In the previous post, we looked at the one-page financial plan and everything you need to know about it. This time, we'll look at what you need to do.
Everything You Need to DO
1. Start with the Big Goal
Let’s put the big rocks in the jar first, and make sure we have a plan for hitting that big goal. Chances are, for most of us, that is our retirement or FI date. Remember that the goal needs to MT – Measurable and Time-bound. Measurable means there needs to be a monetary value placed on the goal – how much do you need; what is your number?
Remember, when establishing the amount of money you’ll need to make up the difference between your secured sources of income and your expenditure, you will need to account for tax on any withdrawals you might make, say from a pension fund.
As simply as I can, the lump sum you’re going to need is something like the shortfall between income and expenses over the first 25 years of your retirement. We’ll use an example. Let’s say that our fictional couple are the same age and they retire at 60.
For five years they have no income at all. They’re spending £40k per year. At age 65 she has a deferred DB scheme kicking in at £18,000 per year. Then at age 67, they each have the full state pension paying them about £17,000 a year.
For the years they have no income, they need to find £40,000 net income. That’s doable without paying tax if they have both pension funds and ISAs. They’ll have £25,000 they can withdraw within their respective personal allowances, and the rest can come from pension tax-free cash or ISA withdrawals. Five years (of no income) times £40k (outgoings) is £200,000.
Then, when the DB scheme kicks in, they need to find two years of the £22,000 shortfall which is the £40k expenses less the DB benefits. That’s another £44,000 they need to have in assets, so we’ve now accounted for seven years in total.
Then once the state pensions are in play, they only need to find £5,000 a year. 25 years less the seven years we’ve already accounted for is 18 years of £5,000, which is £90,000. The total shortfall then is £200k plus £44k plus £90k – which totals £334,000.
I would then add an inflation factor to that based on a chosen inflation rate and the time to retirement. Now, if you’re talking about spending £100k per year in retirement, you’re going to have bigger tax issues.
For most of us, the worst case is that we’ll have to scale up our goal by 20% at most to account for basic rate tax on pension withdrawals. That’s why it makes sense to add ISAs into the mix as you build wealth, to give you a tax-free withdrawal option. The quid pro quo is that tax relief will enable you to build up pension savings more quickly, but you’ll pay some tax back at the other end.
Let’s say you have a figure of £500,000 you need to have in accessible money you can get at from your FI date. That needs to go on your one-page financial plan – it’s the M in MT. The T is the desired FI date, and it should read something like ‘I need to amass £500,000 by 1st September 2035.’
If you already have £300,000 saved, then you could word things to take that into account, such as: ‘I need to amass another £200,000 between now and 1st September 2035.’ You will have established actions that you need to take to reach that goal.
It’s then simply be a case of a monthly savings amount, the account or accounts that those savings need to go into, and the investment approach you’re taking – those need to go on to the one-page financial plan too. “To reach my FI goal, I need to save X per month into my pension, Y per month into my ISA, and I need to invest aggressively”. List the funds you’ve chosen if you like.