Retirement, plan while you are young￼
24th January 2023
Ask yourself, why is money important to you? Only when we can answer this question can we plan for the future. The most common answer would be financial security, with other answers being wanting to support your family or set up your own business. It is important you know what you truly need to feel fulfilled in life as then you can create a strategy to achieve this.
The challenge is that young people are not motivated to start planning retirement early. One study found 53% of people aged 22-29 had no savings and another report found Gen Z were mostly likely to opt out of pension contributions. Starting early will maximise the returns you can gain, allowing you to achieve your financial goals in life. With the UK’s ageing population, a state pension should not be your sole source of income. This is because as people live longer state pension reinterment age has increase and is set to continue in this trend. Another reason being state pension full entitlement only amounts to £185.15 a week. The rules around pensions are also changing; from 2028, you can only draw from your personal pension at age 57 and your state pension at 68.
Managing your spending is vital to any financial plan. Looking at the expenditure that does not add value to you should be eliminated and put to better use. This doesn’t mean you deprive yourself of the enjoyments in life, but over indulgences and spending on things you didn’t even know you did can be a significant restriction to the amount you can invest and save with. High street banks have helped to tackle this issue by offering banking apps that show a clear break down on spending, ability to create virtual piggy banks and budgeting advice/education.
The first thing you should do is relieve yourself from debt, especially debt with a higher interest rate than your return. If you have a credit card with a 28% interest rate and an investment return of 10%, you are 18% worse off. The average credit debt in the UK per adult is £1,155, with overall debt being much higher than this. You should pay off the highest-bearing interest debt and work your way down; helpful information can be found on the internet on ways to move around debt to lower interest accounts to reduce your burden.
After having your finances in check and your debt managed, you should then look to paying into a pension. You are automatically enrolled into your employee pension if you are 22 or over and earn more than £10,000 a year. The current minimum contribution is 8%, which is 5% of your gross income and 3% from your employer. As employer pension contributions are taken out before tax is calculated, you will gain a 20% tax relief on it. Money helper is an excellent website to determine what you’re putting in. Another type of pension you can pay into is a private pension; this is one you set up yourself and is managed by a fund manager. This has tax benefits as you can extend your tax bands and increase the threshold you begin to lose your personal allowance. Most private and employer pension funds are invested to generate a return above inflation.
There are also other ways to save and invest your money in more tax-efficient ways, this being individual savings accounts (ISA). The three types of ISAs are cash, lifetime and stocks and shares. Across the three ISA’s you have an allowance of £20,000 a year to deposit into them. Any interest or returns generated from them are entirely tax-free.
If you are looking at buying your first house (worth up to £450,000), or retiring at 60, a lifetime ISA is a brilliant scheme in which you can put in a maximum of £4,000 a year, and the government puts in £1,000 (25%). Government contributions are paid in until you reach 50, with a maximum lifetime contribution of £33,000. You must also be aged between 18-39 to open the account. Early withdrawal will result in a loss in total government contributions. Lifetime ISAs can gain even more returns as it can be either a cash lifetime ISA that generates interest or an investment lifetime ISA in which it is invested. Cash lifetime ISAs can generate around 3% interest, and the investment option can generate higher returns; however, the value can go up or down as it is invested and so your attitude to risk needs to be considered.
Another type of ISA is cash ISA; this is a low-risk strategy. As you can expect, due to the lower risk, it produces low returns. If you want to withdraw your money anytime an instant cash ISA is available, this typically provides around 0.5-3%. However, if you go for a fixed rate ISA (your money is locked in for a certain amount of time), you can expect interest of around 4%.
If you’re willing to take on risk, you can open a stocks and shares ISA. This can be managed by an investment fund or yourself. You can invest it in different types of portfolios depending on your risk tolerance and expectation of returns. If you choose to be managed by a fund, they will charge around a 0.5% fee, and if you do it yourself, the costs vary but can be lower. Personally, I use the stock and shares ISA, which charges are 0.07%. I mainly invest in index funds as they give you a diverse portfolio (not having all your eggs in one basket). The benefit of a diverse portfolio is that it lowers the risk while producing good returns. For example, the S&P average return since its existence (1950) is 11.88%. The average return for the past 20 years is 8.91%.
If you invested £10.99 (Equivalent to the Netflix Standard plan) a month for 40 years at the average historical return of the S&P 500 (9%), you would see a future investment value of £51,447.71, £46,172.51 being from compounded returns.
If you have £500,000 in a 0% savings account for 40 years at a modest 3% inflation rate, it will be worth £153,278.
Finally, there are other investments that a person can invest in, such as crypto (10-year return of 1,567% but highly risky), UK guilts (4.25% return, low risk) and more abstract investments such as vintage cars and wine. A saver or investor needs to understand what they are putting their money in and, if unsure, seek financial advice.
Financial freedom is something everyone wants, and protecting it from inflation, which is currently around 10% is essential. Choosing the right mix of strategies discussed above is important for the person, as everyone has different risk tolerance and capacity. However, it is important to know that achieving your goals at a faster rate is only possible if you take on more risk and start thinking about financially planning early. Worrying about losing your investment is something everyone thinks about, contacting a financial planner and getting the support and actions put in place will allow you to feel at ease with financial decisions. It’s never too late to start planning for retirement. Starting early allows for more risk-taking and the power of compounding interest on savings and investments. The earlier you start, the better; there is no right time to start, so don’t wait around.
Disclosure: The value of investments can go up and down, and you may get back less than you paid in. The information discussed is for educational purposes and not financial advice.
By Taylor Loveridge