The key message I give to my clients at the start of our relationship is the concept of financial independence.
Being financially independent means that you’ve got enough income, or assets that can provide enough income, to never have to go to work again.
This doesn’t necessarily mean you will give up work immediately, but it gives you total flexibility, and a great new perspective on life, knowing that you are working because you want to, rather than because you have to.
Reaching the point of financial independence is a major moment in your financial life. I won’t equate it to buying your first home, or reaching the pinnacle of your career and earnings power, because financial independence is the destination you reach as a result of these decisions and the mini milestones you pass throughout your life.
Financial independence comes earlier for some than for others. Sometimes this is because of the action (or inaction) that has been taken over many years, but sometimes it is circumstantial. We all have different obstacles to overcome in life, and I always tell my clients not to beat themselves up if they’re not in the position they want to be in, or thought they’d be in by their age.
The key thing is getting into a mindset where you start to get a grip on the situation, and begin taking the key steps to put yourself in control of your finances and your future.
One thing is for sure – you have to be financially independent in order to retire.
The state pension age is now 66, and pays £10,600 a year to those with sufficient national insurance contributions. Although the state pension is a vital component of many people’s retirement plans, it is unlikely to be sufficient to live on alone. Research has shown that up to a third of pensioners will be relying on the state pension for all of their retirement income.
This means that for these people to be financially independent, their outgoings can’t be any higher than £10,600 a year, or £883 a month. Which isn’t very much, and certainly won’t provide the type of retirement that most people aspire to.
It’s a bit easier for couples who both receive the full state pension, as household income would stand at £21,200 a year, or £1,766 a month, and their household living costs are unlikely to be twice that of a single person.
But still, there’s not much scope here for a fulfilling retirement, or spare cash to pay for life’s luxuries.
The good news is that two thirds of pensioners do have extra income in addition to the state pension. This will vary widely from those with a very small income from a workplace or personal pension, to those with significant income from multiple sources.
We work to help you get nearer to the second category than the first!
There are two key elements to achieving financial independence:
· Being mortgage-free
· Having income or income-producing assets to meet your outgoings
Repaying all or most of your mortgage will be a key element of the strategy we create for you. If you have to find hundreds (or even thousands) of pounds a month to meet your mortgage payments, then the level of income and assets you need to be financially independent is going to be much higher.
When it comes to building up the income and assets you need, firstly we analyse your current outgoings, and your anticipated outgoings in retirement (or your financially independent life). This allows us to see how much income you need to provide for your desired lifestyle in the future.
We’re all different, and for some clients their outgoings will reduce when they finish work, as the mortgage will be repaid and they spend less money on commuting and the other ancillary costs incurred by going to work every day.
Some will maintain their current level of outgoings, if they had already repaid their mortgage, and they expect their general cost of living is unlikely to change.
But often clients will want to spend more in retirement than they do at present. Without the time constraints of work they may wish to travel more, to eat out more often, and spend time (and money) spoiling the grandchildren. If they’re going to be spending more time at home, they may want to undertake home improvements. If they are giving up a company car then they probably need to cover the cost of buying one.
Whichever of these applies to you, knowing how much you’re going to spend is absolutely key to understanding how and when you will reach financial independence.
Once we know your income requirement, we can work out where this income is going to come from. We factor in known current and future income streams, for example the state pension, rental income and final salary pensions.
This allows us to see the income shortfall every year from now onwards.
This is important, because your income streams, and therefore the shortfall, is likely to change over the years. If you want to retire at 60, and you have a final salary pension that commences at age 65, followed by the state pension starting at 66, you have a varying income requirement over that period.
In this example, your income shortfall is going to higher in the early years of retirement than it is in the later years.
Now that we know what the shortfall is, we can work out how much you need in incoming-producing assets to make up this shortfall.
We look at your current asset levels (your existing pensions, investments, savings and properties), and we use these as our starting point. We will then work out how you get them from here to where they need to be.
Because we understand your current income and outgoings, we know your capacity to save each year. So we can work out with a high degree of accuracy when you are likely to achieve the necessary asset level, and therefore when you will achieve financial independence.
We use a variety of asset types in our strategies, which each have different tax treatment, both in how you put money in to them, and how you take money out.
We will create your strategy for optimum tax-efficiency both pre- and post-retirement.
By being tax-efficient pre-retirement, your assets will grow at a faster rate by paying little or no tax on the growth, and potentially benefiting from tax relief on pension contributions, which means the taxman increases the amount you pay in.
By being tax-efficient post-retirement, your assets will last longer, because less of the income you take out is being taken in tax.
It’s tricky to get the balance right, but our team has years of experience in creating these strategies for a wide range of client situations – we think we’ve seen pretty much every conceivable scenario, but we like a challenge, and we’re happy to be proved wrong!
In our experience, becoming financially independent can be life changing. It’s a liberating event, and we’ve seen it give our clients peace of mind they have never experienced before.
It will allow you to choose whether you work or not. If you choose not to work, a life of freedom and choice awaits: the luxury of time, with enough income to spend that time doing what you want.
If you choose to continue working, you have the opportunity to change where, and how much, you work. If you stay in the same job, working the same hours, you know you are doing it because you enjoy it. If you change jobs or hours, it is because it will improve your quality of life.
You won’t be a slave to the wage anymore, because you don’t need the wage. Most people would agree, this a great position to be in.
Risk Warnings
· There are limits to how much you can pay in to a pension.
· The annual allowance is £60,000 in the tax year 2023/24, but for personal contributions you are limited to 100% of your earnings in the tax year you make the payment.
· Higher earners may have a lower annual allowance. Please seek financial advice.
· The lifetime allowance of pension savings is £1,073,100 in 2023/24
· Income from pensions is taxed at standard income tax rates and bands.
· The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
· Levels, bases of and reliefs from taxation along with the tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future. A pension is a long-term investment not normally accessible until 55 (rising to 57 from April 2028)