Understanding Money – Retirement Planning

saving whilst working is like pennies flying into your piggy bank automatically

ID-100231157Welcome to our series on understanding money. We hope this will help you make some headway into understanding, and getting a hold of your financial matters. So far, we’ve looked understanding money in everyday life, how to budget, and how to start saving. These basics are important to understand, as they are the core of your financial knowledge; it’s even more important to put this knowledge into practice as soon as possible. Now it’s time to turn our attention to the future, and… retirement!

Retirement Planning

Wait! I’m only 20, why do I need to think about retirement?! Because retirement doesn’t mean working your backside off in a boring job for 46 years, and then living on a measly pension. “M, what are you talking about?!” I hear you say. Well, that’s because “Retirement” can be anything you want it to be, if you plan it properly. Retirement really just means not having to work (hopefully) and being free to enjoy life because you put aside some money regularly for several years. It doesn’t have to be at 67, and it doesn’t have to be a life of beans on toast for every meal, and hopefully getting enough winter fuel allowance to turn on the heating. If you save a decent amount, you might even only have to work 20 years, instead of working for almost 50.

I Thought I Had to Work Until 67?

The short answer is, no. You could retire as early as you want, if you save enough of your wage. “Wait, wait, wait, what?” Okay, listen, or rather, read carefully: the percentage of your income you save, is directly related to how soon you can retire. It’s that simple. Just imagine what you could do with all that free time if you retired when you were 45 instead of 67! You could enjoy more time with you family, friends, spend a lot of time on your hobbies, even develop whole new hobbies. You could also volunteer and not have to worry about earning money. Or, you could actually set up a new business and also not have to worry about it taking a long time to make you some serious money.

Now of course these are just a few basic examples. There really are a lot more other ways to enjoy life, and none of them encompass wasting every penny of your wage on the latest HDTV or a new laptop.

Savings Rate and Early Retirement (Hopefully)

Savings rate to early financial independence chart

This graph of savings rate to years worked comes from Jacob’s site, ERE. It basically shows you how soon you can retire, based on how much percent of your wage you save. Mr. Money Mustache also quoted this graph and gave a lovely little table showing you the percentages and the years until early retirement. To cut a long story short, if you save 50% of your income, you will be able to retire in about 17 years. If you save only 25%, it will take you 32 years to reach early retirement. That is still pretty good, if you start early. There are of course, some assumptions such as not blowing all the money when you actually ‘retire’ (you should withdraw no more than 4% of the income per year), and also being able to achieve some at least average investment returns (5% above inflation).

SIPPs, Stakeholder Pensions, and NISAs

“Ok, this sounds kind of awesome, so where do I actually put the money?” Well, I am not a financial advisor, so do not take my information here to be advice. If you want advice, go to an independent financial advisor. However, I can say that there are many places where you can start stashing your early retirement funds. First of all, if you want to retire early, then you need to put your money where you can get to it. Pensions laws mean that currently, you can’t touch anything until you’re at least 57.

NISAs as an alternative to Pensions

So you may want to open up a stocks and shares NISA (the new ISA). Here, you can invest tax-free (apart from a little wee tax of 10% on dividends). You’re allowed to put up to £15,000 into it in this tax year, and this is likely to increase with inflation for the 2015/6 tax year.

Company Pension Schemes Can Be Awesome

Also, check out your company pension scheme, if you are not already enrolled. Companies will often match the contributions you make, and sometimes give you even more money. My husband, T’s company puts in DOUBLE his contribution. Needless to say, this totally FREE MONEY!

Stakeholder Pensions

These are a simple form of pension you pay into. They start from £20 per month and have capped charges of 1.5% for the first decade, and 1% thereafter. They are subject to strict rules to make them as simple and cheap as possible for the average person. You are paying an insurance company, bank, or building society to basically invest on your behalf. They will invest the money in a ‘default’ investment basket, or you can choose for yourself. This could be a good choice for a child’s pension if you don’t want to worry about picking individual investments.

Stakeholder pensions are ‘defined contribution’, which means that the amount you receive at retirement is not guaranteed.

SIPPs

Self-Invested Personal Pensions are just that, ones that you invest yourself, rather than the stakeholder pensions which do the work for you. SIPPs are very flexible and you can invest in all sorts of weird and wonderful things – stocks and shares, bonds, gilts, gold, trusts, property, and hopefully soon p2p lending investments will also be allowed.

Tax Relief on Pensions

The main point of the SIPP is very flexible choice, but you also get tax relief, just like any other pension scheme. These are the contributions allowed per year to get tax relief:

£2,880 – Unemployed or Not Earning (e.g. kids, students);

£40,000 – Or your whole annual salary, whichever is the lower for employed people.

 

What are you doing about retirement? Are you planning to become financially independent long before 67? Or are you maxing out your pensions to retire at 55? NISA vs. SIPP, which one wins? Let me know your thoughts, leave a comment below.

photo credit: bplanet/freedigitalphotos.net

15 Comments

  1. Hi TV,

    This is nice post. I just wish I had read something like this 10 or 15 years ago. I’d be done already!

    To be honest 2 years ago, I would have thought it would be super-cool to have retired by 55, so I’ve only just come around to this way of thinking.

    I hope there are 15-25 yr olds reading this post and making a start on retirement early.

    All the best
    Huw

    1. Thanks Huw. I wish I had known these things years ago too – back when I got my first full-time job. In fact, my boss recommended I join the company pension scheme, to which I thought ‘why on earth would I want to do THAT?!’ But I didn’t understand anything back then.

      I used to think 55 was cool too, and that only ‘really rich people’ could ‘retire early’, oh how small my mind once was…

      Cheers,
      M

  2. Hello M,

    Very useful read! I wish I had stumbled upon this when I was confused about the different types of pensions and ISAs around, not so long ago!

    Having just started my journey, I’ve opted to stick with a Stocks & Shares ISA, as it’s I’m not locking away my money until I’m 55, like with a SIPP.

    Cheers,

    DL
    Dividend Legion recently posted…My Strategy – The Dividend LegionMy Profile

    1. Hey DL,

      Thanks for your kind comments. I think it does seem to work better if you’re young, or going for FI very soon (before age 55), then the NISA is the way to go. For me, I’m just putting in the minimum contribution to the SIPP, and trying to put as much as possible into the NISA, as I’m aiming for FI by 50, rather than 55 (or 57 as I think it may be for me now?). The other thing is, as the Finance Zombie says, the pensions rules are likely to have been “written in flour on a windy street” i.e. they could just change or disappear in an instant. NISAs and their predecessors are encouraged by all parties, so they’re unlikely to get severely disrupted.

      Cheers!

  3. Nice write up. It’s funny how until March 2014, I really thought I’d have to work until I was 65 (when I can get my works pension) because I just didn’t think I could afford not to work. Now, I’m saving/investing all I can so that I won’t need to work for another 22 years+. My absolute goal is to stop working before I’m 60. As my investing continues, I may well move the goal posts, so retiring in my 50s could even be a possibility, but I don’t want to get ahead of myself here!
    weenie recently posted…January 2015 Savings + other updatesMy Profile

    1. Thanks Weenie. I too, assumed I’d be working until 65, or whatever the government change it to, i.e. 67 or more by the time I get close to that age. I just don’t want to be a slave all my life! I hate the whole 9-5 thing too. It kills me.

      Just think, if we do well, we could retire early, or maybe a good alternative is to reduce your hours or do contract work if that is a possibility in your field.

      Just wondering, I know you have a rental property, but did you know, you can also rent a room in your own house and get up to £354 tax free per month? We had lodgers before, but I’m thinking about getting another one, as it was almost free money.

  4. I have a friend who parent own property in London, and they don’t even live there. I’d imagine you young British having the same problem as us young American having to compete with cash investor from Middle East or china.
    But if you can get a flat and rent out an extra room using airbnb, you might get more cash flow compare to dividend income. Much nicer size, it’s a little bit more like active income than passive, but it worth it. You guys are young and energetic.
    Vivianne recently posted…How to Control Lifestyle Inflation Without Feeling Deprived?My Profile

    1. Yes, we have rented out a room or two in our house, but it is active, and it’s difficult to find good people who can rent from you. If I could find a nice quiet person, I might rent out a room again. It is tax free up to £354 per month too, under the government’s ‘rent-a-room’ scheme.

      1. My parents have 10 kids. I’m used to a whole packed house. Then I moved away, after being alone for awhile. I didn’t realize how annoy it it to hear people talk on the phone all night, or stomp their feet when they walk, slam the fridge door, etc.

        But once I get back to it, it’s not a big deal anymore. It feels safer having people around than not. But giving up freedom is a big thing for us westerners. Ehheh

        1. Yes that’s true. I’m one of 6 kids, but I find it’s worse now as I’m not used to the noise anymore, so ay little noise disturbs me! But I can always use ear plugs I guess!

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