If we can understand what you need to save for, then the tax tail doesn’t wag the planning dog.
The more you earn
Parkinson’s law may not sound instantly familiar, but it is something many of us have experienced - the more you earn, the more you spend. Humans are creatures of habit and if you don’t have savings as part your normal routine, it can be pretty unlikely that you will start without encouragement, let alone increase it. Meals out, online shopping and socialising can very easily eat into budgets and this can even put long-term ambitions at risk.
People’s financial health is a bit like the porridge in Goldilocks, you either have just the right amount of wealth, not enough or too much. Most people have the latter two bowls and each comes with their own unique set of problems. If you have too much, you would need to consider what legacy you want to leave and how you do this sensitively and with maximum benefit. For those with not enough, the need is more pressing as if you don’t rectify it you may well be on a diet of porridge for the foreseeable future.
I have created a made-up example to demonstrate how even a small change can make a big difference to those who may want to build the savings habit, to show how good practices make all the difference.
Small changes can add up
David and Susan are married, in their early 40s and have one daughter Beth who is 10. They are both employed and own their own property with a mortgage. They have some savings, a small investment ISA and workplace pensions. Right now, they don’t save anything other than the money that goes into their pensions from their salary. They never struggle and have a comfortable surplus of income of at least £300 a month. They come to see me as they want to know if they can afford to retire at 60. They recently lost a close friend to illness and have decided to rethink their lifestyle, intending to ‘work to live’ by maintaining their current living standards and then aim to retire early to enjoy more time together once Beth has grown up.
I’ve produced the graphs below from my analysis that show their current situation. The top graph shows the cash needed for each year. Blue lines are fine, but any red shows a shortfall. The lower graph shows the amount of wealth they have outside of the home. You can see very clearly that, as things stand, David and Susan are going to have a challenging retirement. If they tried to retire at 60, they would run out of liquid assets when they are in their mid-70s. They cannot retire at 60, they will in fact probably have to work longer, and still consider either downsizing or releasing equity from their property, meaning they will not achieve what they wanted.
As we know what they want, is it possible to fix these problems and deliver what they both wish? In short, yes. If I assume that we set up a regular saving each year where the excess funds go into a Stocks and Shares ISA, it makes a huge difference. I have assumed a moderate risk investment strategy, with a moderate growth rate of 3% per year. By taking that action and investing the money, rather than frittering it away the shortfall has disappeared, and they now have more than enough assets to see them through, even with retirement at 60 as they wished. What is more, they have some money to spare at the end. And this can all happen without sacrificing living standards, just ensuring they put the excess income they have to work with a small regular payment into an ISA.
From making small changes early, over the course of their lifetime by simply saving more when they are working David and Susan have increased their total wealth from £715,000 to £3.7million, assuming they pass away at age 92 - not a bad return for money that won’t be missed. This small change allows them to build up enough in savings that can supplement the pensions they have and not only see out retirement, but they can leave a great legacy for Beth.
Allowances are great, but they, like assets, are just ingredients to the final dish – a financial plan. In this case, David and Susan had the right ingredients but, to go back to my earlier example, were burning their porridge. Financial planning is as much about helping you to make the right decisions and coaching you to help instil the better behaviours. So, why should you invest? So that you have the freedom of choice to do what is important to you so that your porridge is just right.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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