Category Archives for Pensions

Could you retire at 40?

It’s not often that retirement planning sets the world alight. However, the FIRE movement has gained a lot of media attention over the last few months. If you’ve not heard of it before, FIRE stands for Financial Independence Retire Early. The core idea is that you squirrel away as much money as possible until you have enough to live on for the rest of your life. While this is what most of us do when we save for a pension, members of the FIRE Movement are keen to get there at breakneck speed, often retiring in their thirties or forties.

As you might expect, this involves some disciplined saving and investing. The idea is simple, but the practice is hard. Very hard. In this post, I’ll explain some of the key principles of FIRE, and also point out a few of the pitfalls. This certainly isn’t for everyone.

1. Work out your goal

Before you even think about embracing FIRE, you need to get comfortable with a few sums. Proponents of the mainstream FIRE movement advise you need to build a fund that’s 25 times your annual living expenses. That’s your living expenses when you retire, rather than what you’re spending now.

Say you could live on £20,000 per year – certainly feasible for some people. This means you’d need to save £500,000.

Half a million quid might sound like a lot, but there’s no guarantee this is enough. The main challenge, I think, of pursuing FIRE is that it involves predicting the future: how long you’ll live, stock market performance, and what happens to inflation. If you knew this stuff, you’d already be rich.

This sum might be enough if you’re retiring only slightly earlier, perhaps late fifties. But if you retire at 40 and have a life expectancy of 90, you’d need to manage that savings pot very carefully. All sorts of things could happen during that half-century: runaway inflation, a worldwide depression, or massive changes to the tax system. Which brings me to my next point.

2 – Do some research

FIRE is absolutely not a set-it-and-forget-it process. You can’t just set up a direct debit then shout “I’m outta here” when you’re forty.

You’ve probably noticed that interest rates are abysmal right now. A Cash ISA certainly isn’t going to help you retire early. You must become an astute investor. The only way of getting a decent return on your investment is to take some risk, and not everybody is comfortable with risk.

You won’t get everything right, either – some investments will yield good results, others will go down the toilet. There are no certainties. You need to construct a robust portfolio and review it regularly. Of course, you can pay someone for financial advice or invest in an actively managed fund, but that’s going to take a chunk of your FIRE money.

It’s best to understand as much as possible yourself, and only pay for experts where absolutely necessary.  For instance, if you’re paying a 2% annual charge to invest your £500,000 pot, you sacrifice £10,000 every year.

There are plenty of FIRE books available, but they nearly all focus on the US. While the same principles apply, the tax systems and other financial structures are completely different. Here are my recommendations for those of us in the UK:

  • For a good introduction, get yourself a copy of Reset by David Sawyer.
  • To understand the science of building your retirement fund, there’s no better book than Abraham Okusanya’s Beyond the 4% Rule
  • And to get started with investing, buy How to Own the World by Andrew Craig

Yes, this is a lot of reading. But that’s vital if you want to achieve FIRE.

3 – Think about what you want

One of the many criticisms of the FIRE movement is that it encourages people to leave the workforce without thinking through what they want to do. It’s all about rejecting the yoke of employment and doing exactly what you please. For this reason, FIRE attracts libertarians who don’t want to answer to anyone. Isolation isn’t great for our social skills, and research shows that retirement can cause cognitive impairment. After a few years of watching Watercolour Challenge, you won’t be at your sharpest. Not great if your money runs out and you’re forced back to work.

Some FIRE proponents are focussed on the FI – Financial Independence. It’s all about having enough money to make choices. This could include working fewer hours, retraining for a different profession, or doing voluntary work in the community. One of the most famous examples is Mr Money Mustache, who retired from his job in software development at the age of 30. Since then, he’s pursued many projects, both income-generating and pro bono. His argument is that anyone can do the same by avoiding unnecessary expenditure, ditching possessions, and pursuing a more environmentally friendly way of life.

For a thoughtful blog post on the opportunity cost of FIRE, take a look at the Foxy Monkey blog.

Conclusion

FIRE is a seductive concept, but not a realistic one for all of us. After all, somebody needs to do all those jobs. To retire decades early, you need:

  • A well-paid job that doesn’t drive you completely mad
  • Modest outgoings, so you can save most of your income (this is much harder if you have dependents who won’t necessarily share your ideals)
  • Time to do a lot of research

Even if you don’t reach that optimistic goal, consider the benefits of a partial success. After all, retiring just a few years early is going to improve the quality of your life. Money doesn’t bring you happiness, but it gives you a lot more choices.

I’m giving a talk What I’ve Learned from My Experience as a FIREStarter in Brighton on 30th October 2019. Do come and join us.

How do I save for a pension if I’m self-employed?

If you used to be an employee, one of the perks you’re missing is a workplace pension. While this isn’t as exciting as free gym membership or fancy coffee, you could notice the difference in a few decades’ time. It’s mandatory for employers to enrol their staff in a scheme. There’s currently no such requirement if you’re self-employed. This doesn’t mean you can ignore your pension, though. You’re completely responsible for your own retirement savings, so it’s crucial you make a plan.

In this post, I’ll explain the steps you should take towards saving for a pension.

1. Check you’re making National Insurance contributions

To qualify for the full state pension, you need to have made 35 years’ National Insurance (NI) contributions. While you were an employee, this would’ve happened automatically. As a self-employed person, you must sort it out yourself.

If you’re a sole trader, you pay Class 2 and Class 4 NI contributions annually through self-assessment. Class 2 contributions of £3 per week are required if your turnover exceeds £6,365; once it hits £8,632, you pay Class 4 contributions – 9% of your profits up to £50,000, and 2% beyond that point. For more information, visit the Government’s National Insurance page.

Directors of limited companies who pay themselves a salary make contributions through payroll. The threshold for paying NI starts at £8,628. Accountants often advise company directors to pay themselves this amount as a salary and the rest in dividends. This means you won’t owe any NI or income tax, but the Government makes a contribution on your behalf. If you’re not paying yourself a salary of at least £6,136, you won’t build up qualifying years for the state pension.

You can check your state pension projection on the Government Gateway. This shows any gaps in your record and you get the opportunity to ‘buy back’ those years. It’s much cheaper to make contributions as you go along, though. Even if you qualify for the full state pension, it’s currently worth only [cgv weekly-state-pension] per week. You’ll almost certainly need some extra pension provision.

2. Locate any existing pension pots

It’s time to dig out those old pension statements. Most of us can count our employers in double digits, so you might have lots of tiny pots scattered around. They might look insignificant, but could add up to a substantial amount – especially if they’re left to grow for a few decades.

Can’t find your statements? Try the Government’s Pension Tracker. This is definitely worth doing. Fifteen minutes’ work could yield thousands of pounds.

3. Start investing!

Once you’ve totted up your existing pension pots, you can see whether it’s enough. If you’re not sure what income it’ll provide, read my guide on working out how much you need. There’s probably some way to go, so you need to start boosting your pension.

My earlier post on Building Your Assets explains the different types of pension available. As you’re self-employed, you no longer have an employer making contributions to your pension pot. This means you’ll have to stash away even more each month. The good news is that your pension contributions are tax efficient – when you pay into a pension pot, the Government refunds the tax. For higher- or additional-rate taxpayers, this is a significant perk.1

If you are the director of your own limited company, you can make employer contributions to yourself as an employee. Yes, that does sound odd. So, these contributions count as a business overhead and aren’t subject to corporation tax. This is usually more tax efficient than making personal contributions from your salary or dividends. Your accountant can advise you on the best setup for your circumstances.

Conclusion

Sorting out a pension probably feels like yet another item on your to-do list. It’s worth prioritising now, though, as you need time for your pension pot to grow. The later you start, the longer you’ll be working. Even if money is tight, consider investing £25 per month. You can increase the amount once your business is flourishing. And don’t forget to factor in this cost when deciding what to charge your clients.

To recap:

  • Make sure you’re on target to receive the full state pension
  • Locate those old pension pots
  • Start paying into your own scheme

Some moderate discomfort now means you can look forward to a comfortable retirement before you’re 95.

As a financial coach, I can guide you through the process of your pension healthcheck. By explaining the options available and using forecasting tools, I support you in making an informed decision that’s suitable for your situation.  I never recommend a specific product or course of action. If you require advice rather than coaching, you should see a qualified financial advisor. They’ll either recommend products on which they receive commission, or you’ll pay a fee for independent advice. Please contact me if you’d like a free 30-minute chat about pensions or any other aspect of financial wellbeing.

For tips, tools, and resources on self-employment, please sign up for my monthly email.

Image © nnudoo – stock.adobe.com

  1. 20% for basic rate taxpayers, 40% for higher-rate, and 45% for additional rate. []

Should I opt out of Auto-Enrolment?

If you’re in a company pension scheme, you might notice your pay packet is slightly smaller this month. Believe it or not, this is a Good Thing. The reason is that the percentage deducted for your pension has increased. Your employer is also required to contribute more. This means you’re effectively getting a pay rise, albeit one that you won’t see till you’re at least 55.

In this post, I’ll outline how auto-enrolment works and what it costs you. I’ll also explain why it could make sense to increase your contribution even further.

What is Auto-Enrolment?

Launched in 2012, auto-enrolment is a Government initiative designed to help people save for retirement through a work-based pension. It’s compulsory for employers to enrol any eligible workers1 in the scheme. Both employer and employee make minimum contributions (and can opt to add more).

How much do I and my employer contribute?

The minimum percentages have been climbing over the last couple of years. From 6th April 2019, they are as follows:

  • Your employer contributes 3% of your qualifying earnings
  • You contribute 5% of your qualifying earnings

This makes a total of 8%. Sounds like a lot, doesn’t it? Hold on. Those contributions are based on your qualifying earnings, which is not the same as your salary. Qualifying earnings are those that fall within the National Insurance (NI) band of £6,136 – £50,000. This means you get no pension contributions on the first £6,136 of your salary or beyond £50,000.2

Let’s look at an illustration.

Say you earn a pensionable salary of £24,000. Your qualifying earnings are £17,864 (£24,000 minus £6,136). The contributions are as follows:

Employer£535.92 per year£44.66 per month
Employee (includes tax relief)£893.20 per year£74.43 per month
Total£1429.12 per year£119.09 per month

Your contribution is made from your gross (pre-tax) earnings, so you receive tax relief on this amount. In short, it’s worth more than if you received it in your pay packet.  You still receive tax relief even if you don’t pay tax. In this case, the Government adds £2 for every £8 you contribute.

Higher- and additional-rate taxpayers are entitled to additional tax relief. Some firms apply this automatically, but often you’ll have to claim it through your tax return. Check with your payroll department.

Is auto-enrolment enough?

This depends on how much is going into your pension pot and what you’ll need at retirement. You can use this calculator from the Money Advice Service to work out the figures based on your salary. You’ll need to check what your employer is contributing to get an accurate calculation. They may have chosen to give more than the minimum.

Next, try the retirement income calculator. Here you can see the total value of all your pension pots, along with the state pension. This’ll give you projected retirement income. If it’s not enough, you might need to consider increasing your contributions. Play with the calculator to see the effect of paying more.

You could also look at other ways of building your retirement income. The sooner you start, the more time your pot has to grow.

Most calculators assume that you’ll need around two-thirds of your salary during retirement. As I explained in an earlier post, this isn’t always a good benchmark.

For more scenarios and FAQs, read the MoneySavingExpert guide on auto-enrolment.

Can I opt out?

Yes, at any time. If you opt out within one month of enrolment, any contributions you’ve made are refunded. After this time, you can normally only access the funds when you reach the minimum retirement age (currently 55).

If you decide to opt out, your employer is legally required to re-enrol you every three years (assuming you still meet the eligibility criteria). You’d then need to opt out again if you don’t want to be in the scheme. Think carefully before opting out. Do you have alternative provision for retirement? After all, it’s unlikely you’ll be able to live on the state pension.

Conclusion

It’s good that the Government has made it easier to save for retirement. However, we still need to check that auto-enrolment is serving its intended purpose. Given contributions are based on just part of our salary, those contributions might not be sufficient. For instance, if you earn around £12,000pa, contributions are paid on only half your salary. Please do check that you’re on track to build a decent pension pot.

For many people, though, auto-enrolment offers significant advantages – everything is managed for you, your employer makes contributions, and you receive tax relief. And recent tax changes mean you might not even notice your increased contribution this month.

Make sure you understand what’s right for you. It’s much easier to fix now than when you’re 68.

Image © BillionPhotos.com – stock.adobe.com

 

  1. Those aged at least 22, on a contract, and earning at least £10,000pa. []
  2. Although your employer might opt to make contributions beyond £50,000 – this is something to check when deciding whether to accept a new job. []