Chapter 24
Your Financial Life Plan
A step-by-step financial plan for your life
‘Know from where you have come and to where you are heading.’
Pirkei Avot
First, congratulations for reaching this chapter! If you have read the entire book, in particular the section on taxes, well done!
Second, this is it.
Now, after reading the whole book, you should know what you need to know and what you need to do. Take the actions to financially secure your retirement.
In this chapter, we will go through a list of general points to remember and then through each decade of your life, suggesting what you should consider. Whatever your age is, read what you should have done and try to catch up.
Main takeaways
It is difficult to summarise the main key points, but here are the top dozen.
- Plan, start early and be efficient. Formulate a plan, visioning your desired outcome (accumulating assets that can generate real income for the rest of your post-retirement life) and how to achieve it. The plan is likely to change but at least it pushes you to take action and move in the direction of your target. Start saving early in a pension. Maximise tax reliefs. Minimise taxes, charges and costs. Learn and educate yourself.
- Use ISAs. Supplement your pension with ISAs. Whilst they do not benefit from tax relief, they give you flexibility, choice and a tax shelter.
- Diversify your income. Aim to diversify your sources of income when retiring, such as annuity, income-generating investments and properties to let.
- Buy your home. Own your house. Aim to pay off the mortgage by retirement. You need a place to live and an owned house is a source of wealth.
- Invest, take investment risk and diversify. Take investment risk to generate investment returns. Not taking sufficient risk is a risk you might regret. The biggest risks are outliving your assets and not having enough assets to live comfortably after retirement. Aim to generate investment returns in line with your risk tolerance, increasing the chances of reaching your planned financial goals. Diversify your investments to reduce risk.
- If you are up to it, use active management. If you are committed and skilled, use dynamic SAA, TAA and active funds to add precious alpha. Every little helps over the long run, empowered by compounding. If you are not committed and skilled, keep it simple. Stick with SAA, using mostly trackers. Choosing in which asset classes to invest (asset allocation) has more impact than which securities or funds you choose.
- It is a long journey, so break it up. Break up your journey into separate phases: accumulation, consolidation and de-accumulation. Set up clear investment objectives and constraints for each phase, with an investment strategy and an anchor SAA. Stick with your long-term plan.
- Maximise contributions. Your contributions should be about 10% to 20% of income. Maximise your employer’s contributions. Aim to take advantage of your full annual allowances. Carry forward unused annual allowances from the previous three years. More money in means more money out.
- Reverse-engineer your target return. Think about the target amount to save by the end of the consolidation stage. Aim for an amount to generate at least half of your current salary to maintain your current standard of living. Use annuity rate to calculate the income. Given time and contributions, work out the target return and risk level needed to achieve your goal.
- Use a glide path in the consolidation phase. The consolidation phase needs a dynamic investment strategy, managing the glide path from current to target asset allocation. Apply discretion, avoiding selling just after a market crash. Prepare up to 25% in cash for a tax-free lump sum. Consider an annuity to deliver minimum required income and address some longevity risk. Invest in long-term bonds to hedge annuity price. Invest the rest of the portfolio to generate income and inflation-linked growth, whilst allowing flexibility to tap the assets.
- Continue investing post-retirement. The de-accumulation phase emphasises income and capital preservation, ensuring you are left with sufficient money, even if you live longer than expected. Pace your drawdowns to minimise income tax and to ensure you do not deplete your assets.
- Manage your wealth to achieve different goals. Separate your wealth into three buckets: (1) safe bucket to maintain a minimum standard of living and reserves for emergencies (cash, annuity, insured owned house); (2) market bucket with a diversified exposure to capital markets, matching your investment objectives in a tax-efficient wrapper, to maintain your current standard of living; and (3) speculative bucket to generate high returns (open a business, invest in a private company, buy-to-let property), trying to improve your standard of living.
Decade by decade
We now review the main points to consider at each decade of your life.
Your 20s
In your 20s you may finish higher education, travel, get your first full-time job with a decent salary and enjoy your youth. This is one of the best decades in your life – make the most of it.
Retirement is so far away you do not think about it. Anyway, there are other pressing financial priorities. You are at the beginning of your early accumulation phase. It is never too early to start your financial planning.
Sort out your debt. If you earn more than your living expenses, repay personal loans, overdrafts and credit card debt. These loans come with relatively high interest rates. The longer they are outstanding, the more interest you pay. It is a waste.
Open your first ISAs. Aim to save as much as possible in ISAs. Not using your maximum saving amounts every tax year is losing them.
Experiment with investing. Within your ISAs, start investing some money. You are gaining invaluable experience. Learning how to invest is a long process. Experiment with buying individual securities and funds. Mistakes cost money and you are going to lose along the way. Being humbled by markets, feeling the pain of losing are life lessons. ‘One who can’t endure the bad won’t live to see the good.’ With experience, find your unique investing style. Read a book or two on investing, read the economic sections in newspapers.
Join a workplace pension. If your employer offers a workplace pension scheme, join it. If your employer contributes to it, take this benefit. You do not need to start contributing to your pension at this early stage. However, if your budget allows it, contribute. The earlier you start, the better. Acquire the habit of pension savings.
Your 30s
In your 30s you may get married, start a family, purchase a house with a mortgage, buy a family car and progress at your work. You are likely to have increasing responsibilities, income and expenses. Life is getting serious.
During this decade you may move from early to late accumulation phase, depending on your planned retirement age. Most likely, however, you do not know yet when you are likely to retire. It depends on your career and aspirations.
Consider taking professional advice. HMRC rules are not simple and they keep changing.
Prepare a budget. Consider your earnings and expenses. You may start a family and have dependents, such as young children. Keep some cash reserve for contingencies.
Decide whether to buy a house. Buying your house with a mortgage is an investment for the future and a disciplined way for long-term saving. Save for a deposit. Shop around for a suitable mortgage. Ensure your budget accommodates the mortgage payments. Buying a small house is better than not buying your dream house. Jump on the property ladder as soon as possible.
Sort out your debt. Finish repaying any expensive short-term debt. Consider increasing the mortgage on your house to pay off other debt since the interest rate is probably lower. Consolidate your debt to simplify.
Start your pension saving. If your employer offers a workplace pension, join it. Your employer’s contributions are, effectively, a pay rise. Consider supplementing your workplace pension with a personal pension. SIPP is the most flexible.
Formulate your investment strategy. Most workplace pension schemes put you in a default fund. However, it may not fit your financial needs. Usually, the default fund is a multi-asset diversified fund. However, your time horizon is long. You should probably invest more in equities if it matches your risk tolerance – potentially 100% in equities. Blend equities with the default fund or do it yourself. SIPP and stocks and shares ISAs provide choice.
Maximise ISA savings. Aim to maximise savings in ISAs. If you do not want to invest, use cash ISAs not to lose the allowances. If you need to choose between saving in ISAs and contributing to your pension, pension is probably more tax-efficient because of tax relief. However, ISAs have more flexibility because you can access your savings at any time.
Your 40s
Life is getting more serious. The children are possibly a bit older. Whilst you are past nappies and waking up in the middle of the night, they bring new experiences. Bigger children mean bigger challenges. You may be a late starter with children or have another last baby.
Hopefully, you have progressed at work. You may reach the peak of your earning power. Midlife crisis may strike.
You are moving from early accumulation to late accumulation. You may move to the consolidation phase, depending on your target retirement age.
Take retirement saving seriously. Retirement is not around the corner, but it is on the horizon. If you have not started pension saving, it is not too late. However, start now. If you do not have a workplace pension, start a personal one. Carry over unused annual allowances from the previous three years to maximise contributions. Use bonuses and pay rises to boost pension savings. Escalate proportional contributions as your salary rises. Continue building your ISAs. Use the maximum annual allowances and maximise savings into ISAs.
Plan for retirement. Think when you want to retire and the quality of life you would like. Calculate your required annual income, assuming it is at least half your current income. Think about your changing income needs throughout retirement, not just at its beginning. Imagine how dependent you are going to be on income from your savings, considering other income sources. Work out the target value of your portfolio at retirement, taking annuity rates as a conservative assumption about income. Separate return objectives between required and desired. Work out the risk level you need, assuming a 0.50 Sharpe ratio, with the current risk-free cash rate.
Investment strategy. Formulate a strategy based on your goals. Considering your contributions, calculate your target rate of returns to achieve your required and desired target portfolios’ values. Set a strategy to maximise the probability of achieving your required value. If risk tolerance allows, aim for a strategy that can achieve the desired target as well.
Design a glide path. When entering the consolidation phase, design a glide path to the target asset allocation. The glide path should start about 10 years before retirement. Use discretion, not a completely mechanical approach. If equity markets crash or correct, do not sell unless you must. Stay invested for recovery. If gilt yields are low, invest in investment grade credit and other fixed income investments. Push forward and back decisions, trying to better time changes. However, try using dollar-cost averaging to buy and sell at average prices across years. De-risk your portfolio as you approach retirement. You cannot risk a large drawdown just before you need the money.
Consider starting to build a buy-to-let portfolio. If your budget permits it and it matches your personality, consider buy-to-let. Save for a deposit. Ensure you do not over-leverage yourself. If you take a variable mortgage, run scenarios on what happens if rates rise.
Start saving for your children. Use Junior ISAs to save for your children. They will need the money for university, wedding and deposit on a house. You might end up helping them anyway, so start saving for it in tax-sheltered ISAs. Open a pension for your children, benefiting from a base rate tax relief.
Your 50s
Now, get really serious about your pension. This is probably the most important decade for retirement planning. The children may not need your financial support, but elderly parents might do. You are likely to reach the peak of your earning power in this decade.
Decide broadly when you wish to retire and plan accordingly. Think about the income level you would like to generate from your portfolio after retirement. Decide whether your goal is achievable. Amend it if it is not. Separate your goals between required and desired objectives.
You may reach retirement in this decade when you are 55. It depends on your life style, career and how much you have saved. If you saved enough to support your desired standard of living, you have an option. If you have not saved enough, you need to keep working, saving more. Another 10 years of saving to the age of 65 can make a big difference.
Analyse your situation. Take a holistic count of your current portfolio, including investments, pensions (including State Pension, DB and DC) and property for both you and your partner. Ensure asset allocation matches your risk tolerance. Liquidity should match plans of using money. Diversify across assets and within assets, ensuring you invest in assets that perform differently, not just lowly correlated with each other.
De-risk your portfolio and begin the glide path. Once you decide on the income level and investment strategy post-retirement, start positioning your portfolio accordingly. Consider buying an annuity with some of your portfolio to address longevity risk and provide guaranteed income. Deferred annuity can generate a higher income later in life when other assets are depleted. Phase out volatility from a portion of your portfolio, moving it gradually into long-term bonds to hedge the price of an annuity. Formulate a flexible income and capital preservation investment strategy pegged to inflation post-retirement. Shift your portfolio over time to the target asset allocation. Move away from some equities into more conservative assets, reducing the impact of an equity market dip just before accessing the money.
Use a SIPP. Consider using a SIPP to have more control over your investments. Choose a platform considering investment choice, charges and online service, matching your style and needs.
Maximise contributions. Your earnings from work should be decent. Your living expenses should come down. You may have finished paying your mortgage and the children may be more independent. Whilst they may still need financial support, balance between that and ensuring you save enough to support yourself after retirement, which could last long (longevity). This is also for the benefit of the children since you do not want to be a financial burden on them. Maximise your pension contributions, especially if you are a higher-rate or additional-rate taxpayer. It is now or never.
Your 60s
You are now in or close to retirement. You need to make important decisions about how your pension is going to generate income during your retirement and whether to stay invested.
Take professional advice. Some of your decisions are final and irrevocable. For example, purchasing an annuity with some of your money – you will have the flexibility to change this decision only when a secondary annuity market is introduced. It is important to take professional advice from an Independent Financial Adviser (IFA) for a fee before taking action. Do not rely on advice from your drinking buddy or mates at work. Shop around for the most competitive annuity rate across different providers.
Flexible pension drawdowns. With flexibility and pension freedom, instead of buying an annuity, keep some of your pension pot and drawdown on it when you wish. This allows for greater control over income. Phase drawdowns over tax years, minimising tax. Maintain access to money in the pension if you need a lump sum. Blend annuity’s guaranteed income and unsecured pension’s flexibility. Plan how to drawdown income during volatile markets.
Sort out your debt. Hopefully, you are close to paying off your mortgage on your home or you have paid it. Consider using the tax-free lump sum from your pension to settle remaining debt. Your children could be a liability if they are financially dependent on you. Discuss all these obligations with your IFA before committing to an annuity.
Keep working. Many people in their 60s are still able, willing and interested in continuing to work. The government is set to prohibit employers from forcing staff to retire at 65. Choose whether to continue working, delaying withdrawing pension benefits and even topping up your pension pot.
Your 70s and beyond
Hopefully, after planning for many years for retirement, saving and taking the right investment decisions, you can enjoy your golden age with financial security.
At some point, you may need to spend more on healthcare. You may require professional care or accommodation.
Simplify. Plan for simple income generation at the late stage of your life because your financial decision making might be impaired. Use a deferred annuity to kick in at an older age. De-risk your portfolio to a simple asset allocation using trackers. If you own properties to let, engage a reliable property management company.
Think about estate planning. Your financial planning can shift to leaving an inheritance to your beneficiaries and mitigating IHT through estate planning. Discuss it with your IFA and solicitor. Pensions are not subject to IHT. Ensure you fill in a nomination form. Your ISAs can be transferred to your spouse tax-free, keeping the tax shelter. Draft a will, naming your spouse as the heir of your ISAs. Annuities cannot be passed on to your children. The flexibility to pass on your pension and ISAs is an incentive to keep investing all your life to preserve and, perhaps, grow your capital.
Enjoy. Enjoy your retirement. Financial security allows you to spend time with your loved ones, travel, invest in hobbies, learn and write a book.
Good health, good wealth and good luck.