So you want to be financially independent (FI)? I don’t blame you. And I know you can do it! I got there in under seven years on a mid-five figure salary. But first, you need a plan. I’ll walk you through how to create your own financial independence plan in the steps below.
I know this plan delivers – because it’s the one I used.
You only need to work out a few figures, and the only one that takes much time to fathom is your required annual income. That is, how much will you need to live on?
To set the stage, here’s a fast-forward preview of what’s to come:
- Annual income / withdrawal rate = FI target
- Take FI target
- + monthly saving figure
- + real return rate assumption
- Feed numbers into calculator
- = Years until you are FI
Okay, let’s get on with it. Freedom awaits!
Annual income required
1. How much do you live on now? The ideal way to laser this number is by tracking your current monthly expenses on a spreadsheet for a year or so. By that point you’ll have captured most of the annual expenses that parachute into our lives like enemy commandos behind the lines.
If that’s all too much of a drag – or a traumatising journey into your own heart of darkness – then try an online budget planner. You’ll rustle up a workable number in no time.
Now for the fun bit. Let’s imagine how that number might look once you no longer answer to The Man.
2. Subtract expenses that will no longer apply. For starters you can gleefully strike out all your work-related costs – commuting, work clothes, professional fees, expensive lunches, the lot.
Also eliminate expenses that won’t apply once you’re FI. Mortgage payments (hopefully), saving to be FI and the like can all go.
3. Add new lifestyle expenses. Most people find they live on much less once FI. But it’s worth considering a range of categories that begin with ‘H’: holidays, hobbies, heating, health, and helium (or is that just me?).
The number you’ll be left with is a rough gauge of the net income you’ll need. Obviously it’s not the real number – you’ll only know that once you arrive in the future – but it will do for now.
Also, don’t worry about inflation. Later we’ll use calculators that take inflation into account, so we can keep working in today’s figures. Praise be!
4. Don’t forget tax. As if you would. To turn net income into gross income, just dial up your favourite tax calculator. For sheer simplicity I like the UK Tax Calculator.
Pop in your net income figure as your salary (into the calculator) and you’ll see what you’re left with once your tax bill is chopped off. Play around with the salary figure until you can take home the net income you need. Et voila! The salary figure is the gross income you need to work with.
Remember to cancel out the effect of National Insurance Contributions. You won’t be paying any if you’re not employed.
Bear in mind that income drawn from an ISA is not subject to income tax, but you do pay tax on pension monies over and above your personal allowance.
This is our best post on the eternal SIPPs vs ISAs question. Most people should probably use both, so we wrote this series on how to maximise your tax shelters to achieve FI.
5. Deduct other sources of income. Expect to have money coming in from elsewhere? Then you won’t need to amass quite as big a mountain of assets to pay your bills with. Obviously these other income sources only count if they can be relied upon, and if they’re on stream by the time you achieve FI.
Common conduits of regular cash include:
- State pension
- Defined benefit pension
- State benefits
- Part-time work
- Other passive income – trust payments, royalties, and so on.
Still with us? Having dashed through those five steps you’ll have a good enough idea of the gross income you will need to live on from your investments. Once your assets can support that income then you can declare yourself FI.
Cut a ribbon, run a flag up a pole, fire AK-47s into the air – whatever floats your boat.
Your target asset pile
To generate your desired income from your investments, you’ll need to accumulate a large heap of capital.
How big should it be?
To find out, all you need do is divide your income by your sustainable withdrawal rate (SWR).
Your withdrawal rate is the set percentage that you cream off from your hoard as income.
- If your required annual income = £20,000
- And your withdrawal rate = 4%
- Then your target to achieve FI = £20,000/0.04 = £500,000
You’ll need to accumulate £500,000 to earn an annual income of £20,000 at a 4% withdrawal rate in this scenario.
£500,000 = Financial independence in this scenario
A few things to know:
- The withdrawal rate is the amount you take in year one of your financial independence. You adjust your income in line with inflation every year after that.
- The 4% rule assumes you have a judiciously diversified portfolio of assets, as discussed elsewhere. Shares, bonds, and so on. It doesn’t work with cash in the bank!
- If you withdraw too much then you’ll shrink your hoard faster than it can replenish itself with interest, dividends, and capital gains. Live like a Roman emperor for a few years and you’ll be running on empty with bills to pay.
- 4% is a commonly used sustainable withdrawal rate. According to widely accepted practice, you can set your withdrawal rate at 4% a year and have very little chance of running down your entire hoard to zero.
- What’s less well known is that the 4% rule was derived from a specific set of assumptions that applied largely to the US, and to retirements lasting 30 years or fewer. It shouldn’t be used blindly by UK investors. We’ve previously explained why.
- A 3% SWR is a far safer yet still achievable withdrawal rate, although research is ongoing. But you might be able to increase your withdrawal rate with a few smart investing techniques.
Savings rate
Hitting your target comes down to how much you can save and the returns you earn on your investments.
Your savings rate is absolutely critical. This is the master string that makes the rest of your financial puppet dance.
It doesn’t matter how big your salary is or how much you live on, your savings rate dictates how long you will spend working. The following table – sampled from Mr Money Mustache’s excellent post that underlines this point in red pen – shows you how quickly you can go from zero to ‘cheerio’1:
| Savings rate | Years to FI |
| 85% | 4 |
| 75% | 7 |
| 50% | 17 |
| 20% | 37 |
| 10% | 51 |
It’s a beautiful relationship. If you can save more now, then you have proved you can live on less. Which in turn means your income target is smaller and you will reach it sooner.
So what’s your savings rate?
For the purposes of our calculation, we’re interested in the actual amount you can tuck away monthly.
You probably know this number already, but just to make sure you’re getting as full a figure as possible:
- Take your annual net income.
- Subtract your annual expenses.
- Add all your other income streams including rentals and bank interest.
- Add pension contributions and employer matches if pensions are a factor in your plan. Gross them up to account for tax relief.
- Don’t add investment income and gains. These are accounted for in the return assumptions that follow.
The number you’re left with is how much you should be saving a year. Now take your total savings and perform the following calculation as provided by UK early retirement blogger The Firestarter:
Total Savings2 / ( Total Savings + Expenses ) x 100 = Your savings rate
Once you know your savings rate you know how long it will be until you retire.
Ratchet up the rate if you want out quicker.
Picking an investment return rate
This is the final piece of the puzzle – the return that swells your investments into your own financial life support system.
However you calculate it, this number will be wrong. If I (or anybody else) knew what the market will deliver over the next couple of decades then I wouldn’t be writing this post. I’d be flicking through What Tropical Island? magazine.
You could just use whatever rate is inserted by default into an online calculator, but be aware that these numbers are usually pretty generous. Companies know you’re more likely to use their products if they deliver good news.
A 4% real rate of return3 is a common gambit. That comes from a 5% historical real rate of return for UK equities and 2% for government bonds. It also assumes you’ll plump for a 60:40 equity-bonds portfolio.
A more sophisticated approach (although not necessarily more accurate) is to use an expected return calculation.
Again, even Brian Blessed couldn’t over-emphasise what a shot in the dark these numbers are. You also need to dilute to taste. If your portfolio is more like 40:60 equities-bonds then your expected returns rate will be lower. But you can nudge the rate up to historical norms if your time horizon lengthens and your tilt towards equities becomes more daring.
Your best bet is to run a few different scenarios using nightmare and conservative assumptions, especially if your timescale is fewer than 20 years.
I personally wouldn’t run a dream scenario for fear that I’d anchor myself to an unrealistic number. If the future turns out to be a garden of roses then I’ll enjoy that when the time comes.
Don’t get your nominal and real returns mixed up. If your calculator includes an assumption for inflation, then feed in a nominal return which incorporates that inflation number along with your expected real return. For example, the calculator assumes inflation will be 3% and your expected real return is 4%, so your nominal expected return would be 7%. If you feed in a real return without adding something for inflation and the calculator also backs out inflation, then your future will effectively be whacked by inflation twice! (And the calculator will tell you that you’ll never be able to retire…)
It’s a numbers game
Right, let’s spin the wheel of fortune and see when you’re gonna be FI.
- Feed all your numbers into an investment calculator like this one.
- The annual charge is the total cost of your portfolio, with platform fees.4
- Strip out the inflation figure from the calculator if you’re feeding in a real expected return. If you want an inflation guesstimate then 3% p.a. is around the UK long-term average.
- The lump sum figure is money you already have. It can include the value of any rental property (minus attached mortgage debt), pension assets, savings accounts, and current investments.
- Don’t include your home, wine cellar, fleet of Vauxhall Corsas and so on.
- Check out this post for our ultimate, belt-and-braces financial independence calculation. This one includes how to factor in a boost for the State Pension or any defined benefit pensions that begin long after you FIRE.
The result of all this number-crunching is your answer, in years, to the question:
When will I be financially independent?
Now you’ll know!
Take it steady,
The Accumulator
Note: This article on creating your own financial independence plan was rewritten in August 2023. Comments below might refer to the 2013 incarnation, so double-check the dates if confused!
- See Mr Money Mustache’s post for the assumptions. [↩]
- Include all grossed up savings into pension funds along with employer matches [↩]
- The real return is the return you’ll get after stripping out inflation. [↩]
- If you don’t know that number then you can safely plump for 0.5% if you’ve got a nicely diversified portfolio of index trackers. [↩]
The one flaw I see with Mr. Money Moustache’s system, is that it is reliant on you spending the same in the future as you are now.
I am willing to sacrifice a holiday today. In exchange for the expectation that I can take more when I’m retired. Hence my savings rate is higher today, while my spending in the future will be higher as a result. Thus throwing out the simplistic’ness of the numbers used.
I don’t recall any mention of a safety net or is that meant to be built into the normal expenses?
I guess it’s all easy enough to adjust the numbers to take this into account.
I apologize. It’s poor form to post twice in a thread like this.
After re-reading my comment, it could easily be taken in a purely negative way. It’s not meant to be a rejection of the initial premise of obtaining FI quicker via a high savings rate. It’s just something else that needs to be taken into consideration when a person applies it to their individual circumstances.
Any chance of adding ‘edit’ buttons?
Things get a lot more complicated if you still have a mortgage term remaining and/or pension pots you can’t access until age 55.
One thing that I’ve been thinking about is what you should do with respect to your portfolio when you hit FI?
Its commonly quoted that you might want to have your portfolio consist of 100 – age in terms of % equities.
But does this assume you are still in an accumulation phase in your 30’s, 40’s, 50’s ?
What if FI means you are in a distribution phase in your 30’s, 40’s, 50’s ?
Taking a purely hypothetical situation of someone hitting FI at 35 and moving from an accumulation to distribution phase. Say they had the bog standard portfolio split roughly 60:40 equities/fixed income in a bunch of accumulation type funds. What does hitting FI mean that they should do next?
Maybe you have to have a change of mindset and think about preserving wealth/purchasing power now that you no longer have a target portfolio size to aim for fuelled by salaries? You would also have to think about the technical details of how you would start drawing an income from that portfolio.
Does this imply something like selling all your accumulation type funds and buy income type fund equivalents perhaps? Change your asset allocation perhaps, say to something more conservative?
Should you assume the same risk tolerance as a pensioner as you have effectively retired?
I’m a little unclear on this specific part of the puzzle and can’t remember reading much on this site or in Hale as to what actions you should take when making the transition and whether age should still be a factor.
Crikey. You could be precisely describing my embarrassingly detailed financial spreadsheet in your post. I have negligible earned income these days having majorly downsized.
My expenditure is calculated by downloading bank statements, and credit card statements and after sorting splitting into categories.
My expenditure figure is cross-checked by checking how my total savings have decreased or increased year on year after adjusting for income (such as salary) and amounts moved to investments, and taking out the affect of savings interest income. This check can help locate against mistakes or unrealistic expenditure figures. Sometimes it is easier to determine what monthly amount you have left over from net salary after paying bills to save or invest, than it is to add up the corresponding expenditure.
There is an allowance also in my spreadsheet for one off items like house maintenance, new car etc which may not be represented in yearly expenditure figures.
Everything is expressed in real terms which makes life easier. If I had to make one suggestion to someone working on a financial independence spreadsheet, it would be do numbers in today’s terms. If you crunch the numbers in absolute terms then it becomes ridiculously messy and prone to error. For example you can guess what state pension you will get in real terms, from a current state pension forecast, but calculating it in absolute terms involves projecting forward with inflation and then you have to project back at some stage also.
I have an input on the spreadsheet equal to the real return on savings and investments that I can change that tells me how vulnerable I am to not achieving good real returns.
The other thing I would suggest from experience is to start simple. Over time you can build up your spreadsheet to cover more things.
Like the FI wheel of fortune by the way, brilliant!!!!
Maybe not. Holidays are a very different matter for someone retired. You have more time, which dramatically opens some opportunities for you. You may not be subject to school holiday restrictions.
I’ll be going on my third (out of four) holidays this year in a little while. The pattern is totally different than when I was working. As a worker it was all about max drama and being as different as possible from the working environment. Now I can move towards what I want and not away from what I don’t. It means more, but shorter and less frenetic holidays, which happen to be cheaper than my pre-2009 holidays while working.
I suspect it’s the time spent on holidays and the serendipity of discovering new things that accumulates the experiences I recall, and not the drama of purchased experiences. But everybody is different and wants different things of holidays. And that probably includes your future retired self as opposed to your current working self.
People seem to underestimate the savings that derive from having control of your own time. When you can choose the time you will do something, or fit in with somebody else going that way, or get somebody to do work for you that fills in a hole in their schedule rather than has to happen on specific day x, life often gets a lot cheaper.
Couple of points…..
I’ve been heading down this path for the last 6 years or so – I have found the most important number to get as right as you can is an honest “expenses” number. Not just what it is now, but look ahead and make allowance for possible changes to circumstance (Really difficult). I have found that by adding 30% onto my annual average expenditure has covered every unexpected or overlooked expense.
Also, I think a 4% real rate of return is generous – maybe history has shown this as realistic, however, we live in a different world these days – i’m not sure I would feel safe assuming this. (Regardless of what so called “experts” are predicting). Being the ultimate safety freek I am calculating my numbers using a 1% real rate of return (And a 3% Withdrawl Rate).
Using the above numbers it puts my required savings level into the stratosphere, however, if I pulled the plug with any less I wouldn’t enjoy myself and would constantly worry that I’m going to run out of money.
I’ve probably put far too much padding & safety into my plan, but that is the beauty of this stuff, it’s a personal journey and you have to make your plan based on you and you alone – just make sure they are informed and intelligently made choices.
Great Blog – I’ve passively followed this for years and you have been very very instrumental in helping me get to within 6 months of breaking free and becoming FI – Many thanks.
Thanks TA – great post as always, if a bit of a whistle stop tour! The tax calculator – worth mentioning that if you live with a partner, you need to put in half your projected total household income or you will end up with an overestimate of tax take and required gross income (assuming you are able to set up income so that it is about 50/50, which is the most tax efficient).
I think safety margins are also worth discussing. My problem with all of this is that I can know with reasonably certainty what I need/want to live on today. Fast forward 30 years, and its really anyone’s guess. (just think back 30 years – no mobile phones, internet, computers…) some of the most important uncertainties, if contemplating a long period living off unearned income, are around the price of energy and food, and health and personal care. And of course investment returns and tax regimes. Ultimately its a leap of faith! The ability to be flexible and adaptable is key – thats a lot easier when you are relatively young and healthy, and also without dependants.
If you withdraw a 4% of your portfolio each year as a matter of fact you would never run out of money, would you? But that 4% could end up becoming smaller and smaller.
I assume the 4% is an aproximation, since it might be inconvenient to adapt our annual expenses to the volatility of our portfolio (even if the stocks’ part is small). The logical thing to do would be to withdraw a fixed amount each year (inflation adjusted) whatever the size of our portfolio that particular year.
There is an interesting chapter about this topic in Bernstein’s “The Four Pillars of Investing”.
If I don’t remember wrong, he says that a withdrawal rate of 4% gives you 90% chances of not running out of money, being the worst scenario a bear market in the first years of retirement.
Then, a final remark: this planning is made with the typical stock-bonds portfolio we know.
But at retirement time we particularly seek safety and fear financial ups-and-downs. So, wouldn’t be also a good option to switch at the end to something in the line of Browne’s Permanent Portfolio, which aims precisely at stability?
@The Rhino
Yes, my last remark suggests a possible answer to your question
I really hope this blog isn’t going to turn into an English version of Money Mustache, the Jim Jones of personal finance blogging
I work with spread sheets for a living and the marvellous thing about them is that they give you a very precise view of the outcome from one set of parameters which are very unlikely to actually take place
An inability to appreciate that simple fact led to a lot of the world’s leading banks having to be bailed out by taxpayers
The same could happen with your personal balance sheet if you rely on them blindly
Its better to have a plan than no plan however
Before you embark on a dramatic course course of action I would suggest you need to do a lot of contingency modelling around stress testing your parameters, including:
– bond and equity market crashes
– high inflation
– unexpected large expenses
– reduced availability of state pensions/medical cover
In 1980, when government bonds yielded double figures and inflation had peaked at 27% in the previous decade, no one could imagine the financial conditions that exist now, but that 33 year window is well within the time period you are trying to assess when drawing up “Financial Independence” plans for your 40-50s
Thank you very much for inspiration along the way. Target reached today. I am debt free and I intend to remain so. Inshallah.
> Also, I think a 4% real rate of return is generous
I’ve been averaging 20% annual returns since 2007 (yes, pre-crash), so to me, 4% real feels nicely conservative. It’s all in one’s perspective.
@ Mr Frugal – Most of the anecdotal evidence suggests that people generally spend less once they hit FI and still end up earning despite themselves, I guess it’s a question of how long you’re prepared to wait for the lifestyle you want. You’re right to think about a safety net and of course you can plan that in. One thing I didn’t go into is finessing things like withdrawal rates. I should think I’ll be able to withdraw at a higher rate than 3 or 4% for the first 12 years because after that our State Pensions will turn up, provide a fair whack of our income and take a load off our capital. You could annuitise too, if you’re old enough, to achieve a higher withdrawal rate.
@ Rhino – I think you can safely cast aside rules of thumb if you’ve hit FI in your 30s. The conventions won’t apply to you. There are many different ways to handle the distribution phase. The studies I’ve read on withdrawal generally assume portfolios at the 50% equity level even in ‘retirement’. If you’ve knocked your targets for six though, you could definitely pull back on risky assets.
There is fascinating new work being done by Professor Wade Pfau however that suggests you should reduce your equity level in the period before and after you retire, perhaps down to 20%. Then allow it to glide back up at around 1% a year. The theory is that you are most vulnerable to a sequence of returns risk around the time of retirement, so you reduce risk at that time. As you grow older then you can increase your exposure again. If equities rise then fall then the rise you experienced earlier in your retirement should cushion you from the later fall. If they fall then rise, then your exposure is reduced during the bad times and you’ll benefit from a rising market later. If the market does nothing but rise then you’re blessed and if it does nothing but ball then we’re all doomed anyway. Having said all that, Pfau’s research doesn’t have sprightly 30-something retirees in mind.
@ Snowman – Good to hear from you. What categories do you have for one-offs and how much do you set aside?
@ Mr Careful – Love the name. The longer you track your expenses the more realistic they’re likely to be. I’ve been tracking mine for 5 years and am reasonably confident in them. You can also set aside a monthly amount to cover expenses like buying a new car as Snowman does, and a chunky reserve helps too. I do hope your 1% scenario doesn’t come to pass or I’ll never get there.
Which brings me to another point. I think there’s a danger of being so pessimistic about the future that you decide it’s futile to even bother. Adding 30% to my income and a 1% withdrawal rate would set the bar too high for me. I’m all for realism but let’s not make it too gritty 😉 How high is your savings rate if you don’t mind me asking?
Finally, congratulations on being within touching distance of your goal. Sounds like an incredible journey given the standard you’ve set. I’m proud to have helped in some small way.
@ Vanguardfan – Good point about the tax. Agree 100% with your other comments. It’s a step into the unknown but it’s a leap we’ll all have to make at some point. I mostly hope I’ll be able to resist the desire to buy mind-reading pills or whatever’s all the rage in 2025. Or that productivity gains in other areas will offset the cost. Food-wise I’ve got plenty of scope to grow my own or shop more seasonally and am planning home improvements to reduce energy consumption. As for health… um, ride my bike, eat spinach, cross my fingers 😉
@ Juan – You definitely can run out of money at 4%. That 90% rate of success you quote is only good for 30 years and using US historic rates of return that have not been replicated across much of the rest of the developed world. The UK ‘safe’ withdrawal rate equivalent was 3.77% or thereabouts, 3.59% for the Swiss, 1.25% for the French and worse if you lost WW2. Those rates also assumed no portfolio costs and taxes. In short they’re very misleading numbers because they’re definitely not safe. I read a later book by Bernstein in which he said that 4% was an OK figure, but 3% is far more comfortable.
@ Neverland – That sounds like the perfect recipe for never making a start.
@ Georgina – Congratulations!
@accumulator
maybe an article beckons on what to do when one pops out on ‘the other side’, perhaps a guest article from someone who’s made it there already!
Thanks for another thoroughly detailed post Accumulator which touches on quite a few points bought up previously. Much appreciated.
I’m not terribly mustachian at present, and don’t do budget spreadsheets, I would probably fail the Latte Factor and I don’t make my own soup out of moss from the garden or anything like that.
As such it will probably take longer to achieve FI, added to which the end game is not just FI but living somewhere nice so you don’t have to pay to go on holiday to “escape” all the time. This is something my retired folks have mentioned before.
I also have a tiered set of FI-related goals (mortgage clearance, your bare minimum stash size in various assets, date you can consider shifting from working 12 months a year to 6 months or less, and so on) rather than one single date which is too far ahead and too uncertain to focus on alone.
But whatever motivates you best works, whether its waiting for a single big bang date to kick The Man in the crown jewels, or a gradual build up of goading him by flicking the Vs and prodding him in the ribs before the final KO of full FI.
Apologies for childishness. But you have to visualise The Enemy sometimes.
“living somewhere nice so you don’t have to pay to go on holiday to “escape” all the time.” In my view there are plenty of “somewhere nice”s in the UK and France that require escape only for a week or two of sun in January – when it’s cheap. I know a very nice somewhere in NZ but I’m not going to mention it in case I drive up the prices.
@dierime – I can recommend Nelson and Golden Bay and summer is coming in the Southern hemisphere!
@Monevator – not a criticism but at this moment in time I’ve no idea what my expenses are as I’m trying to live life to the full whilst still working full time having a reasonable final salary pension and having some savings. Before we moved here (NZ) I was on track for FI in 8 years – now I’m not so sure. Everyone is different and I’ve chosen to enjoy life a little more whilst I still can in my mid 50’s.
As ever – love the blog and keep it up!
@accumulator
As mentioned – I am obviously being extremely cautious, plus I take no account of any potential future earnings (part time or any sideline stuff) I would be suprised if my pessimistic outlook is realised. My savings rate is somewhere around 85% at the moment, however, with a good run of dividend income this could end up around 90% this year. I don’t consider myself frugal, I just make sure I get value for money on what I want, I don’t buy crap and get the best deal I can on fixed expenses. My main goal is trying to get to a point where my dividends / investment income covers all my outgoings plus a 30% buffer – I don’t want to touch the capital sum ever.
I think what most people are searching for when they seek FI is to break from a rut, but are scared of what happens next, thus, having enough money coming in “for the rest of your life” is a lifestyle safety net. I think the reality is that most people who make the jump from the rat race move onto opportunities that they could never imagine before, thus the need for FI becomes somewhat less of an issue. I for one do not imagine doing nothing for the rest of my days but I don’t actually know what opportunity awaits……..So, I have a crazy over the top plan to compensate for my fear of this unknown. Actually reading @ermine’s blog over at simple living in Suffolk is very interesting and reassuring in trying to get your head around making the jump. Plus, when it comes to a rant – this man sets the gold standard.
“…living somewhere nice so you don’t have to pay to go on holiday to ‘escape’ all the time.”
SemiPassive, Dearime and BritinKiwi – we moved to Devon for this reason and I hope to expound upon this on my own blog. As well as the feeling of ‘being on holiday all the time’ things do seem a lot cheaper and there are fewer temptations for spending money.
We’re heading to Dunedin next month on holiday and New Zealand is tempting, especially for remote working where there is no requirement to visit a UK office…
@BritinKiwi: ah, sod it, the news is out.
I will be mortgage free,next year,property 100k +
As I’m single,self employed,have no pension or savings being 50+(Now I’m panicking about 0ld age,retirement)
I will be using the full isa allowance,once mortgage is paid
52% of wage
50/50
cash isa—health probs &unknowns for immediate safety
stock/shares–vanguard lifestyle
I’m playing safe,as losses would hurt more than potential returns
thx–TA—great blog
@ Semipassive – Love that. Brilliantly put.
@ Rhino – Like that idea. Although as mentioned by Mr Careful, Ermine has recently made the leap and blogs about the experience at Simple Living in Suffolk.
@ Mr Careful – that’s a phenomenal savings rate. You are truly an expense-chopping, frugal ninja. I agree 100% about the scary ineffability of the ‘what happens next’ question. I’m starting to map that out in my mind, but am encouraged by those beckoning us from the other side who are clearly loving life. Indeed, I spoke to a retiree recently (of a more conventional age) who told me: “It’s amazing, it’s like being on holiday all the time.”
@ all – best wishes to all on their personal journeys, including those who counsel caution or are taking other paths. I get it, I really do, and it’s vital to have some counter-balancing opinions. Really enjoying this thread.
I am aware of the general advice that one should reduce the % equities in a portfolio when approaching retirement. The problem is that ‘retirement’ isn’t what it used to be: far more people now retire early and use drawdown rather than buy annuities. We ourselves are just about to enter ‘decumulation’. We have some other income from bits and pieces of final salary pension schemes, and will have state pensions eventually, but right now we need to start taking an income from a lump sum invested in S&S. For us – with 35+ years of ‘retirement’ ahead – I think the investments need to grow faster than the usual ‘cautious’ retirement portfolios would do. It’s almost as if we need to adopt a similar plan to that of a working person with many years to go before retirement.
If the new recommendation is to take just 3% or 3.5% as income from a portfolio then why not be done with it and buy an annuity?
I echo previous ideas that more articles for people in our situation would be helpful, but I enjoy all your articles anyway. Many thanks!
New to the site and wanted to start by thanking you for the thought provoking articles, starting to prepare for my FI journey so the advice and discussions are invaluable.
One question on the scenario above do you take £20k plus increase for inflation each year irrespective of your funds performances each year or do you take 4% plus inflation of the size of the pot that is left? Assuming it must be the first scenario otherwise your income would drop if the equity Market was badly hit
Just coming back on Lesley’s comment:
I’ve seen a number of different strategies suggested for taking income. How about just taking 4% of the total fund value on each yearly anniversary – never mind about computing an increase for inflation?
You might want a buffer fund in savings so that in a ‘bad’ year you could forego or reduce the amount you took in income from the invested funds. But taking 4% of actual should allow your income, in general, to increase year by year assuming normal stock market trends.
This will, of course, mean that you never exhaust your fund: it would be mathematically impossible to do so. That in itself might be a problem for those of us who wish to ‘decumulate’ and have no wish to leave money for others to inherit.
Any other ideas?
Any other ideas?
Yes, a related one, which is to live off income: http://monevator.com/how-to-live-off-investment-income/
A lot of the withdrawal literature and strategies ultimately emanate from the US, where there is a tradition of lower yields in the past five or six decades from stocks, and bonds and cash for that matter, too. Hence they have spent a lot of time trying to figure out how much they can safely withdraw without running out of money.
I am aiming reach the point where I can live off investment income entirely, by being in a position to get enough investment income to replace my salary.
Efficient market theories say returns from capital and dividends are interchangeable but (a) I don’t fully believe them (b) turning capital into income has costs (c) it exposes you more to sequence of return risks, IMHO. (There is still some with investment income, remember — dividends be cut, rates can fall etc).
The big problem with the strategy is you need more money, because it assumes you don’t run down your capital. And in practical terms, as you suggest, unless you’re planning to leave a legacy (in which case it’s extra attractive not to spend capital) if you had the bigger pot required to live off income you’d also have a big surplus in capital that you could instead just keep in cash to smooth spending your capital. So there’s probably some cognitive illusions going into the mix.
But it’s what I’ll probably do, anyway. 🙂
Hi
I think withdrawal strategies are an important and neglected issue. I have noticed that many UK private investors adopt a ‘withdraw the income’ strategy. I think this has pros and cons. I think the main advantage is psychological – by restricting withdrawal to income, you are inhibiting yourself from making unsustainably high withdrawals, and to some extent building in adaptability to market conditions. You’re effectively going to end up with something like 3-4% anyway.
However, I think there is also an important downside – which is that it could induce people to take higher than average risks, in order to obtain a higher than market average yield.
So, I guess I agree with TI, that this method is a bit of a ‘cognitive illusion’ – but perhaps that is no bad thing, given that behavioural psychology seems to the main source of risk to private investors trying to live off investments.
I presume you are familiar with FireCalc?
This retirement spending modelling software is based on historic stock market data, so obvious warnings apply…. But just used as no more than an illustration it is interesting:
If I choose to take 4% of the portfolio value each year as income (no adjustments for inflation) then the fund never falls to zero (I modelled it for 40 years) and the upper and lower final values (after 40 years) fall within ‘reasonable’ limits.
If I model it based on 4% of initial value, adjusted annually for inflation at 3%, then there is an 8% ‘chance’ of running out of money before the 40 years are up, and the spread of possible final portfolio values is enormous: something like minus 150k to plus 2.5 million!
Of course, finding the line on the graph that corresponds with our future situation is impossible!
great article, as always.
@neverland
could you explain what you mean by this:
“I really hope this blog isn’t going to turn into an English version of Money Mustache, the Jim Jones of personal finance blogging”
i’m a big MMM fan, so i am keen to understand what you’re trying to say here. a quick google search reveals that jim jones was a cult leader leading to a mass suicice of its memebers?!
I’ve looked at FireCalc. Worth pointing out that not only is it historic data, it is US data – I think Wade Pfau did a study looking at other countries, and all had lower returns than the US.
I think it also gives an option to simulate whatever returns/volatility you wish, which is useful, but I have no idea what would be realistic numbers for the UK going forward from now.
Also agree that the range of projected outcomes is so wide as to be somewhat unhelpful. and of course it doesn’t take into account adaptation to poor returns, which surely everyone would do rather than run out of money.
@ Valkyrie – here’s a piece on possible strategies for the retirement phase of life, including using annuities: http://monevator.com/secure-retirement-income/
Most of the research on safe withdrawal rates assumes 50:50 equity:bond portfolios, so possibly a higher equity allocation than many people are expecting. But the more capital you’ve stashed away, the less need you have for a high equity allocation.
@ Lesley – yes, you’re right, the safe withdrawal rate theory assumes that you always draw your required income plus an inflation adjusted top-up. So if you had 500,000 accumulated and the safe withdrawal rate really was 4% then you should be able to withdraw 20K (adjusted for inflation) every year, regardless of stock market performance and never run out of money.
If you only plan on living for 30 years, don’t pay taxes, don’t pay investment costs, have a 50:50 portfolio and enjoy historical US investment returns. The point of the rate is that it’s a worse case scenario. Many retirees would have been able to withdraw more and not come a cropper.
But the rate only applies to the conditions outlined above and the UK can’t match them – 3.77% for us. The saving grace is that if you started to run into trouble then you could always adjust your spending down and avoid running your portfolio into the ground.
For me the hardest number to settle on is the income required for FI…. I have a wife, 2 young kids (5 & 3) & next year i’m 40. It’s a very elastic number full of “what ifs” that one!
If I was just running numbers as a single person, or even as a married couple with no kids it would be a lot easier. As it stands it just feels like a best guess of the most conservative kind…. that whole “bank of mum & dad” being a challenge.
Great article, but it always strikes me that this whole subject is more about philosophy than maths. What are you all saving for? Not working for The Man? Jack in the job then, and sign on.
Jobseekers Allowance isn’t financial independence.
saving for security,I don’t trust the government
liked the job seekers allowance reply (:>)
@ Jim – I don’t expect anyone else to pay for my philosophy. It’s not that FIers are unable or unwilling to work. Most people who make financial independence continue to work, whether they are paid or not. Ultimately it’s a quest for freedom. Freedom to live life on your own terms. To spend your time and energy on the things that you really want to do, not the things you have to do. To find out what you can make of yourself and the world around you when you have the time to develop new skills and interests, instead of dancing to someone else’s tune.
Hate to be pedant but I ran the numbers and found that your explanation of how to calculate savings rate is a teeny bit off the mark
I’ve gone through it all in detail here:
http://thefirestarter.co.uk/calculating-savings-rate/
But if you want the short version, basically you need to ignore the sentence “Compare it to your gross income to find your savings rate”, and do the following calculation instead:
S.Rate = Total Savings / ( Total Savings + Expenses ) * 100
Where total Savings is every single penny that has gone into a savings or retirement account, whether you have saved into a SIPP or any other tax wrapper, including all employer matches, and obviously all taxed accounts as well (as you rightly point out in the article)
Please let me know if I have gotten the wrong end of the stick though and I will update my post with a sincere and most lengthy of apologies? 🙂
Thanks!
@ Firestarter – Love your post and thanks very much for the correction. I’m glad someone can do maths! I’ll correct the above article in line with your comment and link to your post. Haven’t come across your blog before but I’ve just been having a root around and I’m enjoying it a great deal. Agree about living on 10K per year.
Glad I could be of help, and that you are enjoying the blog!
Your website and articles have helped me immensely over the last year in learning about investing, so anything I can do to help you guys back then I’ll try. Cheers again!
What problem would there be with staying in 100% equities if you intend to leave the money in there forever and only withdraw your 3-4% or if the stock market crashes then perhaps going down to a 2% withdrawal rate / getting a little part time work /having a investment property on the side / living in India for a year?
I’ve been looking into this and know what our expenses are as a couple but planning to have a couple of kids so it’s difficult to calculate how much extra expenses will be. We need to work out our FIRE number to cover short term expenses while they are young and then when expenses drop when they leave home. On top of which is dividing your investments between ISAs and Pensions and when you can take each one Extra sums…….but work the extra effort if it pays off!
Cheers for the great articles!
Andrew
Andrew, there’s no problem with staying 100% in equities, except:
Very few people can handle watching 50% or more wiped off the value of their portfolio in a very short space of time. They panic and sell out at the worst possible time. You have to be very sure you won’t do the same and you can only really say that if you’ve been through it and didn’t meltdown.
If you want to drawdown 3 – 4% from equities then there’s a very good chance you’ll be spending capital as well as dividends. William Bernstein recommends stress-testing your plan against a 50% cut in dividends during severe crashes. If you have the flexibility to only live from dividends and you can tolerate such a volatile portfolio then you are likely to be OK.
Hello,
Thank you for this post. Put together a neat spreadsheet for myself this weekend based on it.
Just wanting to double check something: For point 4, if all of my income is from ISAs or from investments (and not pensions), then the only tax I need to worry about is Capital Gains, right?
Thank you,
Nadia
Hi Nada, your ISAs aren’t liable to capital gains tax either. If you have investments outside of tax shelters then capital gains tax is in play (beyond your personal allowance) as is tax on dividends and interest.
Hi. Thanks for the quick response.
Yes, I know there is no tax on money I draw from my ISA. The reason I mentioned it is to give an overall summary of where my investments sit.
So I was trying to ask: given that my money is only in ISAs or non tax sheltered index funds, do I only need to account for CGT? Or are there other taxes I need to think about?
So, if I take out some money from my non-ISA account, will that be applicable only to CGT, or is there a dividend tax applicable too?
Thank you!
Dividend tax is applicable to your non tax sheltered equity funds – beyond your personal allowance.
Income tax applicable to your non tax sheltered bond funds.
Thank you!
To anybody reading this post, and considering the many variables around financial independence and or early retirement then I would strongly recommend reading “Living of your money” by Michael McLung. You need to be reasonably financially literate to read it, and it does require some concentrated study. Its an extremely thorough evidence based study of how to safely use your money in retirement examining a number of different investment and withdrawal approaches. Its the most *useful* book that I have ever read because it has given me the freedom to retire at an age when I would not have thought it possible with a very high degree of confidence that I am not going to run out of money. The only real criticism I have of the book is that (a) it has a US bias (but backtests against world markets such as Japan and UK) and (b) almost completely ignores all taxation issues such as tax sheltered vs non tax sheltered investments. But its still very much worth reading. (It is also a sort of follow up to Smarter Investing by Tim Hale, and I’d recommend that reading that first for anybody still accumulating).
@Kwakil — Indeed. 🙂 And reviewed here for anyone who wants to know more:
https://monevator.com/review-living-off-your-money-by-michael-mcclung/
Also, here’s more on Hale:
https://monevator.com/tim-hales-smarter-investing-whats-new/
This is great info
Does the above calculation in regards to saving rate apply to those on a defined benefits pension? I work in the NHS and our new 2015 Pension links our pension age to state pension age, therefore I cant take my pension without heavy actuarial reduction until 68. The NHS contribution is 20 percent which sounds amazing but I guess it does not go into a pot of money that gets invested, it goes towards buying a guaranteed annuity which I can’t access without penalty until 68. Does that mean there is no point adding my pension and nhs contribution to my total as it doesnt reflect how much money I will actually have?
Thanks in advance
Hey John – you’re right. You can subtract your defined benefit from the sum of money you’ll need at age 68 but at first blush it doesn’t do you any good before then. Except, knowing that cash flow reduces the burden on your investments eventually does mean that you could draw down from your pot at a higher SWR earlier in life. For example, if you need £30,000 in income from age 55-68 but only £15,000 from age 68 (due to defined benefit and state pension) then you’re asking much less of your investments than if you needed them to provide £30,000 for the rest of your life.
To gauge this with confidence – you’d need to model the cash flows on a spreadsheet. Or, if you prefer a baggier approach, you can feel more sanguine about adopting, say, an SWR of 4% rather than 3%, because you know that your pensions will reduce your reliance on your pot to about 2% when you hit age 68. I’m making the numbers up, but you get the idea.
Or, if your pensions match/exceed your likely later life expenses then you could use a much higher SWR for your investments knowing they only have to provide for 10 or 20 years or so.
There’s lots of moving parts there but that sketches out the ground.
https://thepoorswiss.com/updated-trinity-study/
Further analysis -> 1871 to 2020 US Data Inflation adjusted 40 year returns, 100% stocks – 4% rule is around ~90-93% successful, and the 75/25 a few percent below ~88% ish.
Conversely – risk-parity portfolio – reducing volatility/drawndowns by negatively correlated assets – show historical improvements to safe (don’t un out) and perpetual (never reduced inflation adjusted initial capital) – withdrawal rates to ~5-6.3%
https://portfoliocharts.com/portfolio/golden-butterfly/
Note – currency / funds / home bias can be updated and reflects a ~1.3% lower situation as a UK Focused investor in GBP.
https://portfoliocharts.com/portfolio/all-seasons-portfolio/
N.B -> live dangerously… “Your money or your life” -> I feel there are ways to make pulling the trigger earlier – a sensible “safe” choice.
@ Charles – thank you for the links. Hopefully you’re aware of the built in bias towards the Golden Butterfly portfolio on Portfolio Charts?
Most of Portfolio Charts data begins circa 1971. Just as gold begins an astounding run-up after it becomes legal for US citizens to own it again. And after the Nixon ends the dollars convertibility to gold. That’s a historical one-off that precipitated a regime change for gold.
The golden butterfly benefits from that, the bond bull run that begins in the early 80s and the tilt to small cap value which is extremely difficult to replicate in the UK.
I do think the golden butterfly provides valuable insights into the power of diversification but I wouldn’t assume it can provide that much of an SWR boost into the future. What you’re seeing is the product of data mining.
Wow, I made a comment a decade ago on this article. That’s slightly blown my mind and made me ponder the passing of time. I think over that period I’ve moved from thinking about financial independence toward thinking about how to best spend my time. Unfortunately the latter is far harder than the former. Post FI psychology can be a real challenge. Remind s me of Milton, “the mind is it’s own place, and in itself can make a heaven of hell, a hell of heaven”. I don’t know whether he was financially independent, but I’m guessing he was and was then pondering, “so what next?”
Inspiring read @TA, especially alongside your linked October 2013 10 year FI plan and your amazing early accomplishment of it in 2020.
I was one of the lurkers back then in 2013 and 2020, reading but not commenting (I’d never commented on anything online before subscribing this year); but Mrs TLI and I were rooting for you, and we shared your joy when you hit your FI number in 2020.
Interesting that becoming a paid up member has resulted in such a dramatic change in your participation level!
I felt that I should try and put something back in after 15 years of reading this site. Subscribing for me is about supporting something that I don’t want to see disappear, and which I feel does a lot of good.
@TLI — And your support – and thought process – is hugely appreciated thank you. 🙂
You too, Mogul member The Rhino – and yes doesn’t time fly when you’re having fun / compounding 😉
Thanks TLI! I hope plenty of others are coming up behind me but it seems that it must be harder than ever to reach FI as the economy stagnates, taxes rise, and inflation bites. Where are you on your journey?
@ Rhino – yes, I agree, the psychological aspect can be a challenge, especially if the expectation is that life should somehow be amazing all the time in FIREland. IIRC a few FIRE bloggers have recounted going off the rails after about two years – roughly where I am! So far so good but as somebody recently said to me: “wherever you go, there you are.”
Thank you both @TA and @TI for such kind words. This really is one of the best websites out there, and it is simply the very best investing and FI site in the UK, bar none; and I say that having probably looked at them all now (literally 100s of them) since 2008. Monevator’s amazing well written, highly engaging, thoughtful and thorough, practical and actionable. It’s also an important website, as there is a real and serious lack of foundational investing knowledge in the UK. So many people are afraid of finance and investing, almost it seems to the point of superstition. They leave their money in the bank at sub-inflationary rates, they don’t take advantage of tax wrappers and reliefs, they get mis-sold unsuitable products which they don’t understand with low expected returns and high commissions by banks and so called IFAs who are often no more than salespersons, they end up reliant upon living off their state pension and not being able to retire until they can collect it. It’s a collective tragedy of an absence of public financial awareness and education, which this very brilliant website that you’ve built goes a long way to try and address. If the UK ever has the sense to set up a sovereign wealth fund like Norway (perhaps financed by a future wealth tax, Labour’s recent backtracking notwithstanding) then I’m putting you guys in charge of it as CIO and CFO!
To answer @TA’s question: guess 12 years off FIRE now hopefully at 60. Very lucky to have a DB pension (technically two, a legacy final salary and a current CAREs, with NRAs respectively at 60 and 66, rising to 67 and then 68 for latter). Built up ISA/SIPP/GIA totals now pushing £900k overall – never less than 85% in trackers (100% global equity), but closer to 90% at the moment. Mortgage now off set with savings. Never earnt six figures, but have benefited from decent earnings over past 15 years (ranging from £60k to 80k p.a.) and have always invested through SIPP and ISA the equivalent (with tax relief for SIPP) of at least half gross income (if not a little more). Mrs TLI a bit behind me on investments, but well ahead on accrued DB pension. We’re of similar ages. No kids to have to provide for. Mrs TLI says I live like a student (buy clothes and furniture from charity shops, forgo expensive holidays, no car). Started investing before 2008, but got thrown by the GFC, which left me foolishly on the sidelines until 2013. Fortunately, I’d gotten to nearly £200k invested/saved by 2008, and kept up the savings rate for next 5 years whilst out of the market, so wasn’t starting completely from scratch when finally got reinvested in 2013. Even so, coming out of the market for those 5 years was, with hindsight, the most stupid financial mistake I’ve made (at least so far). It’s set back FIRE several years I’d estimate. Back in 2008 I got very scared by some of the more doomerist online amateur financial punditry that was then very prevalent, basically the UK equivalents of Zero Hedge! Needless to say, not only have such sites been proved wrong, but they’ve mostly disappeared since 2008-9.
Agree with @TLI on serious lack of financial education and awareness in UK, especially about pensions. I’ve come across comments about pensions being gambling, or complaints about pension providers being useless (due to fund value having gone down), and then there are the high earning professionals who have no idea about higher rate pensions tax relief, never mind salary sacrifice. The problem is many people don’t know what they don’t know, or where to go for the knowledge, which is essentially free if you know where to look for it. We need financial education in schools or higher education, may be for those leaving to get their first job, and via the workplace for those who would miss out on this. A lot of it doesnt need to be in the financial advice arena, but just plain facts about how it all works, how charges can eat up your funds etc. There is a big trust issue of course, which is very difficult to overcome, and, of course, many find these sorts of topics difficult or boring, even when its their future retirement which is at stake. This site is gold mine of information, for those lucky enough to have discovered it.
An investing friend of mine wanted at end of his life for a cheque written from his estate to cover funeral expenses etc to bounce.
@TLI (#60):
Given the outline figures you provide can you say a bit more about “guess 12 years off FIRE now hopefully at 60”? For example, do you have a large mortgage or are you just being super cautious?
@TLI #60
Interesting to hear your numbers. Perhaps another candidate for the Fireside chat series?
Forgive me for jumping in on your finances a little here but by what metric are you assessing that you’re 12 years from FIRE?
From your post your income is c£80k, saving >50%, so expenditure can’t be more than £40k pa. with a pot of c£900k. It doesn’t sound like you’re more than a year or two from FI, if not already with a little flex in the numbers.
I’m accepting the RE part may follow some time later but sounds to me you’re pretty close to FI?
@TLI. Are you sure you’re not FIRE right now? You have no kids, live like student and have £900k in assets and gold plated DB pensions? Assuming £75k salary and 25-30 years of service, then the pension is worth £30-35k already. So that’s a PV capital value of basically £1mm. So really you have a net worth of close to £2mm. You then add in Mrs TLI who you say it a bit behind on investments but has MORE accrued pension! So net worth as a couple probably £3-4mm?
I’d also note that you are not really 90% in equities. Really it’s 50% since the DB pension is equivalent to a £1mm index-linked Gilt position. I always love these people who say they are 100% in equities but then you find out they have a multiple gold-plated DB pensions!
@oldie #61: love the attitude. I’m leaving my organs to medicine when I check out, so funeral expenses hopefully not going to be an issue (albeit, to my consternation, it turns out that – despite being desperate for organs – the NHS still might not be able to use what’s donated to them as it has to get to a hospital super pronto for use in transplants).
@Al Cam #62, @Rosario #63, and @ZX #64: you’re all right, of course.
I’m a bit of a hoarder, somewhat insecure and rather paranoid about running out of money. I try and avoid spending it, but just knowing that it’s there (albeit tied up in S&S) gives me more confidence.
I suspect deep down that I should just quit as soon as I can access the SIPP, and not at 60, and take the 5% p.a. reduction to the DBs for early retirement.
But even though I’m at best only average at what I do, and neither enjoy nor dislike it, it does give a bit of structure to life, and for me some self-esteem. So I plough on, at least for now.
Knowing that I’m inching closer every day to being able to walk away from it if there was a massive stress peak at ‘the Firm’ is, in itself, a huge source of comfort to me. I know that they don’t own me, even if they think otherwise.
I also think that I’m being slow to adapt mentally to higher rates. Became used to thinking of in terms of 1% to 2% yields and interest rates on shares, bonds and savings during the 2010s. In disbelief to see today that NS&I now offering a 6.2% one year fixed rate saving product. So I’ve perhaps become over cautious about how large a fund in the ISA and SIPP I’d need if I were to use the natural income.
@ZX #64: I’ve mentally ‘annuitised’ the DBs as though they will be a notional combined ‘fund’ at 20x income using LTA cap formula for DBs. Perhaps this is a bit too low from a market value perspective (25x?, 30x?), but 20x is what the gov uses for DBs, so I use that multiple too for my own accounting.
If the LTA is restored after the GE at the former level of £1.07 m (or less) then I’m going to end up breaching it if I retire at 60, and will then have to take the 25% tax hit to any income representative of the excess.
If I’m in that position on retirement, then I’m not going to take any lump sum at all because the 55% excess tax charge on lump sums over the LTA will presumably then also be back.
The DB income here is what I could draw on at 60 from both of the legacy and current DBs (allowing for the current CARES one having an NRA tied to state pension age, so that even at 60 I’d still suffer several years of 5% p.a. reductions on that, but not linerally, so 0.95 x 0.95, and not 0.95, 0.9 etc).
In a way, it would make sense to take the DBs as soon as each set of pension scheme rules allow (at 50 and 56 respectively), to take the 40% hit to DB income for early retirement that this would entail (i.e. taking benefits at the 10 year maximum before normal scheme retirement ages), whilst going into some sort of drawdown on the SIPP at the same time.
Doing that would likely avoid breaching the LTA, if it’s restored, as the LTA is not linked to retirement age but instead only to the actual (for SIPPs) and/or (for DBs) a notional (actuarially derived) fund size.
However, this is in the event that the LTA is restored at no more than the previous level. But Labour hasn’t actually won yet (I can’t presently see how they won’t win, but 2 years ago BoJo was actually polling ahead, and there is still 15 months until the GE has to be held, so I guess that anything’s possible). And if they do win, maybe Labour will go with an LTA of, say, £2.5 m, which would still be below what the original £1.8 m LTA is equivalent to now, if adjusted for inflation.
Because of the 5% p.a. reductions to the CARES for retirement before 66, if we both retire at 60 (i.e. 12 yrs to go for me), then I’m projecting that we’ll be at a bit under £40k p.a. for me from DBs, but at nearly £50k p.a. from them for Mrs TLI. I’m in the 20-25 year bracket for accrued pension now, as I joined a little later on in career in my later 20s. Mrs TLI is in the 25-30 year range for accrued pension.
I’d like to try and arrange matters to have our incomes at retirement at the BR/HR cut off (c. £50k p.a. each) for maximum tax efficiency (i.e. £7.5k p.a. IT each to pay), leaving the SIPP to pick up the little over £10k p.a. needed to get me there.
None of these numbers account for either inflation or any tax changes over next 12 years. Not sure one can really plan for those. My experience of the last 12 years is that equity returns were much higher than I would have expected them to be but, on the flip side, both my career (stalled) and the UK economy (stagnant first, now punctured post Brexit) turned out worse than I’d hoped for.
@TLI
> But even though I’m at best only average at what I do, and neither enjoy nor dislike it, it does give a bit of structure to life, and for me some self-esteem. So I plough on, at least for now.
That’s actually a separate issue. You are not your work, and three days after you walk out the door it’ll be TLI who?
I’m with ZXSpectrum48k #65. You’re minted, dude, given the setting, unless you have an expensive hobby or a mistress and kids on the QT. GTFO. There’s summat else you’re running out of, 24 hours every day. Tick tock…
I look at my former mustelid self #6, just retired and scared shitless of running out of wedge. Looking back on it, TBH I didn’t have enough when I pulled the plug, but I did have some decent luck of which the GFC was part, although it was also the reason my job went bad.
It came good in the end. Like you I have a DB pension, and the transformational aspect of that to stiffen the spine cannot be understated.
You ain’t gonna live the next few years again, and the view outside the office beats the hell out of the one inside it.
@TLI:
Re: I’d like to try and arrange matters to have our incomes at retirement at the BR/HR cut off (c. £50k p.a. each) for maximum tax efficiency (i.e. £7.5k p.a. IT each to pay), leaving the SIPP to pick up the little over £10k p.a. needed to get me there.
I kind of recognise this objective.
Couple of thoughts if I may:
a) once your SP kicks in any further SIPP withdrawals will be taxed at 40% [unless you use ufpls and do not draw maximum PCLS at commencement]; and
b) fiscal drag (due to stick around until April 2028 IIRC) & triple lock will likely conspire to make crossing the HR threshold happen much earlier, – especially if inflation and/or wage rises remain high. I found out on closer examination/study that this area was much more of a threat than I thought it would be.
Lastly Ermines point about running out of life vs running out of money are IMO very important too
Love this site and the comments.
@Ermine, love your site too. Have you ever done a post about your travails at work and how you dealt with the end game there? Have a feeling it would resonate with me so would be interested to read such a post if it exists
Also have a smile on my face as I read these comments. Heartening to see ZX and ermine nudging TLI about how much may be ‘enough’. And thanks again to TI and TA for all the moderation that goes into a great comments section.
“We need financial education in schools …”
No; just think of how many hours you’d have spent being droned at about endowment mortgages. Aren’t you glad your time wasn’t wasted on that?
If pupils are no longer taught about compound interest then that should be restored. Otherwise schools should stick to things that school teachers are competent to teach and should avoid fleeting fancies that governments can, and indeed will, abolish on a whim.
Or if that seems a little harsh, I invite you to explain what you think should be taught and to identify who would be assigned to teach it. The games master on wet afternoons?
@dearermine #71: Understand your concerns here. but it’s more about expanding upon, and building out from, what’s already available than creating something from scratch.
Economics should be much more widely available as an A Level subject, and those that teach it already can help with spreading the core knowledge to pupils beyond those who are actually studying it.
And, after a long campaign, financial literacy education did finally become a part of the National Curriculum for 14-16 year olds in 2014.
As a fruit of that campaign, we now have Martin Lewis’ excellent 150 page financial textbooks for 15 and 16 year olds (one for each nation in the UK), which he both helped to write and which he donated £325k to distribute 340,000 printed copies to schools in England (100 each to the 3,400 secondary schools in England, at 1 copy per 2 pupils); with further donations paying for 15,450 copies to schools in NI, 27,000 copies to 350 schools in Scotland and 16,500 copies to 200 schools in Wales.
The textbook is available for free as a PDF from here:
https://www.young-enterprise.org.uk/teachers-hub/financial-education/resources-hub/financial-education-textbook/
Using the core ideas of Monevator, maybe it would be possible to build out on what’s already contained in Chapter 5.
Presently ML’s textbook covers: 1. Savings – ways to save, interest, money and mental health; 2. Making the most of your money – budgeting, keeping track of your budget, ways to pay, value for money, spending); 3. Borrowing – debt, APR, borrowing products, unmanageable debt; 4. After school, world of work – student finance, apprenticeships, earnings, tax, pensions, benefits; 5. Risk & reward – investments, gambling, insurance; 6. Security & fraud – identify theft, online fraud, money mules.
For a good starting point on thinking about life after work, I can recommend the book: How to Retire Happy, Wild, and Free (Zelinksi)
It’s a cavalcade of ideas that can help prospective FIREees / retirees imagine how they might spend their time and who they might be after escaping Da Man.
@tetromino. Sorry but I’m not nudging TLI on FIRE. I was underlining the tendency for those with large DB pensions to conveniently ignore their implicit capital value. If they work till they are 60, they are looking at a £90k inflation-linked pension. The use of a 20x multiple is a joke. It’s clearly at least 25x. So £2.3m at current annuity rates.
Added to their investment pot, they would be in the top 2% by wealth. Their DB pensions will likely dwarf the investment pot, so TLI/MrsTLI are not 90% long of equities. They are essentially long of UK linkers with a side serving of global equities. They are heavily de-risked by any metric.
This all has implications for retirement timing but whether they are FIRE or not, frankly, who cares! I’ve decided over the past few years it’s a pretty meaningless idea.
Hi ZX, no problem. I only meant it in the most general sense, such as the question you asked in 65 about ‘are you sure you’re not FIRE right now?’.
[Just spotted in #72 I typed @dearermine, not @dearieme. My apols. Now realise I’ve been misreading that pseudonym!]
@ZX #74: you’re right in a way, but with an important caveat. As the DB schemes’ capital values exist only in notional terms, it’s more like an index linked annuity for us than, say, the yield on a long dated linker. There’s no way at all, sadly, that we can ever realise the equivalent capital value of the annualised pension sum. Believe me, if I could have done so then I would and I would have encouraged Mrs TLI to have done likewise as, back in 2020-21, those persons who were lucky enough to have DB scheme rights which could be cashed in (unlike ours) were, in some cases, reportedly being offered from 35x to even as much as 45x the annual sum (although, of course, they’d be paying 45% IT on that). In contrast, Mrs TLI and I are stuck with the annual sum no matter what, and so the capital value that it notionally requires in order to generate the pension income from an investment like a gilt is entirely theoretical for us.
I take your point though about the DB income meaning that the effective mix is no longer really 90% (or 100%) long equities (most of the just over 10% in ISA/SIPP/GIA totals which aren’t in global equity trackers are actually still in equities in some form e.g. SMT, a HYP; or, for unlisted equities, HarbourVest. I should add here that those active investments have all so far unperformed the passive trackers resulting in their share slipping over time from nearly 15% to just over 10%).
Always enjoy these refreshed basics articles as helpful to remind yourself of the details and make sure you’ve not missed anything.
Reading the time lapsed comments was a joy for someone that wasn’t reading the site back in 2013 and great to see follow ups from some regulars too. I laughed at Neverlands post – almost reassuring to see
@TLI thank you for the extreme open book approach as it’s both interesting and useful to see someone else’s working out. Now for this bit you can fairly tell me to toddle off but bear with me. Reading your posts it strikes me you are very self aware and able to describe some of your characteristics and thought processes, however it feels like there’s a dam waiting to break regards what is “enough” and more importantly “why”.
I heavily recommend the TV show Couples Therapy for, as someone who in a classic English/Male fashion would never consider it before, I found it fascinating to see people’s justifications and behaviours peel away though a very gentle process of scrubbing by the therapist.
Who knows after a couple of £50 sessions and a bunch of those questions none of us want to think about answered out loud you might find your FIRE date is much closer than you think!
@TLI. If I want to hedge the risk of inflation-linked annuity rates falling, I can buy linkers to hedge that risk. There is a fairly clear beta. So functionally they are quite interchangeable.
It’s a shame there is no tradeable market in DB pensions. You should have the right to sell that DB income to those that want it. Selling back to the pension company at whatever CETV they like is not capitalism.
It might be a theoretical sum but it means you have £90k/annum less to provide from your capital. That’s wealth. A few weeks ago, you were quite keen on getting me to pay a wealth tax. I hope you would be happy to pay a wealth tax on that theoretical value or are you going to argue that DB pensions somehow don’t need to be included but my DC ones do?
@TLI curiously, I am with dearieme though for different reasons
> And, after a long campaign, financial literacy education did finally become a part of the National Curriculum for 14-16 year olds in 2014.
The trouble with young folk is that they are young. That is good for human development – they are energetic, enterprising, favour novelty and make stuff happen. I’m all for it.
The problem is they have no experience, the backdrop, and so all the financial education in the world can’t help. IMO Martin Lewis has it right. When you are just out of school/university Rule 1 is Do No Harm. Forget about the second order stuff, the main thing is to not screw up.
As anecdotal Exhibit A I offer my younger self.
My parents educated me competently in the basics of money, from how a mortgage worked to the rule of 72 – they warned me off endowments – and I have some recollection of my mother educating me as to the difference between NAV and the share price of an investment trust, a couple of decades before our host did on here.
So what do I go an do, and this is at the end of my twenties? I go buy an endowment mortgage, because I like the sound of the final value being twice that at the start (at the then prevailing late 80s projections). You great big moronic young mustelid berk, after 25 years of typical inflation of course the number’s going to be twice as much in nominal terms, FFS, you don’t have to take all that risk. Oh yeah, and I bought at a market high even worse than the housing market at the moment, and spent the next 30 years hating on residential property as an investment as a result. Because I had no experience of market cycles, since I started work in the pits of Thatcher’s second recession and had only seen the rising part of the cycle.
The problem with financial literacy education is that people confuse the process of instilling knowledge with that of transforming it into wisdom. The former you can achieve from outside. The latter has to come from within, and observation shows that the transformation involves the school of hard knocks.
So keep the literacy education at the level of avoiding cock-up. The rest has to come from experience IMO.
> In contrast, Mrs TLI and I are stuck with the annual sum no matter what, and so the capital value that it notionally requires in order to generate the pension income from an investment like a gilt is entirely theoretical for us.
Go and take a look on the open market on how much it would cost to buy you an annuity of equivalent income and indexation. It is a chastening experience 😉
@ZX #77: Well, if I could (contrary to the reality now) trade up the annual pension income entitlement for an open market capital value (although I’d prefer – if hypothetically I could do this, which I can’t – to do so when interest rates were a bit lower than now, as the capital value would then be more) then, after paying the 45% IT on the receipt of capital, I’d then be happy to pay a wealth tax of 1% p.a. on the net of IT balance.
If you can’t trade the annual value for its capitalised value then it’s different in kind to, say, unrealised capital gains, where although you haven’t realised a gain you do hold ownership of the asset and could in principle sell it (or part of it, if fungible shares) in order to pay a wealth tax.
I would prefer any future wealth taxes to be steeply progressive and can see the case for them being broadly based – so it could start at 1% p.a. somewhere between as low as £250k per person or as high as £10mm and then go up by say 0.01% per further £10 mm up to a maximum of 10% p.a. just above £10bn, which I accept is bordering upon confiscatory but, from a utilitarian perspective, what benefits can someone enjoy from having over £10bn compared to £5bn or even £1bn?
@TLI:
I assume you are talking about public sector DB pensions?
Sorry for replying over 2 posts. Rushed out the last one, and didn’t get to thank or reply to either @Steve B #77 or @ermine #67 and #79. Also managed to screw up my numbering when referencing @ZX’s previous post (#78).
> what is “enough” and more importantly “why”?
Why do any of us do what we do? Maybe 80% of decisions are emotion and instinct, wrapped up as faux rationalisation. We see what we want to. Evidence becomes the information which we use to justify those conclusions the mind has already reached, without the conscious self even realising. I fear shortage / running out. I fear abject failure (I’ve failed ordinarily in plenty of things already, so I’m talking about ending up on the streets). Is it remotely rational? No, of course not. It’s completely absurd. But I still fear it the same nonetheless.
That’s the mind forged manacles which will keep me at work.
> There’s summat else you’re running out of, 24 hours every day. Tick tock
Every day I look into the mirror and I see my worst enemy looking back at me.
> had no experience of market cycles, since I started work in the pits of Thatcher’s second recession and had only seen the rising part of the cycle.
It’s path dependency. Grow up in the teeth of a deep downturn with steeply rising rates and end up fearing the crash which follows, buying the least expensive house that you can live in, paying down the mortgage ASAP and sworn off shares as too risky. Grow up with an asset price boom/’bubbles in everything’ and become a YOLO trader on Robinhood, going long GME on options and buying Dogecoin on margin in 2021.
As Feynman said, the first rule is not to fool oneself. The economy and the market does not care when any of us were born, into what personal circumstances, or what the economic backdrop was then. There are no moral lessons to be learnt here which can be applied to investing. The market doesn’t care if we brought low or high, with due diligence or without. The market’s gonna do what the market’s gonna do. For better or worse, all we can do is guess. It might work out, or it might not. But you can’t beat yourself up over it after the fact. Opportunities and risks happen in the future, so all we can do is think about what happens next, and not what just happened before. No point regretting – not that that stops regrets.
@Al Cam #81: I’m taking the Fifth on that one, or as the character Francis Urquhart puts it in the first season of the original House of Cards ‘you might well think that, but I couldn’t possibly comment’.
@TLI (#82):
Re: taking the Fifth …
Fair enough.
In any case, I strongly suspect that the key factors that will determine how fiscal drag, triple lock, etc will impact you are: how your current DB’s accrue from here on, how your legacy final salary DB re-values (assuming it is deferred), and how all your DB’s are indexed once they come into payment vs CPI. Depending on your precise details I would not be surprised if you find that fiscal drag has a larger impact than you might at first have assumed. It sure did for me, and paying income tax at 40% may remove some of the shine off those DC’s. I suspect there are a growing number of people who would never have assumed they would be a HR tax payer once retired that are sleep walking into this situation.
“so it could start at 1% p.a. somewhere between as low as …”
Ah, but ‘start’ has another meaning, as in: the modern income tax started under Peel at just under 3% versus the effective 60% band some people pay today.
Do you seriously suppose that wouldn’t happen with a wealth tax?
@Al Cam #82 and @dearieme #83: Got CPI protection during accrual phase for the current CARES, but not for the legacy final salary. Have CPI uprating after taking the scheme benefits (or on leaving the scheme and not taking benefits) for both.
Agree on fiscal drag risks more generally.
Having ruled out raising the Additional Rate, equalisation of CGT with IT, and introducing a wealth tax in the space of a few weeks; Labour’s now running out of good options to pay for stabilised, yet alone much improved, public services.
Shadow cabinet can’t make the numbers add up by raising VAT (or restricting zero rate and reduced rate) because that would be highly regressive and unacceptable to rank and file members and Parliamentary party.
SDLT; environmental levies; duties on alcohol, tobacco and fuel; and IHT don’t really stretch enough to pay the big bills. Maybe there’s a few billions extra in there if Labour’s very lucky, but that’s just small change in a £1 tn public spending round and a £2.5 tn economy.
Also, as the comments on this site have demonstrated, it seems most people hate IHT.
After their Uxbridge campaign misstep, doubt Labour will want to be able to be easily attacked as anti car. Hasten to add, I’m in favour of ULEZ and discouraging car use, but this is a party leadership terrified of dropping the ‘Ming vase’ of a 20% poll lead.
Can’t see either HR or BR being raised by Labour either. How could Rachel Reeves rule out increasing the 45% AR and then go and increase the rates for the much greater no’s of BR/HR payers? Likewise with NI.
With CT at 25% that one looks maxed out too. Wouldn’t help Labour’s business cred to try and milk much more.
A re-rating of house values for Council Tax bands might help eventually, but it will surely take years for the District Valuers to survey the UK’s housing stock.
So what does that leave?
Labour can’t go and do an austerity 2.0 (3.0?). They’re just not an austerity party (perhaps 1945-51 excepted). Yes, they called in the IMF and curbed spending in 1976, but they didn’t do the deep cuts of the ‘axeman’ Osborne after 2010.
As for borrowing more, I’m basically a Kenysian, but even I’m worried at the persistent and very high levels of deficit spending. Look at inflation, rates and the tight labour market. It’s no longer cheap money. It’s gone beyond a counter cyclical thing now. And then there’s the spectre of Trussenomics. Unfunded tax cuts and spending are just different sides of the same coin.
So what the heck is left for Labour to raise extra monies from or to do instead?
They can’t just let public services collapse further still. What’s the point of Labour if they allow that? It’s normally why they get elected; to ‘save’ public services after a long period of Tory rule.
Having more or less now ruled out raising rates on the really significant taxes, being unable to do massive further borrowing, and having to do something to improve services; the only obvious things left are fiscal drag and restrictions on pension tax relief (i.e. limit it to BR, bearing in mind that most of the £40 bn p.a. pension relief goes to HR payers).
So perhaps in power Labour doesn’t raise allowance thresholds or tax bands limits. More non-taxpayers fall into BR (and NI), more BR drift into HR, and more HR come into AR.
On the thought experiment of a future (Labour second term?) wealth tax, don’t underestimate how much is owned by the truly wealthy, i.e. those with ten figures: 171 UK billionaires averaging £4 bn apiece. Even allowing for the no’s being a bit off, there’s going to be £600 bn to try and tax there. If the effective average rate were to be 3% annually (say 4% nominal p.a. with 25% slippage to avoidance) that’s then still of order £18 bn p.a. from virtually no one in terms of the no’s people affected.
Interesting new piece on AWOCS on retirement in the past. Not such a golden age:
https://awealthofcommonsense.com/2023/08/the-evolution-of-retirement/
@dearieme (#84):
IIRC, income tax was first implemented in Great Britain by William Pitt the Younger in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic Wars.
I think it was also said to be a temporary measure!
@TLI (#85):
Limiting pensions tax relief to BR on the way in but paying HR tax on the way out sounds like a sure fire winner to me! Especially when the numbers of HR tax rate payers are seemingly ever increasing.
IMO, all HMG calculations re tax forgone to pensions tax relief are flawed as they only measure the tax deferred on the way in and not the tax paid downstream on the way out! And guess what, those who seemingly get the biggest reliefs on the way in generally pay the most tax on the way out! Granted this is not an easy calculation but it is not beyond the government actuaries who may well already know these numbers.
@dearieme (#84):
Apologies; I got my PM’s mixed up. It was seemingly Peel’s lot who said income tax would be temporary measure when they re-introduced it in 1842, see:
https://www.parliament.uk/about/livingheritage/transformingsociety/private-lives/taxation/overview/incometaxbolished/
@Al Cam — Always value your input, but just a reminder to you and all readers that it’s best where possible to include all your replies in one post (with the ‘@’ tradition) to keep things as tidy as possible — thanks! 🙂
The mention of the wealth tax in comments above is interesting. I’ve been reading some detailed analysis over the last few days and putting it all together, I don’t believe we’ll see one being introduced, but I do think we’ll see a range of taxation changes which increase tax-take, particularly on the more affluent. A wealth tax is simply too complicated to introduce and there are much easier ways to collect billions more than now using existing legislation and frameworks.
I was astonished to find that if you have net assets of £500k (including equity in your home) then you are up towards the top end of the wealth spectrum, and in fact the median wealth is £100k. Yes, that’s all ages, and won’t be reflective of people who are in mid-life and beyond, but even so, the figures are surprisingly low. I suspect most who are on a FIRE journey are very much in the higher deciles – nobody can retire years or decades early with net assets of £100k.
I’d love to know if there is any research on people’s wealth at the point they triggered FIRE and their wealth when they die, and the strategies they employ in the intervening period. I strongly suspect there is none (and probably no way of doing it) but wouldn’t it be interesting to see hard data on whether people are more likely to end up destitute and eating baked beans for the final decade before they die, or dying with millions and leaving a large IHT bill to settle.
@Semi-FI-Guy (#91):
For a UK view you could try: https://ifs.org.uk/publications/use-wealth-retirement
IMO, there are some issues with the methods used in the paper but I think it broadly covers the areas you wanted. Also, IIRC the paper examines households and not individuals.
I think there are also companion papers that cover each type of [household] wealth in somewhat more detail.