Moving on...
This blog is now closed.
My future writing will appear on www.thefireplace.info.
To Boldly Go on a Five Year Mission
To Boldly Go...
When I became serious about financial independence, I decided to see what I could do in order to speed things along. I decided I'd try five years of restraint on my spending, to help fund the investing project.
This "five year mission" began with opting to cut back on travel spending.
Travel had always been my spending vice, and I like to think that spending on experiences is more valuable than spending on stuff. So it formed a big part of my lifestyle inflation.
I didn't want to suddenly switch to zero travel, but I needed to cut down on the long-haul trips. I decided to step down my trips, from long-haul to short-haul, and from international to domestic. This coincided with getting an electric car, making UK trips very cheap. It was also a good fit with my environmental values - I wanted to fly less.
It also coincided with the Covid pandemic happening within a year, which among its many effects did at least make it a whole lot easier to cut out spending on travel.
It also coincided with the Covid pandemic happening within a year, which among its many effects did at least make it a whole lot easier to cut out spending on travel.
This led to some great trips in the British Isles. Cornwall, Inverness, the Isles of Scilly, the Isle of Man, Aberdeenshire, and various trips to the West Highlands. In particular we set about visiting the Hebrides, which we'd previously dabbled at, and so far I've been to Eigg, Rum, Canna, Muck, Mull, Staffa, Iona, Skye, Raasay, Coll, Tiree, Colonsay, Seil, Lismore, Kererra, and Easdale.
This plan was also helped by the fact that we had a holiday home on the edge of the Lake District. Well, to start with. It was great as an overnight stop for the Scottish trips, but as a destination the overhead of travel to get there began adding up, as I was still working at the time. Eventually I took stock, decided that the other members of my family were using it less than they had been, and opted to sell it and throw the proceeds at the FI fund.
I eventually "threw everything including the kitchen sink" at investing. Money left outside, uninvested, became an opportunity cost. This served me well - we had some good investing years and the time in the market sped me to FI.
This plan was also helped by the fact that we had a holiday home on the edge of the Lake District. Well, to start with. It was great as an overnight stop for the Scottish trips, but as a destination the overhead of travel to get there began adding up, as I was still working at the time. Eventually I took stock, decided that the other members of my family were using it less than they had been, and opted to sell it and throw the proceeds at the FI fund.
I eventually "threw everything including the kitchen sink" at investing. Money left outside, uninvested, became an opportunity cost. This served me well - we had some good investing years and the time in the market sped me to FI.
How Bad Was It?
It wasn't bad at all! I didn't miss flying. I enjoyed travelling on ferries. The destinations were every bit as rewarding as the places I used to visit.
My other economies, on things like eating out, are good habits that I'll continue. My preference is for keeping cars for longer, generally spending less as I have seen the value of leaving a pound invested where it can quietly compound.
Now that I've reached my goal, some of these frugal habits are ingrained and won't easily change. My environmental concerns are unchanged, so I will continue to try to fly less. If there's a train or bus option, I'll strongly consider it. If there's a choice between closer or more distant trips, I'll err toward the closer. And I am dead set against jetting around for brief visits - a journey needs to be defrayed across more days in the destination, which fits with retirement and a preference for slower travel.
Your Five Year Mission
You could choose your own similar mission. Decide "it's only five years" and slash your lifestyle spending in pursuit of the goal.
Don't be so severe that you make yourself miserable - but you may be surprised at what you don't miss. If you are in a pattern of endless hastily-grabbed European city-breaks to stave off the burnout, you may find that you enjoy switching things down a few gears and going walking in Wales instead.
A downshift may permanently change some of your habits, or it may be a sacrifice that you end after "time's up". That's perfectly fine. You will have done your portfolio a lot of good. Those savings will remain invested, compounding. Throttling back on the saving regime may eventually be the right thing to do, and by doing your heavy saving early on you will have maximised your time in the market.
Good luck whatever you choose to do.
It wasn't bad at all! I didn't miss flying. I enjoyed travelling on ferries. The destinations were every bit as rewarding as the places I used to visit.
My other economies, on things like eating out, are good habits that I'll continue. My preference is for keeping cars for longer, generally spending less as I have seen the value of leaving a pound invested where it can quietly compound.
Now that I've reached my goal, some of these frugal habits are ingrained and won't easily change. My environmental concerns are unchanged, so I will continue to try to fly less. If there's a train or bus option, I'll strongly consider it. If there's a choice between closer or more distant trips, I'll err toward the closer. And I am dead set against jetting around for brief visits - a journey needs to be defrayed across more days in the destination, which fits with retirement and a preference for slower travel.
Your Five Year Mission
You could choose your own similar mission. Decide "it's only five years" and slash your lifestyle spending in pursuit of the goal.
Don't be so severe that you make yourself miserable - but you may be surprised at what you don't miss. If you are in a pattern of endless hastily-grabbed European city-breaks to stave off the burnout, you may find that you enjoy switching things down a few gears and going walking in Wales instead.
A downshift may permanently change some of your habits, or it may be a sacrifice that you end after "time's up". That's perfectly fine. You will have done your portfolio a lot of good. Those savings will remain invested, compounding. Throttling back on the saving regime may eventually be the right thing to do, and by doing your heavy saving early on you will have maximised your time in the market.
Good luck whatever you choose to do.
Want to read more of my ideas? I have a new book out - The Teen Wealth Challenge. Or other books here.
Or you may prefer my FIRE series for beginners.
Don't try to die with zero
You're happily going along earning, trying to spend less than you earn, and investing your gap into productive assets to build up your financial freedom fund. Then you come across this cool book, Die With Zero by Bill Perkins. In it, you are told the book's central concept - don't waste your life at work, eat your assets so that you don't outlive them.
Okay, I'm simplifying a long book there, and it's true that there are lots of other ideas in there. But there are a couple of problems with this idea which I feel that I need to address.
One, you can't switch to eating your assets right now, because: risk! We need to play it cautious enough that you're very likely to build up an excess, because of the very real risk that we get one of the worse scenarios. The 4% rule will probably lead to you having an excess later on, but it may not. In about a tenth of cases it's just enough, and in about one in twenty cases you'll have to take extra measures to get to the end of your life without going broke.
Two, Perkins doesn't have much of a sophisticated solution to the conundrum of giving yourself an income in later life. His solution is just to buy an annuity. Well, you see, annuity rates are terrible - at least if you're under the age of about 75. To earn enough to buy a big enough annuity to cover your living costs, you'll spend many more years at work than if you leave things invested in index tracker funds for drawdown and do things the FIRE way.
I think his perspective on this may be influenced by the fact that he's multi-millionaire rich and a gambler. Ordinary people have to think a bit more about keeping food on the table and paying the electricity bill. Running out of money too early is a different thing if that only means being down to your last million.
Is there a solution?
Understandably, you want to have maximum bang for your buck. Is the cautious 4% rule approach leaving money on the table?
We spend most of our time working out our defences for those negative scenarios. We talk about mitigating sequence risk, and flexing our spending down.
Having already adequately covered that, what we need to do is give ourselves an overflow valve - a way to eat the excess if it does come.
I've talked about this previously in the Two Pot Stratagem, and I plan to go back to that idea again at some point and refine it further to take account of the help that your State Pension gives. But the basic idea is, cover your core spending by building a pot from which you withdraw at a very safe rate, and then allow yourself to go a little more wild with the second, "fun" pot.
The key is to plan on burning through the fun pot before you get too old to enjoy it. In this way, my thinking is quite like Die With Zero - but critically not with your core spending pot.
The "before you get too old to enjoy it" part is tricky. In my case I am aiming at age 75, and trying to plan a suitable withdrawal rate to run the fun pot to zero by that time.
Secondly, there's the actual overflow valve. When your core pot shows an excess, as it almost inevitably will since you are being so cautious with your withdrawals from it, you should sweep the spare money into the fun pot to be spent. I do this by setting a Minimum Withdrawal Rate. If you think 3.5% is the ultrasafe level, it follows that when your core pot grows so much that it pushes your actual withdrawal rate down by a decent margin below 3.5%, say to 3%, that you should keep sweeping away any excess money which would reduce your actual withdrawal rate even further.
This sounds messy but really isn't. And the effect is to let you maintain your ultrasafe core spending pot, but eat through everything else, letting you spend all that you possibly can whilst remaining safe.
Want to read more of my ideas? I have a new book out - The Teen Wealth Challenge. Or other books here.
Or you may prefer my FIRE series for beginners.
Guest post: From Polishing Screens to Pressing Buttons: My First Steps Into Investing, by Trisha Lee
I'm pleased to introduce this guest post from newbie investor Trisha. She and her husband have been working through the steep learning curve, having done the Rebel Finance School free course and are now putting things into action.
Trisha initially posted a shorter version of this on Facebook, and I suggested that she expand it into a blog post. The perspective of a newbie doing this for the first time is really valuable - us old hands will struggle to see things that way, so hearing her experience - and series of "lightbulb" moments - is incredibly useful.
I hope that it helps other newbies and gives them some lightbulbs too.
From Polishing Screens to Pressing Buttons: My First
Steps Into Investing
I’m new on this journey. If you’d asked me three months ago what I knew about stocks and shares, I’d probably have mentioned men in dark suits shouting “buy, buy, sell, sell” very loudly.
I once worked at the London Stock Exchange. I had a temporary cleaning job for a few days, and as I polished my way through the offices, often with computers left on, I couldn’t help wondering if I had the power to crash the market with a misplaced spray of polish. But that was as close as I got to stocks and shares.
Then, a few months ago, my sister told me about Rebel Finance, so I signed up for the course, and that was that.
I’m still right at the beginning of my journey, but I wanted to share some of my early lightbulb moments, in case they help someone else.
Firstly, it’s scary, and that’s ok. I’ve realised I’m not actually scared of the risk itself, but of pressing the wrong button or answering a question wrong, and as a punishment my money would somehow be catapulted to the moon.
But I pushed through that, and today I opened a stocks and shares SIPP.
It’s baby steps. I’ve only put in £5,000 so far, but it feels like I’ve climbed the first mountain.
Andy Farrell said to me, “Only take the amount of risk you’re comfortable with, at each step.” I think that’s the best advice I’ve had.
So here are my lightbulb moments from the last few days:
Lightbulb Moment 1: Vanguard isn’t right for everyone
I was just about to sign up to the Vanguard platform when
I discovered that they don’t allow employer contributions into their SIPPs for
people who are PAYE.
Realising Vanguard didn’t meet my needs, I turned to another platform I’d heard mentioned in the Rebel Finance Facebook Group – Interactive Investor.
Lightbulb Moment 2: Interactive Investor actually pick up the phone
Interactive Investor have a phone number on their website that is reasonably easy to find, and they answered quickly both times I called. They even walked me through how to find the form I needed to set up employer contributions. In this day and age, that is impressive.
https://www.ii.co.uk/ii-accounts/sipp/useful-forms
Lightbulb Moment 3: I finally understood the difference between platforms and funds
This was huge. It sounds silly now I understand it, but when I realised I could invest in the Vanguard FTSE All Cap Accumulation fund from another platform, it was like a confetti gun went off in my head.
(The Rebel Finance course covered this, but it was only seeing it in real life that made it click for me.)
Lightbulb Moment 4: Getting a referral link saves money
Discovering that using a referral link from someone who has an Interactive Investor account means I get no fees for a year, and they get £200, was a fantastic bonus.
Lightbulb Moment 5: You have to open the account before choosing a fund.
Another big learning curve. I now understand that with Interactive Investor you have to open your account first, before being allowed to choose where you put your money.
This was scary as I was adding money without being able to say where it went, to a website I had never used before. Would it end up on the moon? This almost made me run away, but instead I reduced the amount I was adding to £500 to calm my nerves and pressed forward.
Account opened – £500 staring at me. Then what to do? This was where I felt most out of my depth.
Lightbulb Moment 6: Money sits in cash until you invest it
It was only after going through all of this that I realised that the money you add to the account sits there as cash until you choose to invest it. If you don’t touch it, it will stay there doing nothing. I have just been told that someone left their money in cash for months before they realised this. I can see how easily that could happen.
Lightbulb Moment 7: You can pay to invest now or wait and do it for free
So, there I am with £500 in cash, and I’m confronted with a new problem, how to invest.
I now understand there are two ways to do this:
· You can either pay £3.99 to invest immediately and choose the fund then, or
· Use the free regular investing option in the profile tab.
I went for the free option. They give you a date each month when any money in cash will be invested. All money you add to the account stays as cash until that date unless you pay to invest it immediately. When you set up the free regular investing option, you choose which fund you want to go with at the same time.
You can also add more money here too, either as a one-off amount or as a regular contribution. This money will just sit there until your allocated date each month when the free invest sweeps to see what is there and invest it in your chosen fund. It will also sweep up any cash from dividends or tax relief which turns up.
And that is it – for now.
I played around with the page until I felt more confident. And when I finally understood how it works, I added another £4,500. That was enough for today.
I now have a month to recover before I begin my next lot of baby steps.
For some of you, everything I’ve written will be second nature. For me and my husband, it was a scary morning. But I’m so proud we’ve done it. We have set up two SIPPs and, rather than cleaning the Stock Exchange, I’ve finally dipped my toe into investing. But old habits die hard – I think I’d better polish my keyboard.
Want to read more of my ideas? I have a new book out - The Teen Wealth Challenge. Or other books here.
Or you may prefer my FIRE series for beginners.
Reader Case Study #3 - Retired But Feeling Precarious
Our latest case study features someone who has already stopped working, but whose business interests remain precarious. They also have a lot of their wealth sitting in uninvested cash...
Age : 61 single
Kids & ages : 32,39, left home
Earnings:
Salary : £10k PAYE, £9k directors dividends
Monthly spending £1000 essential, £1600 inc hols, clothes sinking fund etc
Monthly spare gap for saving £0
Current work Nest pension £3k pot
Regular contributions £21.20
Employer match details 3%
Balance £3,600
Regular contribution 5%
Provider NEST
Funds : Nest retirement date fund
Personal pension/SIPP: None
S&S ISA savings: £0
Lock-in period march 2030
(can only be released to bank acc losing ISA status)
Debts £0
Goals
Retire early?
Up/Downsize house? No
Gifts to kids? No
Aged 45 & in a long term relationship we had a definite future investment plan, a business each, only 2 yrs mortgage left, we would then retire age 55/60 respectively on £1.5 million combined pensions/investments. And then along came ‘life’ & screwed the plan completely.
Reality : Relationship break up at 49, needed to buy myself a house, house paid in cash.
Age 51 : Long term health condition plus pace of work results in a physical burnout, at 7.5st (47kg/105lbs) I’m told to stop work or suffer the consequences. Part time not logistically possible. Business partner can’t afford to buy me out so it’s agreed I will step away & get a third of usual income as I need to be replaced by extra staff.
I need the best strategy to invest my income into a Sipp /S&S ISAs as dividends don’t qualify with income to put into a pension. Business partner not keen on paying me wholly as PAYE as it doesn’t benefit the company. He’s open to considering PAYE plus directors pension payment but that doesn’t get govt contribution to benefit me? (If director's pension payments need to be equal he can only spare £600 a month from his income, spends personal money like water
) Business partner age 50, one heart attack this year. Cannot afford to retire until 57. Need 2 -3 years cash buffer (£40k-£60k) in case he croaks it suddenly. Business sale will hopefully bring £150k after cgt.
John
No one is coming to save you
You have taken your eyes off your own financial future for too long. It's recoverable but the fundamentals are currently lacking. You need to learn the basics and spend some time and energy in fixing this. Most of all you need to develop an investor mindset.
It’s not all bad news
I calculate using the 4% rule and bridging formula that you need about £300K invested to retire now on £1,600 per month, assuming full state pension in 6 years.
Fortunately, you appear to have over £300K, with potentially more in the future. Unfortunately, most of it is in cash or default pension funds, and some of it is locked away. You need to understand basic index investing to take the next step and get that money invested sensibly. I would consider following a free course like Rebel Finance School to learn the basics.
You will also need to understand efficient drawdown in due course. But that’s a task for after the fundamentals are in place.
If you don’t have full state pension, then buy whatever years you can. I believe you can do that cheaply as a business owner.
Incidentally, I didn’t think you could fully refuse to release an ISA by ISA rules, though you can make it a painful loss of interest. I would double check the small print on the 2030 locked ISA.
Misunderstand pensions at your peril
There's some misunderstanding of director's pension here. Direct company contributions from pre-tax profits, avoiding all income tax and employers and employee NI, are the most efficient pension there is. But only for income that would be above the personal allowance. For income under the personal allowance, it’s mathematically better to contribute personally.
As you earn £10K you could personally contribute £8K to a SIPP and get £2K tax relief automatically.
If you instead take £12.5K PAYE and get the rest as directors pension, then I would strongly consider doing that. Also, as instead of taking dividends which are incurring corporation tax you would have slightly more for your directors’ pension payments which are pre-tax. Then also put £10K into a SIPP personally and get £2.5K tax relief.
I would strongly consider doing this while still working and live off cash reserves. I would not use NEST for this.
I consider NEST a poor choice of pension provider as it has a massive 1.8% contribution fee and a limited range of poor funds. I would use a low-cost retail SIPP provider instead.
I would also strongly consider consolidating your pensions on one retail platform for ease of administration and likely lower fees.
Mike
The interesting fact about this person’s finances is that there are hardly any of the income-providing investments you would expect to see for someone of that age and a huge proportion of their wealth is in cash.
There is some good news in that the mortgage is fully paid off and there is a healthy ‘emergency fund’ of £11,000 in Premium Bonds. There are maybe some good reasons for the state of the finances in the person’s recent history, but rather than dealing with them here we will need to start from scratch with the existing financial situation.
The desired spending level of almost £20,000 per year looks high compared to the actual income from work and lack of any investment income. But a regular salary does at least provide some opportunity for tax-efficient investment in pensions.
Being the director of a UK limited company and paying pension contributions into a self-invested personal pension (SIPP) is one of the most efficient ways of investing for retirement anywhere in the world.
The first suggestion I would make is to talk to a good accountant and come to an agreement with the other director to reduce the salary and dividends and to use as much of this money as possible instead for SIPP contributions. Establishing and paying into a SIPP is going to be by far the most tax-efficient way of providing for retirement here.
The current Nest pension is not going to a good use of income from the company and my suggestion would be to close this immediately and move the proceeds into the SIPP established above. With this invested in a simple low cost global index-tracking fund, along with the regular contributions, it will provide an inflation-proof income for the future.
The existing Aviva pension could also be moved into the SIPP but this will depend on the range of funds and fees associated with it. At the very least, this fund should be moved to a more share-based fund in place of the existing one.
The cash in the Virgin and Halifax cash ISAs should also be converted into stocks and shares ISAs and invested in similar broad global index-tracking funds. The money in the Skipton account is probably left where it is for the next five years, but it may be worth investigating what penalties would apply if the money were released?
A portion of the additional £150,000 in cash could be placed into a savings account and used to fund living expenses, allowing greater SIPP contributions and a smaller income to be taken from the company. The remainder would be invested – first in a general investment account (GIA) and from here £20,000 transferred each year into an individual savings account (ISA). In both accounts the money would be invested in one of the global index trackers mentioned above.
In this way the subject will gradually build up a SIPP, GIA and ISA all containing productive assets to complement the very small income from the existing defined benefit pension.
In time the business may be sold, which would impact the salary and SIPP contributions, but the resulting proceeds could be used in a similar way to the cash above, with some to live off and some invested in the GIA (and from there to the ISA) to provide income.
The actual amounts involved would need to be tuned to fit the spending patterns and the arrival of the state pension should reduce the need to draw down so much from the accounts.
Tax may be liable on the capital growth in the GIA for the first few years, but as the contents get transferred to the ISA this should disappear.
Once the subject retires, a tax-free portion of the SIPP can be ‘crystallised’ and moved into the ISA allowing a tax-free income of £12,570 (currently) per year from the resulting taxable pension pot and supplemented (if there is enough) with additional tax-free income from the ISA.
Andy
As you are effectively retired already, I think the goal here is to find a way to employ your capital to give you safety in case the business goes belly-up due to your business partner's health.
Yes you don't have much in the way of private pension or investments, but you do have a fair amount of raw capital built up which could be put to work. I make it £389k, made up as follows. Cash ISAs £158k, DC pensions £20k, Premium Bonds £11k, Cash as emergency fund £40-60k (which is a bit vague but I'll go with £50k for my maths), and Other Cash £150k.
I'm going to plan what could happen if you got your existing capital invested into global index funds now, making it productive.
I see you think the Skipton Cash ISA can't be moved whilst maintaining its ISA status. Looking at Skipton's 5 year Cash ISA terms & conditions, I think you are reading the section about Withdrawals being only to a bank account. There is a further section on Transfers which suggests that this ISA can be transferred to another, as I would expect.
Spending is £19k.
Your State Pension is due to begin in 6 years at age 67. This is great news. It means that in our worst case scenario of your income ceasing now, we only have to fill your full £19k spending from the investment pot for 6 years. After that the State Pension does most of the lifting, and you'll only require a £7k top-up from the investment pot.
If we assume that you can safely withdraw 4% per year from a global index fund investment pot on a long-term basis, that means a pot of 25 x 7 = £175k will be needed at age 67 to give you the boost beyond State Pension. This pot will have 6 years to grow from now before it is needed. Doing a bit of magic with a compound interest calculator, I think that means it actually only needs to be £115k today, if you get average investing conditions during those years, but to play it safe having a bit more invested would be ideal. Let's say you play it cautiously and put in the full £175k now.
If we take the £175k from your current £389k of potential investments, that leaves £214k available to fund an earlier retirement. That seems a healthy sum to get us through 6 years - we could do it just by staying in cash, and as for the possible investment returns, running it through the Firecalc stress test tool shows that it would never have been a problem in any historical scenario.
If you were simply to invest all of your funds in a global tracker, the stress tester says that there is no past retirement year, and subsequent series of market returns, which would have led to portfolio failure before you reached the age of 100. This is pretty cast iron reassurance, as that stress tester includes some unusual and rare situations. Reaching 99% safety is relatively easy but getting to a full 100% safe (as your situation is) requires a lot of extra money in the portfolio.
In fact, you could raise your spending to £21k and still be 100% safe to age 100. A more relaxed goal, say 99% safe to age 95, would allow you to raise your spending to £23k. And that's before you take any action to boost your pot.
Boosting the pot
Much of your money is already tax-sheltered within ISA wrappers, which is great in terms of future growth being protected from tax.
Yes you could make contributions to a pension, and alongside this you can get your existing pension pots working harder. Neither Aviva nor Nest are great, and I suggest looking at transferring these pots into a SIPP and investing in a global index fund.
Your business can make company contributions to your pension. Since this comes before corporation tax I believe this is more efficient for the company than paying you in dividends or PAYE. There is no requirement for a similar payment for your partner, and yes paying into an owner's pension is considered reasonable in terms of the company's aims.
As this is before any personal tax has been paid, there is nothing to reclaim. This is a nice efficient way of doing it. It is already paid gross, so there is nothing to gross back up. It isn't limited to your earnings, just to a cap of £60k per year which won't be a problem in this case.
As your income was already quite tax-efficient, making use of dividends, the gain won't be quite what it was for an ordinary person on PAYE, but I think there's still a win from making use of your pension.
It may be that the saving in corporation tax means that the company can afford to contribute a little more than it was previously paying you through dividends and PAYE. Your bookkeeper or accountant may be able to assist here in seeing what you were previously costing the company, so that you can continue to benefit to the same degree.
I would want most of your remuneration paid to your SIPP, and while you do this use your existing cash to cover your living costs. If you end up with some pay in PAYE, it would gain tax relief from going into your SIPP, even if this pay is below the £12,570 Personal Allowance - you would be getting tax relief on money which hadn't been taxed. Lovely! Eating down your non-ISA cash funds to fund your living costs whilst you do all of this will still benefit you.
A goal of getting all the money that you can into tax-sheltered accounts would be a good one. You are pension-light so building up your pension pot is a good goal. It looks like you also try to max out your ISA allowance each year, and I would continue to do so. It will reduce the tax that you are paying on interest from your non-ISA cash, and if this wealth gets properly invested it will also reduce the tax that you pay in terms of Capital Gains Tax and Dividend Tax on investments which sit in a General Investment Account.
Action Points
Here's what I would do in your shoes:
- Transfer existing pensions to a SIPP
- Transfer existing Cash ISAs to a S&S ISA
- Move existing cash to a General Investment Account
Cheapest platforms for this may be Vanguard for the SIPP and Trading 212 for the ISA if you want to keep costs to the minimum. If you prefer a one-stop-shop with a customer helpline and full range of services, consider Interactive Investor.
- Keep the comfort blanket of a cash buffer uninvested (say one year's spending, £19k) but otherwise get your wealth invested in a way which stops you missing out on money.
- Switch your company earnings to a company contribution to your SIPP.
And Then What
You're going to have surplus capital.
In reality, you are going to continue to get income from the business for some period of time. Then you expect to get around £150k windfall once the business is sold. Thirdly, you're going to get a bit of boost from using pensions more. And fourthly your investments are extremely likely to see gains above and beyond the stress-test scenarios I've used above.
Your future is secure; you can relax and start to think about either gifting or increasing your spending.
As you have remained invested in cash until now, I imagine it will be a struggle to invest your wealth. But I feel you will be much safer that way, guarded by wealth held in productive assets, as opposed to zero return cash which is prone to inflation.
I expect you will only really feel comfortable when you reach State Pension age, and your withdrawal rate from your investments drops to quite a low level. It's quite likely that your investments will have reached around a million by that point, if the business were to limp along until your business partner reaches 57 and is sold at that point, and this would take your withdrawal rate to under 1%.
I think an ultra-safe withdrawal rate is around 3.5%, and I'd personally set a minimum withdrawal rate of 2.5% to ensure that some use is being made of the wealth rather than it just rolling up forever. In your case this may mean you have a surplus on the order of £15k a year at this point. You can afford to do more of what you enjoy, whether that's travelling more, volunteering, or gifting some wealth to your kids.
Want to be a case study? Read more here.
Want to read more of my ideas? I have a new book out - Build Your Retirement, 5 ways to improve your wealth in retirement. Or other books here.
Or you may prefer my FIRE series for beginners.
Coasting through the Sequence Risk Zone
We often talk about retiring when we hit 25 times our annual spending and can retire on a 4% withdrawal rate. But then we acknowledge that there is still some risk. How to square this circle?
A 4% retirement
With a 4% withdrawal rate the risk is perhaps one in twenty that we'll encounter a bad sequence of returns and our portfolio would eventually fail.
If we are lucky enough to get some normal years at the beginning, with the market behaving and giving us something like average conditions, we would have some excess growth above the 4% we're withdrawing. As the portfolio grows, our fixed amount of cash withdrawal is a percentage withdrawal rate which is diminishing. The 4% withdrawal becomes 3.6%, 3.3%, etc.
Eventually we reach the "ultrasafe" level. As with all these things, arguments rage as to the actual ultrasafe figure. Some think for the UK it is 3.5%, others say 3.1%.
This period of time from starting withdrawals at 4% and running until the cash withdrawal has, if looked at with fresh eyes, diminished to 3.x% of the pot, can be called the Sequence Risk Zone.
In the Zone
Getting through the Sequence Risk Zone is our next goal after reaching FI.
Doesn't this make our usual 4% withdrawal idea of FI a bit of a con? Well, no, not really. We're trading freedom time for extra safety. It is very unlikely that a 4% retirement will fail us, and it's very likely that someone retiring on 4% will naturally progress through the Zone without doing anything special.
But if you are naturally cautious, as I am, you will want to traverse the Zone quite quickly.
Here's where the Coast part comes in. CoastFI is when you do the bulk of the portfolio-building work and then quit the well-paid career job but continue doing some work. Perhaps that's part-time, and perhaps it's more fun and less lucrative work.
I'm embarking on the Coasting phase imminently. I want more freedom and more travelling, but at the same time I don't think I'm ready to do absolutely zero earning activity forever more.
Coasting
Initially my plan is to treat this period as a sort of career break, or pre-retirement. I've had some success at writing, so the plan is to do more writing and creating alongside some travels. In my head this can be for a couple of years. At the end of that time, I can take stock, see whether writing is a useful way to spend my time, or if I'm bored that may be the point at which I start some other small business.
This is also my solution to One More Year syndrome. This is a frequent phenomenon when people reach financial independence. They're not quite sure, and working feels safe and comfortable, so they stay working for one more year - which sometimes leads to another and another.
So I commend the idea of Coasting to you. It could mean drawing your core spending needs from your portfolio, and using your earnings for the fun stuff like travel. In this way you can spend a few years with a lower withdrawal rate, easing the strain on the portfolio and hopefully allowing it to grow and propel you more quickly through the Zone.
Whilst in the Zone, I'll continue to flex my spending down when necessary, if any crashes come along. I think the dual tools of flexible spending and coasting to continue earning are the best way to cross the Zone. They don't require you to divert capital, as selling stocks and buying bonds would do, and so they don't slow down your passage through the Zone.
I'll probably write more about my Coasting experiences...
Want to read more of my ideas? I have a new book out - Build Your Retirement, 5 ways to improve your wealth in retirement. Or other books here.
Or you may prefer my FIRE series for beginners.
Simple drawdown
If you go deep into it, the whole field of pension drawdown can be massive, but you don't necessarily need all of that. If you're not a high earner / high spender, it gets simpler.
Access
Here's when you can get access to your various pots of wealth.
- ISA / GIA - anytime
- SIPP - at personal pension access age, probably 58
- State Pension - at 68 (probably)
So if you want to retire before the age of about 58, you'll need to build up some wealth in an ISA (or GIA) as what is called a "bridge fund" to span that gap until you can access your pension.
You don't want too much money in this, since it misses out on the free money that pensions get.
There's not much to learn about the first and last ones. You access your ISA whenever you want. And you have no real choice in when your State Pension begins. (It's not worth delaying it.) This just leaves your Personal Pension to figure out.
Pension Withdrawal
The government have made a stupidly complicated system, but here's a simple version of it.
It's based on old-fashioned DB pensions where you got a tax-free lump at the start of your retirement, and then you got regular payments which counted as income. That income part may be taxed if you went over your personal tax-free allowance for the year.
In the current system, you get 25% of your pot taxfree. You can draw from either bit.
A PCLS is a pension commencement lump sum. It's a stupid name as it doesn't have to be at commencement. This just means drawing purely from the taxfree part.
A FAD is a flexi access drawdown. Another complicated name. It just means drawing from the taxable part.
Finally they allow you to draw a blend of the taxfree and taxable parts. This is called UFPLS. Uncrystallised Funds Pension Lump Sum. The most ridiculous title of all. This just means taking a lump, for example £1000, of which £250 is from the taxfree pot and £750 is from the taxable pot.
All of these "taxable" withdrawals use up some of your taxfree Personal Allowance each year. More on that next...
Use Your Allowances
The basic tax strategy is to use up allowances as much as you can. This is a similar idea to when you were working and you tried to use as much pension allowance as possible.
I'm just going to cover the two big ones.
- Try to use up your taxfree Personal Allowance each year.
- Try to use up your ISA contribution allowance each year.
We currently get £12,570 per year Personal Allowance. You can use this up with the taxable parts of personal pension withdrawals, either using FAD or UFPLS.
If you have some remaining ISA contribution allowance, it's worth taking money from your pension to fill it, so long as you don't get taxed for doing so.
Why? Well, an ISA is a better place for your money to grow than a SIPP. We wanted the initial benefit of passing money through a SIPP to get the tax relief, but after you've had that, getting it into an ISA is better.
The ISA has two benefits. You get taxfree growth, like in a SIPP, but you also get fully taxfree withdrawals there. The SIPP, on the other hand, only gets taxfree growth - the withdrawals are partly taxable.
To give a practical example of this, I may make an UFPLS withdrawal each year, taking £16,760. That will include 75% taxable portion, which perfectly uses up my £12,570 Personal Allowance, and 25% taxfree portion of £4,190.
This £16,760 may cover my living costs, or I may have some left over. I can chuck any spare into my ISA.
At the end of this, I'm going to have some spare space in my ISA. It's worth using that up, so I'd take a PCLS of taxfree cash to fill it up.
In the above example, maybe that £16,760 was about right to cover my living costs, so I'd have taken £20k PCLS to fill up my ISA.
If my spending was higher than that and I needed more money, I'd pull out more taxfree money with a PCLS. I'd still take enough PCLS to fill my ISA.
Crystal what?
Because you can use different withdrawals at different times, your pot could get messy. They keep track of how much taxfree cash you've juiced from your pot by calling the juiced part "crystallised".
They need to do this to keep track of things, because you may have various different assets continuing to grow in your pension and you may sell and cash out different ones - with the crystallisation marker on the account none of this will matter.
As you go along making withdrawals, your platform will keep track and your level of crystallisation will gradually increase, until you reach the point where you've had all of your taxfree cash out and the remaining pot is all taxable.
And there we are.
Want to read more of my ideas? I have a new book out - Build Your Retirement, 5 ways to improve your wealth in retirement. Or other books here.
Or you may prefer my FIRE series for beginners.
Sequence Risk Survival
We say to retire once you reach 25 times your annual spending, meaning a 4% annual withdrawal, because that's reasonably safe. But it's not completely safe.
We face a risk with the rather florid name "Sequence Of Returns Risk". This means that if you get very unlucky and soon after you retire there's a combination of a stock market crash and high inflation, you could find youself drawing your 4% from a pot which has a much lower value than when you began.
The 4% withdrawal we talk about is an initial 4% of your pot. But from there, the size of your pot fluctuates, and that means that the percentage you're withdrawing fluctuates. Let's call this your Actual Withdrawal Rate.
If a crash wipes a third off your pot size, this pushes your withdrawal rate up to 6%. We hope that's just for a brief period.
Investment pots are designed to take this. Their total price will dip sometimes, and that's okay. We just need them not to hit zero at any point, as we'd be broke.
If this year our spending means that we actually pull 6% from the pot whilst it's down, and then the recovery is slow to come, the following year we may be pulling another 6% out. Our sequence of returns has been bad. We'd quite like a good return right about now to bounce the investment pot back up. Otherwise we are doing damage; we're pulling an outsized chunk out, and that's leaving less in there to bounce back up when the recovery eventually comes.
If we get some "normal" years after retiring, we'd hope to see about 7% growth after inflation, and we'd be withdrawing 4% to spend. This leaves a nice gap of 3% real growth in there. This growth is really useful. It nudges our pot up in size year by year, and edges us toward safety.
Example
To use an example, let's say I retired with a £500k pot and £20k annual spending, so that's a 4% withdrawal rate. To keep things simple I'll ignore inflation for this example. I get 7% growth in year one, so my pot grows to £535k. I withdraw £20k for my living costs. I'm left with £515k - my original £500k stake and a further £15k growth.
For year two I get the same typical growth. The £515k pot grows to £551k. I withdraw £20k. I'm left with £531k.
If we measure my withdrawal, £20k from £531k is 3.766%. As the pot grows, my Actual Withdrawal Rate diminishes.
We want to encourage this! Because when we said you could retire safely at a 4% withdrawal rate, we cheated slightly. The historic ultrasafe level may be more like 3.5%. And in future something even worse may happen - so a 3% WR would let us sleep really soundly at night.
These things are unlikely to happen. It's not worth working for more years to guard against this very slight chance. Instead, we'll keep an eye on that Actual Withdrawal Rate. We'll try to encourage it downwards.
About five years of "normal" investing conditions after retiring should be enough to get us past the Danger Zone - for our WR to diminish to about 3.5%.
Assist Your Investment Pot
How can you help it along? Be aware of your Actual Withdrawal Rate, and try to take steps to stop it going above 4%. There are two ways to do this.
You can reduce your spending when the market is down, so that your now-lower withdrawal stays at (or below) an actual rate of 4%. This is known as flexible spending, and works best where you have catered some luxury spending which could be cut. Holidays and new cars. It's harder to do if you have retired on a bare-bones budget.
The second method is Coasting. CoastFI is where you have traded your full-time career job for something which pays less but is either more fun or takes fewer hours. You get your life back, but still do a little work. This pays for some of your lifestyle spending, and means that you're pulling a lower amount from your investment pot to cover the rest of your spending.
Between these two methods you should be sorted. It should take very little of this extra help to get you to safety.
The Opposite Problem
Later on, as our WR diminishes even further, we may want to think about actually raising our spending so that we don't build up an impossibly large excess. Unless you have a large family to cater for, there's little point building up tens of millions in later life - surely you would be better off spending and enjoying it. My solution to this is to adopt a Minimum Withdrawal Rate. If it drops below 2.5% I'll be finding ways to spend the excess. This may be on travel or gifting.
Want to read more of my ideas? I have a new book out - Build Your Retirement, 5 ways to improve your wealth in retirement. Or other books here.
Or you may prefer my FIRE series for beginners.
Subscribe to:
Comments (Atom)