The plan is to be financially independent [1] in a decade. I can see now that it can be done. And I can see how it will be done.
The thought of it is making me tingle. This will be the biggest and most rewarding challenge of my life.
In my case, becoming financially independent (FI) requires all the things the gurus said:
- A stupendous saving rate [2]: 67% of after-tax income.
- A moderate annual expenditure: £20,000 for the two of us.
- A final ‘retirement’ pot that can sustain a 3% withdrawal rate (the standard 4% is too risky in my view, for many reasons).
- A decent spurt of growth from my portfolio over the next decade: A 4% real return a year will do it.
The growth rate [3] is out of my control, so let’s not worry about it here. The final pot is negotiable, which leaves the savings rate and annual expenditure target [4] as the twin keystones of the plan.
Hitting a 67% savings rate without pauperising ourselves means the near removal [5] of Ms Accumulator and I from the tax system.
[6]
Tax ghosts
Part one of going off the tax grid is to stick to that £20,000 annual income figure.
From next year, the income tax-free personal allowance [7] is £10,000 each, updated annually in line with inflation.
Split between the two of us that means our entire year’s worth of spending ducks the taxman’s net. £1 of spending over that line actually costs us £1.25 – once you deduct 20% income tax.
Going tax dark part two means stuffing every spare penny we have into our pensions.
Famously, pension savings are taxed at your marginal income tax rate when you withdraw. In other words, if we each spend £10,000 a year from our pensions (in today’s terms) then we will pay 0% tax.
But the beauty is that every penny we save attracts 20% tax relief at the basic rate and 40% at the higher earner’s rate.1 [8]
That means every £1 saved is actually worth £1.25, or even £1.67 at the higher rate.
Which means that £10,000 saved is actually worth £12,500 or £16,700 and is returned to us un-gouged by HMRC, if we live within our personal allowances.2 [9]
I can’t emphasise this enough. We get an instant return of 20% or 40% from saving into our pensions (not including company matches) and, if we’re careful, it’s never taken back because we’ve danced clear of income tax.
An ISA can’t compete with that
It should take us 10 years to hit financial independence (FI) using company pension schemes and SIPPS. It would take over 13 years if we maxed out our ISAs [10] instead.
If I was trying to hit FI in my 30s or 40s then, yes I’d be all over my ISAs. But that boat has sailed for me.
We’re in our early 40s, so we’ll be within sniffing distance of our pensions by the time the 10 years are up.
If progress is slower than I hope, then we could easily be 55 – the age at which you can begin to make withdrawals from a pension – by the time we hit our FI bullseye. In that scenario there won’t be any hanging around.
Sure, if things go spectacularly well, and I hit my numbers early, then I could be like a pirate becalmed off treasure island – so close to his booty but unable to touch it.
I’m fine with that. I intend to work on for a couple of years anyway to build up a juicy tax-free lump sum [11]. This will be slipped into ISAs to create an emergency fund / extra tax-free income generator / travel-the-world slush fund, depending on the mood at the time.
Final thoughts
It took being able to smash my mortgage [12] before I was able to think clearly about FI. (If you can cope with two things at once then you won’t have this problem…)
You can add even more tax relief gas if your company pension scheme supports salary sacrifice. That will spare you another 12% in National Insurance Contributions (or 2% for higher raters).
At some point in these discussions, somebody will always say:
“The Government can change the pension rules, spanner your personal allowances, or even confiscate your pension.”
To which I say: Yes, you’re right to point out the risks.3 [13]
That risk is one of many I’m taking to achieve something big in my life. I’m also entrusting my wealth to assets scarier than cash, believing I have a long and happy life ahead of me, counting on the UK not to suddenly turn into Argentina, and so on.
By all means be aware of the risks, but don’t be paralysed by them. Play the game in front of you.
There’s a good chance that any adverse pension rule changes:
- Will happen early enough for me to change course.
- Will happen late enough that I’ll be exempt.
- Won’t happen as foretold.
My chances of being left high and dry are small.
When all is said and done, the key is being able to live happily on £20,000 or less.
My prescription: Fall in love, maximise your tax allowances [14]!
Take it steady,
The Accumulator
- I’m not too worried about the 45% rate. Are you? [↩ [19]]
- i.e. Save no more than our annual salary into a pension scheme, or our pension annual / lifetime allowance, and withdraw no more than our personal allowance in any given year of retirement. [↩ [20]]
- Only last week Ed Balls gave notice of his intention to end 40% tax relief on pensions if Labour are elected. Though most will be better off if reports of a new 30% flat rate relief for all are to be believed. [↩ [21]]