In the previous post, we looked at everything you need to know about the next stage of moving from goals to actions. This time, we'll look at what you need to do.
Everything You Need to DO
1. Set Your Saving Allocation
Pots are an easy way to keep your life simple while achieving your goals. By pots I don’t just mean what kind of account (pension/ISA/etc) you save into, I mean, is there a way of keeping your money separate?
I think the easiest way of thinking about all this is with an example. Let’s say we have a 38-year-old couple, two ladies, Jane & Laura. No kids, and no plans for kids. Together they earn £60k net – £5,000 a month – and they’d love to hit FI by age 50, so that’s just 12 years away.
Right now, they live on £3,250 including their mortgage payment, on which they have 12 years left – they’ll be mortgage free by their intended FI date. They’d like to have a big holiday when they both hit age 40 in two years’ time, costing £20,000.
They’d like to change both their cars in the next three years, but they’re keen not to go into debt for this – they expect to buy for £10,000 each. And they have a nephew that they’d like to give a smallish sum to, maybe £5,000, in five years’ time when he goes to university.
It doesn’t really matter at this point what their FI number is, just try to keep the scenario in your head as we walk through how they might apportion the disposable income that they have, which comes to £1,750 per month. They would need to consider their timeline and where the goals sit along it.
They can, if they want to, ignore their mortgage payment – they’ll pay it off by their FI date anyway, so they don’t need to apportion any more of the disposable income to that goal. They have £45,000 worth of short-term goals to find the money for – the holiday, the cars and the gift to the nephew.
The holiday and the cars come to about £40,000, give or take, and two years of saving £1,750 amounts to £42,000. Given that they are paying into their work pensions anyway, and paying down their mortgage, they can put enough money away in the next two years to pretty much nail their short-term goals. Because of this, I would recommend allocating all of their savings towards their short-term goals for two years.
Now, any pay-rises they get over the next two years, the extra money they get should be sent towards their FI pot, because they know the short-term goals will be realised, unless they want (or need) to buy the new cars more quickly.
Once that’s done, they can allocate less than 10% of their disposable income towards their now three-year goals of giving money to their nephew. Three years at £160 per month will add up to £5,800 (which is £5,000 in today’s money inflated up for five years at 3%) – job done.
Or they can save for three months using all their disposable income and hit target quick as a flash. Then they can throw everything at their FI plans, maximising tax relief with salary sacrifice, taking out a LISA before they reach age 40 and getting the bonus.
2. Choose Your Tools
You know that pensions are the best vehicle for wealth-building. Nowhere else do you get such great tax benefits, especially if you’re a higher rate taxpayer. But Jane and Laura have a problem, because they want to hit FI at 50, not 55. They’re going to need a pot of money from which they can draw before they get to pension age.
They should probably take out a LISA for the bonus, but that’s not available till age 60. So, they have a window between age 50 and 55 where they’re going to need to fund their lifestyle, and this is going to influence their choice of accounts. Logically, an ordinary S&S ISA should be the choice for this period.
So here’s the logic: They should work out how much they need to have in ISAs by age 50 to fund five years of their lifestyle. I would probably aim to have this fully funded two to three years in advance of their FI date to provide a buffer of time.
So, once the short-term goals are funded, I would keep the pensions being funded as they are for now, max their Lifetime ISAs and then throw everything else into their S&S ISAs until it is funded. Any pay-rises, I would divert into pensions to max the tax relief.
Can you see the thinking, here? We need to identify pots of money the we need to draw from at different points once we stop work, with an understanding of the accessibility rules of each. Let’s say their holiday goals was seven years out, rather than two: they could and should consider investing towards that goal rather than keep the money in cash.
They could use a General Investment Account (GIA) to keep the money separated out form their FI pots. The amounts involved are not likely to cause them an income tax or a capital gains tax issue, so it makes it easier to keep the money separate by not having it in their ISA. Understand the rules of each kind of account and figure out which apply best to the given goal you’re working towards.
It can be easy to say that, as an S&S ISA is accessible tax-free at any point, let’s just put everything into that, but that’s an example of being too simplistic. Jane and Laura will have no other earned income from the point at which they stop earning. Once they hit age 55, they can draw from pensions to use their personal allowance – drawing a tax-free income from a taxable pot.
Once their state pensions kick in, they’ll most probably have to rethink this. Throw in a rental property inherited from parents and it all changes again. Financial planning is fluid because life is changeable. Choosing the accounts we’re investing in is important, and we need to understand tax, accessibility and rules, and work out the best one for each goal we’re working towards.