I'm 22 years old and I've been trying to get a good control of my finances. I'm still a student so I don't have a regular income. I've set up a LISA account to save for a house but I'd also like to begin saving for retirement. I've looked everywhere online but nothing seems to explain what different kinds of pensions there are, how to open them and how they work. Please help!
Alex, this is an amazing question to be coming from a 22 year old! Well done for setting up a Lifetime ISA, that's a good move especially as they are considering phasing that scheme out.
I have been meaning to write a post on personal pensions this since Christmas because another person asked a few specific questions so I’ll tick their questions off in this post too as they could apply to you as well at some point in the future.
Pensions are one of my favourite topics. If you were in a job you would have access to either:
What you need to open is a self-invested pension plan or SIPP.
When you do have a work place pension, you can also have a SIPP in addition to it; there are no penalties for doing so unless you’ve reached the annual limit for investing in a pension but this isn’t something most people need to worry about.
Once you open a pension account, you need to decide how you want your money to be invested. This is your decision unless you hire a financial adviser. However, even if you do get financial advice I always strongly advise getting some financial knowledge so that you can judge whether you agree with the advice you are getting or not. Every financial adviser has her own beliefs and biases about investing, that's human, the question is whether you agree with her.
Most people don’t know a lot about investing (including me when I started working) so some investment sites might ask you to answer a few questions on how you feel about risk-taking and then they suggest “ready made portfolios” to you to invest in which would be aligned with what you say your risk tolerance is, your “stated” tolerance for risk.
On some sites you might have access to “target retirement funds” this means you state when you want to retire and they adjust the risk of your investments based on that. For example, if you want to retire at the age of 62 which is 40 years from now, in your case, you would select a 2060 target retirement portfolio. The fund manager would then manage the risk by investing in more risky stuff now when you are far away from retirement and as you approach retirement the balance of investments would be adjusted away from higher risk, higher return investments towards lower risk, lower return investments.
The risk-return relationship is very important here. If you say you have a lower tolerance for risk then the options you will be given will have a lower associated risk but also a lower return on your money.
If you have a long time until retirement, and being 22 Alex, you have a very very long time until you need to retire then you can afford to take more risk. Personally, 100% of my stock investments are in equities (that is, they’re invested in company shares) because I get a fixed bond-like return from property investing so that balances it out.
By comparison, the average investor will usually have a portion invested in bonds and a portion in equities. By buying bonds you lend money to companies or a government and they pay you a fixed amount for that loan. As a lender, you are not a part-owner of the company and as such you don’t get a share of the company’s profits as you would if you invested in the shares. By the way: shares, stocks, equities are usually used interchangeably – they mean the same thing in most cases.
Equities vs. bonds
I won’t go into too much detail on equities vs. bonds but here are some important differences:
Why am I telling you all this? Because you need this sort of high level knowledge to decide how your money will be invested. What portion of your investments will you put into equities and what portion into bonds?
If you’re investing in ready-made portfolios and they give you an indication of risk, the higher risk portfolios have more equities and the lower risk portfolios have less equity investments.
Single stocks or index funds
You can manage your risk by only investing in funds or portfolios that invest in a wide variety of companies.
Some people find it more exciting to buy a single company's shares (single stocks) but that is much more risky than investing in funds because a fund is a diverse portfolio of lots of companies. As Index funds include a large number of companies, the complete failure of any one of those companies would have a much more limited impact on your return. I have dabbled in buying single stocks myself and I can tell you that it’s very difficult to choose winning stocks – to maximise your chance of winning “buy a whole stock market”, either by buying index funds that track a whole country or by buying index funds that track a whole industry.
If you do want to dabble in single stock investing, don’t put any more than 10% of your portfolio into them and as your portfolio gets larger I would reduce that to 5%. So, for every £1,000 invested don’t put more than £100 into single companies and as you move towards a portfolio worth £100,000 I would personally reduce single stocks to no more than 5% of my investments. These are arbitrary percentages and as you gain experience you will decide what feels more appropriate for you.
Actively managed vs. passively managed funds
There are two main types of fund to choose between, actively managed funds and passively managed funds.
Passively managed funds track a whole market such as the S&P500 which tracks the 500 largest, listed companies in the US or the FTSE100 which tracks the 100 largest listed companies in the UK - I emphasise listed because there may be companies that are just as large as those listed on the stock market but because they are privately owned you wouldn’t have access to buy their shares.
Alternatively, instead of tracking the whole market in a given country you can choose to invest in a specific sector such as utilities or technology or consumer goods.
Actively managed funds have an actual person choosing which shares are likely to outperform the market and investing in such undervalued shares or choosing companies that are likely to grow rapidly and enjoy a rapid increase in value. The objective of an active manager is to beat the market index, while the objective of a passive fund is to match the return on an index.
Now, you would think active funds, managed by "clever" fund managers are likely to beat the average market return from passive funds, right? Unfortunately, history has taught us that this very simply isn’t so: over 95% of the time fund managers do not beat index trackers. Not only that, the fees on actively managed funds are higher so even if you observe that an actively managed fund has achieved the same gross return as a market tracker you would be earning less from the active fund after fees have been deducted.
Where to start? Where to start?
I realise that this is all very technical stuff especially if you are beginner so here are links to a few indices to get you researching and investing. These are all funds I am invested in but I am not recommending you invest in them, only that you look at them to see what is included in each fund, what countries are represented, which companies are invested in, what the fees are and what returns have looked like over the last 5 years.
I have put the fees each fund charges in brackets as the fees charged is one of the primary reasons I choose whether or not to invest in a fund. Fees can dramatically erode your return so you should always consider what the fees are before you invest in anything:
Even from the above you can see the large difference in fees between my actively managed fund and the passively managed ones. However, I am personally convinced by the management of Fundsmith. Their investment philosophies are aligned with mine and I think they have the potential to beat the market over time but I don’t put all my eggs into the Fundsmith basket despite my confidence in them.
In summary, if you invest in a self-invested pension plan there is no commitment to a fixed pension income at the point of retirement. You therefore need to carefully decide how the money is invested. In doing this you need to consider:
Where can you open a SIPP?
The biggest difference between the various platforms where you can open a SIPP is the user interface, customer service and the FEES.
In a nutshell you might be charged any and all of the following fees:
Here are a few places you can open a SIPP account including the fees. The money to the masses website has a table showing what the fees look like depending on the amount invested. I recommend you have a look at that but below I share four that I consider to be popular and cost effective.
Halifax share dealing
Having only Vanguard’s funds is not necessarily a bad thing, they are cost effective and if you have an ISA elsewhere in addition to the SIPP at Vanguard, you can use that to invest in funds run by other institutions, e.g. Legal and General and Fidelity to name a few. Vanguard are very well rated in terms of performance and customer service in addition to having good fees. That said, you could save money on the account fee by investing in Vanguard funds via Halifax share dealing or iWeb and those two platforms would give you access to a wider variety of funds as well.
Also, Vanguard’s minimum investment is £100/month or £500 lump sum. If you want to start out with £25/month which at your age is absolutely fine, then you need a platform that will allow lower monthly contributions.
Where do I invest?
I have a SIPP for my son at Hargreaves Lansdowne and I have a SIPP for myself at iWeb. The fees at iWeb were the cheapest for my ISA and I decided to have my SIPP there too as the fees were reasonable although not the cheapest at the time I opened it. It didn’t make sense to have a SIPP elsewhere to save not very much money.
iWeb don’t offer junior ISAs and I wanted to keep my son’s SIPP with his ISA as well so I added it to his Hargreaves Lansdowne account. Based on the small amounts being added to his SIPP (£100 per month) the SIPP fees were actually cheaper at HL but they would have been more expensive for me because my SIPP account has much more invested than my son’s.
To cut a long story short, where you choose to open a SIPP can also be influenced by where you have an ISA and whether you want these to be kept together. It’s not necessary to have your investments all in one place, I certainly have several investment accounts for various reasons. Before you decide speak to a few people including family members so you have a flavour for where your social circle seem to be investing, if at all.
How much can you put into the SIPP each year?
You can have a SIPP if you're resident in the UK whether or not you pay tax but your earnings impact the maximum amount you can put in each year.
If you are not employed via the PAYE system, the maximum is £2,880 if you are not employed which becomes £3,600 including the government top-up which is equal to what you putting times 100/80.
When you are employed you can put the equivalent of your full salary into your pension up to a maximum of £40,000 per year.
I won’t go into lifetime limits for you as you are so young and will discuss those in my general post on pensions.
Can you have a SIPP if you are a British citizen living abroad?
You cannot make contributions to a SIPP if you are not a UK resident even if you have a British passport. You have to be a UK resident. If you have spent some of the year abroad and some of the year working in the UK, HMRC counts the number of days spent in the UK to confirm if you are UK resident. I won’t go into detail here because the actual number you need to qualify as a UK resident depends on whether you were a UK resident in the previous few years.
You can, however, set up a SIPP if you're resident overseas and want to transfer a UK pension from a previous job to the SIPP (but you cannot make further contributions to it). So, for example, if you have a pension with a UK employer and want to transfer that to a SIPP while you are abroad, you can do that.
If you’re resident abroad but paid in the UK and pay tax here you can also have a SIPP. So, for example, some British expats work abroad but are paid in the UK and pay a portion of their tax in the UK and are likely to qualify, however, speak to an accountant or financial planner to make sure you don’t fall foul of any rules if you’re ever in this complex domicile situation.
What happens if the company you have your SIPP with goes bust?
If your SIPP provider becomes bankrupt, your money should remain unaffected. Your money is not invested in the SIPP provider themselves; they either simply manage your investment or act as a platform for you to manage your own investments.
I hope this helps!
What happens if my SIPP provider goes bust?
Build a low-cost DIY pension
Have a money question for me?
Based on the things you told us about investing, my husband and I started putting £125 per month each into our SIPP pension. I hope this isn’t a silly question but what are these savings for? When can we expect to start spending that money and should we try to spend it in specific ways or on specific things? Both my husband and I are 30, we don’t plan on having children and our jobs have fixed pension benefits.
That’s a great question. While everyone has a different value system, there are two main reasons that I strongly recommend that people put money into a self-invested pension plan or SIPP a) flexibility and b) security including funds to help pay a mortgage off early.
A SIPP can be better than a stocks and shares ISA, in some cases, because you effectively pay less tax and because you can’t use the money until you are about 58 so it forces you to save.
Let’s talk about each reason in turn:
The first reason: is flexibility over when to retire
In the past, a lot of work-based pensions (aka defined benefit pension plans) used to allow early retirement from between the ages of 55 and 60, most of these type of scheme are being completely phased out and are instead being linked to the state retirement age which for you is currently expected to be 68. There is talk of moving this to age 70, so this is a future possibility.
Whatever happens, the funds that you build up in your SIPP can be taken from 10 years before the state retirement age. This means if the state retirement age moves to 70 you will still be able to use money that’s sitting in your SIPP from the age of 60.
If you and your husband are putting £125 each into a SIPP then when you are 55 years old, you and your husband’s combined pot of savings would be worth £135,000 if the pot of money only grows fast enough to keep up with inflation of about 3%; if you get growth equivalent to the average stock market return of 7% then you would have £250,000 at the age of 55 and if you get an average stock market return of 10% you would have £410,000 saved up.
At age 60 the figures would be £180,000 @ 3%, £375,000 @ 7% and £700,000 @ 10%.
These sort of returns aren’t cuckoo. According thebalance.com, “the S&P 500 Index, delivered its worst twenty-year return of 6.4% a year over the twenty years ending in May 1979. The best twenty-year return of 18% a year occurred over the twenty years ending in March 2000.”
Various sources suggest the S&P 500 has returned 10% before inflation if you buy and hold the money you invest into it. But of course, it’s useful to remember that this past success doesn’t guarantee that future returns will be as good.
Right now you would struggle to find a bank account that gives you an interest rate of 1.5%.
Back to flexibility on when you retire, however, unless you believe the US has no room for growth, then this total of £250/month you are saving could amount to a lot of money over a 25 to 30 year period and this would allow you to retire with a decent income well before the state retirement age.
If your mortgage is fully paid off by the time you retire then your cost of living could be low enough that even a modest growth in the SIPP would provide a comfortable income before your state pensions and work-place pensions kick in.
The second reason: to save the money is the added security from having extra retirement income
Having money in a SIPP means you can top up your retirement income.
Having the SIPP would mean you have 5 sources of income:
If the pension income from your jobs is lower than your final salary having access to extra funds will mean you can more or less maintain your lifestyle. This will be especially important if one person lives a lot longer than the other.
There is one special feature that the SIPP has but all the other 4 pensions do not: and that’s the fact that if you or your husband dies the state pension stops coming through and the work-place pension either stops completely or is massively reduced. However, whatever money is outstanding in the SIPP would fully transfer to the spouse without penalty.
Just to be clear, I will make that point twice: a work-place pension either dies with the person and at that point the spouse receives nothing or, from that point, the spouse gets a heavily reduced benefit – usually 50% of one-third of the amount that was being received before their spouse died.
A LOT OF PEOPLE forget this about SIPPs and other defined contribution pensions. I won’t go into the differences between defined benefit and defined contribution pension plans here but if someone is interested go to themoneyspot.co.uk and leave me a voicemail with your request.
Finally, when can you expect to start spending that money and should you try to spend it in specific ways or on specific things?
Technically, the plan is that you will never have to spend the capital but can just spend the growth.
If the fund is worth £250,000 when you start drawing from it and you are earning a 10% return per year at that point, then you could just withdraw the 10% (i.e. £25,000) or less and spend that.
If your withdrawal rate is lower than the growth rate of the fund then your retirement would continue to grow even as you take money out.
Note that some research suggests that the ideal withdrawal rate to maximise the likelihood that the money will never run out is 4%. But given you have pension income from your jobs in addition to the state retirement and you’re not worried about passing wealth on to children you could be more aggressive than this.
As for how you spend that money, well that is up to you and is a great problem to have. Having more money doesn’t only mean more holidays, it also means you can buy private health insurance which might be a necessity to avoid NHS waiting lists at a time when health problems are more likely. This would give you a lot of peace of mind.
Ability to pay mortgage off early
One thing worth adding, is a note that once you can withdraw money from your SIPP you are allowed to take 25% out as a tax-free lump sum. If your household had £250,000 saved up, you could take £62,500 out in one go which could be used to clear all or most of your mortgage.
You would then be allowed to take the rest out as an income or you could buy an annuity – with an annuity you essentially buy a fixed income which keeps being paid to you for the rest of your life.
I wouldn’t recommend an annuity for you given you have two fixed pensions coming in already, you don’t need the extra security and annuities don’t tend to be worth the money now that interest rates are so low. What you could do instead of buying an annuity is withdraw what you need from the SIPP every year. You would pay taxes based only on what you take out and could manage the withdrawals to minimise the tax bill.
I hope this helps.
Have a money question?
I want to earn extra income, however I work as a nurse in the NHS which takes up my time, do you have any suggestions on any investment that can make money. I am also interested in the stock market but don’t know where to start.
I am interested in both generating extra monthly cash flow now and increasing the amount of money I have in retirement.
Thanks for this question. I love it because I have two nurses in my immediate family, my mother-in-law was a nurse for a long time and my cousin is still one now.
Boosting current income
The, “how can I make a little extra cash now” question is one I asked myself quite recently because I wanted to put extra cash into our household ISAs. There are a few things you can do to boost your cash now:
1. Working extra shifts / locum shifts
My mother-in-law says this is not a great idea because being a nurse is hard enough work, as it is. I agree that it is very demanding work but one of the great features of working at the front line of medical services is that you can actually make more money by working more hours, even temporarily. Some jobs don’t offer opportunities to earn more by working more, you’re paid a fixed annual salary and that’s it - no overtime. Overtime either goes uncompensated or is compensated as time back in lieu.
You can sign up to a locum agency and do the same type of work for higher pay on your free days.
If you want to really juice up your income you can even look at things like working a 4-day week in your regular NHS job (your NHS pension would therefore be lower) and work for a locum agency on the 5th day. The advantage with this strategy is that you will boost your income without working more hours because the hourly rate is higher as a locum nurse. If the extra income is invested wisely it could more than make up for the lower NHS pension.
Also, keep your eyes open for higher paying promotions.
2. Do some extra work in another field.
If you have another skill that you can monetise you can look into doing extra work in that field. So ask yourself, "what other skills do I have?" I'll give you an example from my own life:
In my early 20s when I worked in banking the bonuses were not good one year and to make some extra money I slipped flyers into doors offering massages (for women only) at my house for £25/half-hour. I had someone sign up that very day. I had done a course in therapeutic massage at London College of Massage for fun and when I needed it, that skill helped me boost my income. I didn’t do it for long but it showed me that if I wanted to earn more money I could monetise other skills in my free time.
There are some things you can do that don’t even need a new skill such as babysitting. You could sign up at childcare.co.uk or sitters.co.uk and your credentials as a nurse would be very attractive to people that needed a babysitter for nights out or weekends. You haven’t said whether or not you have childcare responsibilities of your own so I don’t know if this is possible for you.
If you have skills that you can monetise online then list yourself on freelance websites like upwork or fiverr. There is a wide range of professions people hire for on these sites. I have used these sites myself to buy all manner of things including artwork, copy, copy editing and even voiceovers! Imagine that, all you’d need as a voice over artist is a microphone that records your voice clearly. Some people make serious money side-gigging on these sites.
These first two options are not completely aligned with your question as you asked for “investments that you can make” but I decided to add them to give a fuller answer.
3. Invest in or produce products that make cash.
Investing in something necessarily involves parting with money in the hope that you’ll earn even more money. You haven’t said how much money you have to invest so here are a few options.
Can you make something that people would be interested in buying that you can sell on etsy, eBay, amazon or Facebook marketplace?
Make a few samples of what you want to sell and list them on all these sites. I ran a product business myself for almost 6 years mostly using Amazon so I would recommend that you:
I would never discourage anyone from starting a business but having experienced it, I would tell you that it is very hard work. It involves a lot of long hours and is nothing like as glamorous as our culture makes being an “entrepreneur” sound. A business could consume absolutely every free moment you have – evenings and weekends. And all that time might not even produce a profit. Investing in a business comes with a lot of risk – stats vary depending on source, however, 80% to 90% of businesses fail in under 3 years.
Could you make money teaching something online? You could create a course and list it on Udemy, Teachable or another similar site. This would take some time to produce well, in the first instance, then you would need to spend some money on marketing your course but you could keep the costs very low.
Alternatively if you want to teach a GCSE or A-Level subject (High school level) or even a university course level, you can sign up to places like tutorful (previously, tutora).
5. Invest in property.
If you have enough for at least a 25% deposit then it may be worth looking into property investment. Because interest costs on buy-to-let property are no longer fully tax deductible, (that means, you can’t subtract the interest payment from the rent you receive before calculating your tax bill), property is not as attractive an investment as it used to be. That said, if you can buy a place with cash, or if the property produces a high enough profit to clear the mortgage within a reasonable amount of time (I personally target 10 to 15 years) then it could be worth doing.
Overall, the option you go for will depend on your risk tolerance and the amount of cash you have to invest. If you are relatively risk averse and don’t have cash to invest then working more to earn more will be more attractive. If you can tolerate some risk and do have some spare cash saved up, then investing in property will provide you with medium risk while investing in a business will be the higher risk option.
Boosting retirement/future income
If you’re looking to boost future income then you have two main options:
Property investing we've already talked about.
The stock market provides a good return over long periods of time; most investment advisors would suggest an investment horizon of 5 years or more. Putting money into the stock market in the hopes of a good return in a year or less is gambling rather than investing, that's why I didn't offer it as an option when we were thinking through how to "boost income now".
The most tax efficient options for investing the stock market are investing via an ISA or a SIPP. ISA are individual savings accounts and SIPPs are self-invest pension plans, they are a type of personal pension.
If you invest the money via a SIPP then you won’t have access to that money until you are between 55 and 58 years old. The exact age will depend on your age and has been set at the state retirement age minus 10 years.
The SIPP is a good option because for every £100 you put in, HMRC pay back £25 of tax and this saving is automatic. It is claimed by the SIPP provider and is shown on your investment account. The maximum you can put into a pension a year is £40,000 or your salary whichever is lower. So, if you earn £30,000/year you can put up to £30,000 into your pension without getting a tax charge. If you earn more than £40,000/year and haven’t reached the lifetime allowance of £1.055m, you can put up to £40,000 into your pension without getting a tax charge/penalty.
I will be writing several blogs on investing over the next few months that should hopefully build your confidence to make the move. In the meanwhile, you might find this useful: What platform should you use for investing and what should you invest in.
I hope this is helpful.
Have a question?
If you have any personal finance questions send them to [ME] – I will answer whatever piques my fancy via a blog post.
Heather on Wealth
I enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™.