM
 
There are two ways that your savings and investments can be used to secure your income in retirement:
 
The first way is to buy what is called an annuity. The second way is to just draw down your income slowly over time.
 
ANNUITY
 
An annuity is a financial product that provides a guaranteed income for life. Essentially, you take a lump sum of money, give it to a financial provider and they tell you how much they can pay you for life depending on the features you want. For example they can give you a fixed amount every month for life, or they can increase that amount every year by inflation, if you want an annuity that grows with inflation the starting amount will be smaller than if you go for the fixed amount. You can also buy an annuity that covers one person’s life or two people’s lives, that is, once the first person dies the annuity continues to pay out until the second person named on the annuity also dies.
 
Annuities used to be popular in the past but because interest rates have fallen drastically since the 2008 financial crisis they have not been so attractive.
 
How much would you need if you were planning on retiring today, were getting a state pension and were planning on buying an annuity?
 
According to this is money who in turn source a report by Royal London, you would need £260,000.
 
“Royal London’s sums were based on the amount needed to bridge the gap between an £8,500 state pension and two-thirds of the £26,700 average salary.”
 
Two-thirds of £26,700 is £17,800. This means Royal London are assuming that you would live on £17,800 every year: £8,500 of this would be coming from the state pension and £9,300 would be coming from the purchase of the annuity. These figures suggest the annuity is giving a return of just 3.6%.
 
In my opinion, that’s a very poor return and not even worth getting the annuity.
 
This is money also confirm in their article that if you plan to retire in 30 years’ time rather than today, this £260,000 becomes £400,000 and this further assumes that annuity rates improve by then.
 
If interest rates are just as low in 30 years’ time as they are now and if we assume average inflation of 3% per year (which is what it has been historically), then instead of £260,000 you would need £630,000.
 
Personally, I do not recommend the annuity route AT ALL. If you are happy to take a little risk then you would be FAR better off just drawing on the invested money.
 
DRAWDOWN
 
The most popularized rule for drawing down on your invested pot is the 4% rule. The 4% rule essentially says that if you drawdown 4% of an invested pot every year, you are unlikely to run out of money over a 30 year period. While the study that came up with the 4% rule used 30 years as the period during which a person would be retired, the general conclusion is that even at the end of that 30 years the money invested will have grown because the average drawdown rate of 4% is lower than the average growth rate of your investments.
 
So, for example, if your investments grew by 7% in the last year then taking 4% means you are still ahead.
 
The beauty of drawing down rather than buying an annuity is that whatever is left when you die can be passed on to children, charities or whatever you choose. With an annuity, the payments die with you. For example, if you bought the annuity of £9,300/year today and died next month, tata £260,000 – that’s it. The full benefit of your early demise goes to the financial institution that sold you the annuity in the first place. Rubbish, right, well that’s what you get for playing it too safe!
 
If we take the £260,000 lump sum we have been using and continue with it for example purposes, then a 4% drawdown would produce £10,400/year in the first year which is better than the £9,300 you were getting from the annuity that ‘this is money’ talked about. Not only that, in the following year it could be that you will base the drawdown on a bigger number than £260,000 because the investments will have grown in value. The average growth rate of the stock market over the last few decades has been 10% before accounting for inflation. Of course, this says nothing about the future as stock market returns in the future could be better than or worse than this.
 
Rather than working backward from what income a given lump sum will give you? Let’s figure out how much you will probably need to spend in retirement, that is, let’s work out your desired retirement income.
 
Once we have your desired income we will subtract income from your state pension and any other pensions.
 
We will then divide the gap by 4% and this will give you the value of investment assets that you need.
 
SPENDING
 
I’ll share two sources that I have found for trying to work out how much money you will need each year in retirement.
 
SOURCE 1 – on how much money you need for retirement
 
“According to research carried out by Loughborough University and the Pensions and Lifetime Savings Association (PLSA), workers who only manage to save enough for a retirement income that provides them with £10,200 a year (£15,700 for couples) will achieve a minimum living standard, those who managed to save enough for £20,200 a year (£29,100 for couples) will be able to live a moderate lifestyle during retirement and those who are able to save enough for £33,000 a year (£47,500 for couples) will be able to enjoy a comfortable retirement.” (source: moneyfacts.co.uk)
 
This £33,000 a year (£47,500 for couples) includes holidays abroad, a generous clothing allowance and a car.
 
These are the lifestyles that the Loughborough University and PLSA study creates:

• A minimum living standard assumes a single retiree spends £38 per week on a food shop, has a one week holiday and a long weekend in the UK each year, will not be able to afford a car and will have £460 per year for clothing and footwear.
• A single person able to afford a moderate retirement will be able to spend £46 on a food shop each week, enjoy two weeks in Europe and a long weekend in the UK each year, and will have £750 to spend on clothing and footwear each year.
• A single person enjoying a comfortable retirement will be able to spend £56 per week on their food shop, enjoy three weeks in Europe every year and spend £1,000-£1,500 on clothing and footwear each year.

 
I don’t know about you but I would like to target the comfortable lifestyle or better!
 
Using the 4% rule, if you are targeting a comfortable lifestyle then:

• You need £825,000 if you are single before accounting for state and other pension income; (33,000/4%=825,000).
• If you are getting £8,500/year in state pension income, this falls to £612,500 if you are single; ((33,000-8,500)/4%=612,500).
• A couple without any other pension income needs £1.2m in investment assets; ((47500)/4%=1,200,000)
• A couple with two state pensions that sum to £17,000 needs 762,500 in investment assets to achieve a comfortable retirement; ((47500-17000)/4%=762,500)

 
Before you give up before you’ve even started because these numbers sound too hard to achieve, keep listening, I’ll give you an example at the end of how much you need to save now and it will sound much more achievable.
 
If you are targeting a moderate or minimum living standard, you can calculate the equivalent numbers by following this formula:

• For the amount of investment assets you need before accounting for pension income, just divide the income you want by 4%, e.g. £30,000/4% = £750k.

 

• To account for pension and other income, subtract amount of state pension and other income you expect to get when you’re retired from your ideal retirement income then divide by 4% e.g. (£30,000-20,000)/4% = £250k.

 
As a reminder, the full state pension is currently £8,767.20 per year but I used £8,500 in my examples for simplicity.
 
If you plan to retire based on the minimum standard of living at say 60, then when you start getting the state pension as well if you are a single person, you would be boosted to close the moderate living standard; and if you are in a couple, you would be boosted just beyond the moderate living standard by receiving two state pensions – assuming both people are entitled to the full state pension or close.
 
SOURCE 2 – on how much money you need for retirement
 
Using a report from the Joseph Rowntree Foundation, a respected charity, Fidelity.co.uk allows you to start of with a basic standard of living which costs £16,300 and allows you to add annual costs to this depending on the lifestyle you want.
 
This £16,300 accommodates basic rental accommodation, basic costs for food, alcohol, clothing, water, gas, electricity, council tax, household insurances and other housing costs, public transport costs and an occasional visit to the cinema.
 
The basic £16,300 cost of living assumes a single person not a couple. Within this figure you don’t run a car, you don’t eat out much at all, you don’t smoke and you don’t have internet access or paid-for film channels (I guess you would watch only free channels and have to go to the local library for the internet).
 
Note that this £16,300 is higher than the £10,200 suggested by the Loughborough University study for a basic standard of living but lower than the £20,200 suggested for a moderate standard of living so we can call it basic Plus.
 
I would guess the Loughborough study assumes you have paid your home off in their basic living assumption which could explain the difference.
 
So, how do we boost the £16,300 basic income to improve our life style?

• For 4 weeks in the sun each winter, add £3,500;
• For another 2 weeks of holiday each year, add £1,600;
• For dining out with friends every two weeks, add £2,200;
• For home improvements each year, add £3,600 – this sounds like a lot to me but anyhow, this is what is suggested;
• For a new car every 5 years worth £16,500, add £5,500 – this could also get you a higher spec second hand car;
• For health club membership, add £500;
• For shopping trips, add £1,600;
• For theatre, concerts etc., add £1,700

 
If you added on every single one of these extras, you’ll be at a very comfortable £37,500/year which is not too far off the £33,000 suggested by the Loughborough University study for a comfortable retirement.
 
This would be equivalent to £54,000 for couple if we increase in direct proportion to the Loughborough study (37,500 * (47.5/33)).
 
What level of investment assets do you need to achieve this?
 
You need c.£940k if you are a single person or £1.35m if you are a couple before the benefit of a state pension. This £1.35m is very aligned with the £1.2m we got using the Loughborough University study. State pension income reduces your need to save and invest by about £200,000.
 
If you keep a budget it might be easy to calculate what your monthly spending in retirement will be; just remove all the things you spend on now that you won’t need to spend on in retirement, like travel to work or rent or a mortgage payment if you plan to own your home outright at the point of retiring.
 
There are a lot of numbers here but it’s more or less pretty straight forward once you have worked through it systematically. How much do you need to save now to live your ideal lifestyle and to hit your goal by retirement? You’ll need to take the next step and figure that out. If you want me to help you do this, request a call.
 
As an example, if you are a 22-year old couple now and plan to retire at 67, you only need to be saving £285/month in total into pensions (that’s only £140/each). This has to be into pensions and not into an ISA as I am assuming you get the tax benefit of saving into a pension. My calculation assumes you get an average market return over those 45 years of 7%. If returns average 10% as they have in the last 45 years, you would completely overshoot and end up with a retirement pot of £3.7m – how’s that for compound interest?!
 
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I hope this helps!
Heather

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