We’re back with another interview with a Monevator reader who has attained financial independence and/or early retirement (FIRE). This month John explains how he achieved a very comfortable retirement by working hard, maxing out pensions, and buying property – all while raising a growing family. Plenty to chew on, especially for those aspiring to Fat FIRE…

A place by the FIRE

Hello John! How old are you and are you married?

I’m 53 and my spouse is 59. We have been together 30 years but only married in the last ten. (We didn’t want to rush!) Marriage does simplify things such as wills, defined benefit (DB) spouse pensions, ISAs, and so on.

We FIRE-ed about seven years ago and we still feel financially secure. But world events and double-digit inflation do concern me.

All this positive talk of inflation eating away at mortgages only works if you get inflationary pay rises. FIRE types may have ‘real’ investments such as property. But they probably don’t get many inflationary increases.

Do you have any dependants?

We have three kids and eight grandkids. The kids are 35-40, the grandchildren 3-23. All three of our children went to university and two work in the NHS. Their lives seem a little harder than ours in terms of getting on the housing ladder and settling into adult life. We still provide some financial help. Mostly interest-free loans and below-market rents.

Childcare can be expensive and we’ve helped out a lot during the last seven years. We even got NI credits for four years!

The little ones are now all in school so it’s more drop-off and pick-ups a couple of days a week. I’ve really valued time with the little ones this time round. The first time I was more selfish and work focused.

The older grandchildren seem like a different species. They just don’t grow up as quickly as I remember. Two of the older ones decided against university. One is an apprentice trades-person and the other works in the hospital, waiting for a suitable apprentice opportunity.

Whereabouts do you live and what’s it like there?

We are currently in East Anglia but have lived in the North and South following job opportunities.

The weather is fantastic compared to where I grew up. Rail links are good for the capital.

When do you consider you achieved Financial Independence (FI) and why?

By age 45 I thought I had enough for a fairly ‘Fat FIRE’ – around £5,000 per month – without running down investments in nominal terms, and hopefully not in real terms1.

FI to me means work is an option, not a requirement, and “how much is enough” to achieve that is a tough question for a young FIRE-ee. I needed to be confident that my living standard wouldn’t take too hard a hit and that we’d be robust to changes in interest rates and inflation.

The big question for me was about the gap between the work pensions and exiting date. I had ten years until I could access the defined contribution (DC) pension pot and 15 for the DB pension.

What ultimately decided it for you?

I resigned when I’d truly had enough of working 60 hours per week and being away from home for 150 days a year. The less you need the money, the easier it is to walk away.

Also, as your FIRE fund grows, each extra year of work moves the dial less. At some point you realise your assets earn enough to live off. At that point you start to think about things differently.

What about Retired Early?

I left aged 45 and haven’t returned to any full-time work yet. There has been some interim consulting and contract work and quite a bit of unpaid work with a tech start-up that eventually fizzled out. About 100 days in total paid work – things dried up post-Covid.

I’m still open to day-rate work and short contracts but the telephone calls are much less frequent than when I was working.

If I went back now, my earnings would be lower than when I left. A three to four-month well-paid winter contract every year would be nice. It would make the summers off even sweeter!

Assets: Fat FIRE

What is your net worth?

Current net worth is around £2.8m.

This roughly made up of:

• Four properties at £1.2m total (valued at 90% of the 2022 peak)
• Defined Benefit pension £900,000
• Defined contribution pension £450,000
• Cash £250,000
• ISA £500,000
• General investment account £75,000
• All minus two mortgages totaling £500,000 (@Jan23)

The DC pots have been set to retirement age 70 and I’m in the default funds. The ISA and General Investment Account are in the FTSE 100 and Pref shares (45/55% split).

I’m a sucker for yield. I should have bought a world tracker, I know!

The interest-only mortgages have been my friend for 12 years (costing the Bank of England’s base rate +.75% on average across two properties). But now rates have risen, the £1,800 per month interest is starting to hurt. I’ve had such a good run on ultra-low rates it’s hard to complain.

My main (and only) residence makes up about 20-25% of our net worth. It’s a four-bed detached house at 2,000 sq ft set on a quarter of an acre.

We will consider downsizing again soon. I just need to work out how to take the mortgage with me.

Is your home an asset or an investment?

I consider my home to be an asset. It’s an asset that pays your rent.

I often wonder what percentage of net worth is sensible to spend on your home? We have downsized once already and will probably do so again in the next five years. I’m keen to take advantage of the inheritance tax rules, so I will downsize in terms of size, but probably not value.

My three remaining buy-to-lets are clearly investments and a hassle I don’t need. I would like to sell at some point. But evicting family is unlikely, and a spare flat could be handy if we move abroad.

I sold one property last year with a rental yield of 3% and bought preference shares at 6% yield, so I nearly doubled the income. But I subsequently lost the capital gains potential and about 15-20% in their value!

Earning: High-earner, SAYE, and property investment

What did you do in your regular income-earning days?

I spent my career working in the finance departments of insurance companies in senior technical and director-level roles.

In order to achieve pay rises, I frequently applied for external roles. Sometimes I left and sometimes I stayed with a pay rise.

In all I had about seven different roles over 24 years, and worked at five different companies.

For the first half of my career my average earnings were ~£40,000, including a car and bonus, but excluding the DB pension. The second half averaged around £170,000 (including car, DC pension, and bonus). Total career earnings excluding the DB pension was around £2.5m, before tax & NI.

Other income sources included Save As You Earn (SAYE) share schemes and similar discounted share buying schemes. I tried to invest the maximum. Free money is the best money! I ended up with around £250,000 of employer company shares in total. All sold now, with minimal CGT.

Buy-to-lets happened accidentally at the first, and then on purpose. We relocated with work and we didn’t sell the old house for a few years.

All told we’ve bought nine properties. Four main residences and five rentals. Across the properties there has been around £900,000 capital growth and £250,000 income. Costs are harder to total up!

Did thinking about FIRE influence your progression?

Planning to retire early didn’t impact my career. With hindsight I wish I’d moved jobs sooner and more often to get broader experience.

I should also have been more choosy about my first graduate employer. A good graduate training program can offer a great foundation and career springboard.

Saving: a saver born and bred

What is your annual spending? Do you stick to a budget or otherwise structure your spending?

We don’t actively stick to a budget, but I’m a value-focused Northerner who isn’t keen on waste, and who demands value for money. It’s probably to my own detriment. I’d rather go hungry in an airport than pay £15 for a burger! But your money DNA or blueprint stays with you.

I’m very aware of what income is coming in and try not to spend too far over that level. The large volatile number is travel and holidays. And also gifts to kids.

Our income will increase significantly when I can access my pension pot at 55 and final salary pension at 60. Until then we stick to spending the current income, but we probably could spend more.

What percentage of your gross income did you save over the years?

I don’t have good record keeping for savings and cash flows.

The first half of my career didn’t involve savings, apart from owning two houses, a DB pension, and some employer shares. I recall my net worth was around £250,000 after 13 years, excluding the DB pension. Roughly £200,000 was from the houses, which benefited from the fall in interest rates around 2001.

In the second half of my career I moved to DC pensions. I usually put in about 10% on top of the company’s 10-15%. Towards the end I also put in bonus payments.

Based on my DC contribution and the properties I bought for cash, I estimate my savings rate in the last ten year to be around 35% of work earnings. That includes the company pension element.

As earnings increased and then later as children moved out, our savings headroom increased. We never massively changed our lifestyle – yes to a nicer car, house, holiday, clothes (my wife) but not in a silly way. We’ve only ever bought one brand new car and my daughter has it now 12 years later. The cost of that car works out at about £4 a day so far…

Essentially, most of the money came when we were over-35. By then we were set in our financial ways. It isn’t always a good thing. I’m going to Tesco later to take advantage of an £8-off coupon!

That’s always a good thing in my book! But what is the secret to saving more money?

Earn more, earn more, earn more!

Maximise free money – pension contributions. Don’t buy new cars, learn to cook, avoid keeping up with the Jones’s, and aggressively manage your direct debits and bills.

Savings happen when you earn more than your lifestyle is costing you.

If you want money and freedom, you must focus on your market worth in the job market. Think long and hard – about what industry, qualifications, and training time are required – and then work hard to become expert and knowledgeable.

Add value, be flexible, and move companies often.

Do you have any hints about spending less?

Everyone is different and enjoys different things. I suppose actively think about the cost of something versus how much joy it brings. We don’t think about opportunity cost often enough.

Looking at the grandkids, they seem to have a problem with delayed gratification and labels. They have £100 a month or more mobile phone contracts, £14,000 car loans – this when they’re 20 and earning £300 a week or similar.

I have a friend who is a city lawyer charging £600 per hour. Listening to his lifestyle is completely alien to me (but hugely interesting).

Having too many friends a lot wealthier than you must cause some anxiety and extra spending. So pick your social circle thoughtfully.

Investing: not over-thinking or too taxing

I tend not to check share prices too often and intuitively like the invest-and-forget approach.

Rebalancing hasn’t happened yet. So, I’d say I’m passive in that I very rarely buy or sell.

Most of my investments were made before I found the FIRE websites and before I read the books. A big mistake was not buying world trackers to begin with.

Best investments – or rather lucky ones that worked out well:

• Discounted company share schemes. Put in about £75,000 investment, sold for around £250,000 over a 20-year period.
• Residential property – we must be close to £1m up over 25 years.
• Joining the DB pension scheme on my first job, even though I thought I was leaving within two years.

It’s hindsight speaking, but while I was financially comfortable enough to have gambled a small percentage of my money on crytpo or tech shares in the recent boom, I didn’t do it. I lost £1,000 on Motion Poster shares in around 2000 and didn’t try my luck again!

I have no idea what my overall return has been. I mostly focused on the earnings and tax-efficient savings. Once I realized the size of the DB pension, the pressure was off a little.

Can you tell us more about your thinking about tax-efficient savings?

Tax incentives have had a big influence on my strategy. Pension tax relief at 40-50% was too good to ignore. My timing was fortunate in that the annual allowance taper didn’t exist – and I took Fixed Protection 2014 to preserve the £1.5m limit.

My plan is to drain the DC pot from age 55-60 tax efficiently – no 40% tax – and I will probably get close to hitting the £1.5m in aggregate.

DC pension contributions were around £250,000 for 2006-2014, including the company element. Avoiding 40% tax in retirement is also probably what led me to max out ISA for the last 12 years (for me and my wife).

I do wonder sometimes if I over focus on tax efficiency at the expense of growth.

Wealth: buying freedom

Did you have a target for when you’d consider you’d ‘made it’?

Between my late 30s and my early 40s my ‘number’ was around £800,000 plus pensions. But once I got close to this the number I revised it to £1.2m plus pensions. Mostly because 15 years is a long time to wait for the pension.

In real terms I’m broadly level with the 2016 position. I’ve given up potentially a lot of earnings, but I gained a lot of freedom and time.

There is still a niggling question around my children’s finances. Should I return to work to make their lives a little easier?

Things I wished I’d known sooner, or thought about more:

• Your spending habits change as you get older or retire. New shiny stuff isn’t that important – apart from a nice iPad obviously!
• Enjoy the journey more. Why rush? Some things are better enjoyed 25-40 than at 45-65.
• If you didn’t find time for it when you worked then you probably won’t when you retire. Fitness, learning Spanish, and so on.
• My working 60 hours a week for that last ten to 15-year stint was probably unnecessary.

Do you have any passions, hobbies, or vices that eat up your income?

We used to smoke, which was incredibly expensive. But we stopped after getting a cancer diagnosis. That was probably the catalyst for aiming to retire by 50. It also makes me think about selling the DB pension.

Our main areas of discretionary spending are family, travelling, holidays, and motoring. Motor homes aren’t cheap! I decided against flying lessons and I struggle mentally with the David Lloyd £120 per month membership. So I found one costing £32 with a monthly rolling contract instead.

We don’t have expensive tastes. That’s probably a good thing. An £8 bottle of red is good enough for us.

In the longer-term we are giving serious thought to moving to Spain or Portugal. The older I get the more I like spending time in shorts and in the sun!

Your money mindset

When did you first start thinking seriously about money and investing?

I grew up fairly poor on a council estate in the North. Since money was always short, I’ve always being focused on getting more of it. Probably over-focused.

Being relatively poor shapes you and your thinking, and it’s hard to change. I gambled quite a lot in my 20s but stopped when I started earning good money.

My 20s were focused on kids, career, and trying to get housing security. We spent five Christmas Days in five different houses. Tough with three kids.

Late 20s saw earnings increase. I took advantage of Save As You Earn share plan schemes (SAYE) to the tune of £250 per calendar month. This was probably my best decision as within a couple of years they were worth £60,000, though only briefly. I settled for about £30,000 in the end.

My 30s were about career, bigger houses, nicer cars, and a move from final salary pension to a money purchase DC pension.

From 40-45: my career, the four BTLs, and I started an ISA and maxed it every year since.

Around 45 I left work, downsized property, and tried to invest the proceeds sensibly.

Did any particular individuals inspire you to become financially free?

Mostly it was just that strong desire not to be poor – and to never be poor again.

The best FIRE resources are websites – Monevator, Indeedably, Simple Living in Somerset, and Retirement Investing Today. When I first found these websites it was like I’d found my tribe.

A lot of the old websites have died and their creators have (hopefully!) moved on to better things.

Other interesting reads include:

• Early Retirement Extreme – hardcore saving for retirement, with much to think about.
• The 4-Hour Work Week – read this around 2009 and loved the creativity and different style of thinking. Not sure about the podcast though.
• I’m also a fan of Nassim Taleb, Tim Hale, Mark Spitznagel’s Safe Haven, and The Psychology of Money by Morgan Housel.

What is your attitude towards charity and inheritance?

Seeing my father-in-law deteriorate quickly aged around 80 led my to see that the phrase “go-go years, slow-go years and no-go years” is probably correct.

I plan to help the kids into their own houses. One has already bought a buy-to-let off me, with a 25% discount. As an aside, filling their LISA accounts is great tip for free money from the government.

We also currently help with childcare, holidays, after school activities, and so on. I see this continuing.

An inheritance unknown is the grandchildren. We have about eight, but the number grows! They are aged between 3-23. My gut says to focus on their parents as they are not comfortable enough and let them sort out the grandkids.

Most of my giving or charity is within the family. This may change when I’m older and the kids are sorted. I admire those who tithe but I’d worry about what if I need it later myself? Growing up poor stays with you.

What will your finances ideally look like towards the end of your life?

My assumption is I have 25-30 years left.

I’m aiming to spend or give away down to around £1m in the ISAs and then maintain at that level. We will also probably have £1m in property – which is above the inheritance tax (IHT) main residence allowance – so there will be IHT to pay. I haven’t really given IHT enough thought, I tend to over-focus on income tax.

When we have a greater understanding of our spending patterns as we age, I can see gifting accelerating, because my DB and State pension together should be more than enough.

Mental abilities fade so I want to simplify and de-risk in later life. I’ve thought long and hard about selling the DB pension, as it dies with us. But keeping it also simplifies things. I can’t spend it, I can’t lose it, and it’s guaranteed (mostly).

My ambition is to give my kids the option to retire a little early. Two work in the NHS and should have decent pensions. I’d like them to be mortgage-free by 60 and have the option to give up work 5-10 years before the state pension. I probably don’t have enough to make that happen but I should be able to help.

The money game took a lot of my energy and focus from a young age. It’s funny how once you have ‘enough’ it’s just not important anymore.

Perhaps I’m lucky not to know many very rich people. I can see how that would make you more competitive.

But if £2m is your ‘enough’, and you have £3m, then wasting your life (and time) chasing £10m seems a bit nuts to me.

Lots of life lessons in there readers. Of course John’s balance sheet is at the higher end of the FIRE spectrum and will be out of range for many. But equally lots of our readers might well get there in the long-term. Besides, enough is enough, whatever your enough is, as John concludes. Questions and reflections welcome. As usual please remember John is not a regular Internet commenter and he is just sharing his story to inspire others, not to provoke nastiness. Of course you can disagree on practical matters constructively, but please keep that in mind. One particular person’s situation isn’t a comment on yours. Thanks!

1. That is, inflation-adjusted. [↩]

What caught my eye this week.

Watching a handful of my friends get pretty rich over the past few years, it’s been striking how little they’ve changed.

Of course the props are swapped. Better cars breakdown. Household appliances are replaced with services, or even by part- or full-time staff. Baggage is stranded in more exotic locales. Arguments with their partners go upscale.

Sometimes one of them does something odd, like painting all the interior walls of their home griege and replacing literally 95% of the furniture to match the same rain cloud tone.

But mostly they are the same old Tom, Dick, or Harriet they were before.1

I recently had a coffee in Berkeley Square with one who was fitting me in between the hedge funds. He was lamenting in turn his success or otherwise with dating apps, and trouble with his teenage son.

The same pep talk I offered could have been delivered to an old childhood mate in his caravan in the provinces back home.

Spare any change?

Of course this is a convenient narrative for those who want to argue that we’re all in it together.

We’re not. Those of us with a lot of money have it better.

But it’s true, too, that there is a limit to how much better.

Not because of the canard that, after a certain point, happiness brought about by money plateaus. This bit of social science no longer appears to be true, according to recent research. (See the Guardian article I linked to above).

Rather, it’s because much of what really matters to us simply cannot be bought.

As a beautiful post by Lawrence Yeo on More To That put it this week:

You can be the healthiest person on the planet, but if you love no one, what’s all that vitality for?

You can be free to do whatever you want, but if there’s no one to spend that time with, what’s the point?

Is it even possible to feel a sense of purpose in your days if you believe that you’re loved by no one?

Yeo is doing original digging on a very well-worked seam in his article – albeit not so much in the Beatles-y extract above, which nevertheless ring true – and I’d urge you to give him a read.

Maybe follow up with Ben Carlson, who this week wrote:

Happiness is a complicated topic because when you ask people what they want out of life the answers typically involve career achievements, financial goalposts, or status.

A good job or a high salary or a certain level of fame are easy to quantify and define. Relationships are not.

Money has a value you can attach to it. It’s impossible to quantify the value of strong relationships in your life.

Or with Indeedably, and his sombre reflections from a palliative care unit:

Over the weeks spent visiting the ward, I got to know some of the patients. Lending a sympathetic ear or supportive hand to those in need of a diversion, while the person I was there to see slept.

None reminisced about the jobs they had performed. The nappies changed, houses built, essays marked, budgets prepared, businesses founded, or lines of code written. Beyond their former professions being a token of identity, they barely rated a mention at all.

None reflected on the things they had bought or experiences they had purchased. Cars. Holidays. Houses. Concerts given or attended. Sporting events witnessed or participated in. All irrelevant.

It must be something in the water?

(Middle) class warriors

I do sometimes wonder if I’ll look back on all the effort I’ve put into saving, stock picking, and even running this investing blog over the years as a bit of a tawdry exercise.

I long ago gave up believing Monevator will make many poor people less poor. If we’re doing our job properly, then we help make ‘are or soon will be well-off’ people a little bit more well-off.

Which isn’t nothing, but it’s hardly God’s work.

I’m not looking for sympathy or anything like that. I’m proud of this site!

I just wonder now and then if I should have been writing poems, or helping out at a care home.

The feeling passes, and I’m grateful for the autonomy my decisions have given me. But I’m also left wondering at the counterfactual shadows. Flitting around, just out of sight.

Have a great weekend.

[continue reading…]

1. At least after a hard-to-endure 12 months for those who got rich very quickly, before they get over themselves… [↩]

Note: This article on pensions and inheritance tax aims to provoke ideas and discussion. It is very obviously not personal tax advice, which neither the author nor this website are qualified to give. Speak to professionals about your circumstances, if required. Also we’re not getting into politics here. (Indeed Monevator owner The Investor would scrap all this malarkey and whack inheritance tax up to 90%, above a modest allowance for recipients!) As always we’re mostly about making you aware of the tools, not telling you exactly how you must use them.

The Lifetime Allowance for Pensions (LTA) is to be abolished. Subsequently there’s been much gnashing of teeth about how big pension pots are a sop to ‘wealthy families’ who can use them to avoid inheritance tax.

Will your pension now save you a plane trip to Panama?

How much can you legitimately pass on to your heirs via your pension pot while mitigating inheritance tax (IHT)?

We run some numbers. 

Setting the scene: pensions and inheritance tax

A quick (partial) recap of how pension rules work (as of now): 

• You get (income) tax relief at your marginal rate when contributing to your pension. 
• There’s a limit to what you can put in per year (the ‘Annual Allowance’).
• This limit is currently £40,000 (gross), rising to £60,000 in April 2023.
• You can employ ‘carry back’ to use unused allowances from the prior three tax years.
• You can withdraw a ‘tax-free’ lump sum of 25% of your pot. (Now capped at £268,275).
• You pay regular income tax on your withdrawals / income from the pension in retirement.
• You can’t touch the pension until you’re 55. (Rising to 57 in 2028.)
• Your pension falls outside your estate. There’s no IHT to pay. 
• You have to tell the trustees (the pension administrator, essentially) who you want the beneficiaries to be in the event of your death. 
• If you die before age 75 your beneficiaries get the pot tax-free. (Alternatively they can leave it in the pot tax-free and pass it onto their descendants).
• If you die after age 75, your beneficiaries have to pay income tax on withdrawals / income. However, there’s no ‘minimum income drawdown’ requirement. They can just leave they money in the pot if they don’t need it. (And can pass it on to their descendants tax-free, ad-infinitum).
• The LTA was a limit on the value of your pot of about £1m. You could have a bigger pension pot, but above £1m you had to pay 55% to withdraw the money – as opposed to 20%, 40%, or whatever your income tax rate was.
• The LTA was NOT a cap on total contributions, despite mainstream press reporting it as such. 
• This 55% charge over the LTA limit also applied in all sorts of other situations. For example you dying, getting to 75, and so forth.
• Labour has already said it will re-introduce the LTA for everyone who isn’t a doctor, a judge, or presumably, an MP.

Here’s a ridiculously brief summary of Inheritance Tax (IHT):

• When you die, the value of your estate over the allowance of £325,000 is subject to IHT at 40%.
• If you give assets away and then live for seven years, there’s no IHT to pay on the gift. 
• There’s no IHT between married couples. 
• Reminder: pensions fall outside IHT.
• There are lots of other boring and complex rules I won’t go into. Read up and get professional advice as needed.

Sarah and Stephen

Let’s meet a hypothetical middle-class couple, Sarah and Stephen, both in their late 40s.

The couple live in a £2.5 million north London townhouse of which Sarah is immensely proud. They have two kids, Amelia and Jack, and a Labrador, Max.

Jack is 17 and still at public school (that is, a private school). Jack is smart, but he doesn’t work very hard, except at rugby, beer, and girls. Amelia is 19 and is nearly halfway through her first year ‘studying’ psychology at a mid-ranking university on the South Coast.

Stephen reckons they spent more than half a million quid on Amelia’s education, once you throw in the field trips to Norway (geography), and Italy (classics). But Amelia still didn’t do well in her A-levels. Worse, she suffered some fairly acute mental health problems during sixth form. She’s hopefully over that now, but nonetheless they do worry about her.

Stephen has had a few health problems himself and Sarah is into cycling – we’ll see how this is relevant in a minute. 

Financially, they are doing okay. They both – conveniently for our maths – earn exactly £160,000 per year. Sarah is in marketing and Stephen works in the back office of a large global bank.

Their net (after-tax) household income is about £200,000. They still have a £800,000 mortgage outstanding on the house. Inconveniently, their super-low fixed-rate deal rolled off shortly after the ‘kamikaze’ Mini Budget and they’re now paying 5% on the loan.

Stephen and Sarah are great savers. They each have about £500,000 in their ISAs. Stephen has £900,000 in his SIPP, and Sarah has £700,000 in hers. (Sarah took a few years off work when they had Amelia and Jack).

Because of the LTA, they stopped contributing to their pensions a couple of years ago.

They have a few other assets, but most are fairly illiquid: a couple of private equity investments that Stephen made, some VCTs from when they still thought those were a good idea, and some ESOP shares in Stephen’s employer. 

Now the LTA is abolished, they’d quite like to do what everyone else does and pay the slab of their income above £100,000 into their pension. That’s because the £60,000 above £100,000 is taxed at an effective marginal tax rate of about 50% (thanks to the withdrawal of the personal allowance).

Cash management

Our couple is clearly well-to-do, with masses of assets and great incomes even for London. They have options. However they have a bit of a cash-flow problem.

Let’s look at their budget. (I’m assuming Jack has turned 18 and with Amelia has a £20,000 annual ISA allowance).

Sarah and Stephen both feel strongly that they should fill up both their and the children’s annual ISA allowances. This may seem like an indulgence, but ISAs are use-it-or-lose it allowances and they have the cash to do so.

The couple worries that neither Amelia nor Jack will have the financial fortune they had. The political mood music for the treatment of income and assets outside of tax wrappers does not sound good, either.

(Unfortunately, the couple doesn’t read Monevator. They don’t know about this one weird ISA trick to preserve your allowance even if you don’t have the money.)

Stephen and Sarah acknowledge they could do better on the general expenses front. They swapped the bi-weekly hand delivery of fresh organic bread from the local artisan bakers for Waitrose. And a frank conversation was had about how much money was spent – and on what, exactly – when Stephen went for a weekend snowboarding with ‘the boys’ in Val-des-Aire. That’s one of three annual foreign holidays now substituted with a week at a friend’s holiday-let in Norfolk.

Still, it’s not plain sailing. Maintenance on the house seems to be a bottomless money pit, there are payments on the car that they only use at weekends, Max (the Labrador) is getting on a bit, and the vet’s bills are ridiculous. 

Were interest rates lower, they might be tempted to borrow more on the house. But they’re not.

Indeed as things stand they are running a £40,000 deficit every year, when you take into account their ISA contribution ambitions. They can’t currently afford to make any pension contributions.

Enter Mike and Mary

Now let’s meet Sarah’s parents, Mike and Mary.

In their late 70s, Mike and Mary are classic wealthy boomers. They live in a mortgage-free multi-million pound pile in the Home Counties and have oodles of assets and cash. Their estate would be worth close to £7m if they died tomorrow.

In very good health, the couple can reasonably expect to live for more than seven years. (Mike’s dad only just died, aged 102).

But the family is still aware that there’s a looming inheritance tax problem, and now is the time to be planning.

However Mike and Mary don’t really consider the IHT their problem. They can’t really be bothered with any complicated arrangements.

Mike and Mary also feel, given the general state of the NHS and the possibility that they will need expensive care, that the £7m is money worth holding onto.

For that matter they can’t imagine, given Stephen works for a big bank in the City, why their daughter Sarah would need any help?

Sarah is a bit annoyed about this. In her opinion, the Brexit that mum and dad seemed to think, inexplicably, was such a grand idea, is causing half her problems. Brexit has them paying higher taxes. It also impacted Stephen’s promotion prospects at work. The bank has moved functions to Dublin.

(Naturally, they never discuss any of this at family get-togethers…) 

Obvious inheritance options

Why don’t Mike and Mary just give some money to Sarah now, in the reasonable expectation that she’d pay for their care or medical bills if it came to it later? Even if it’s just for the younger couple to put in their ISAs?

If Mike and Mary live for seven years, that’s £40 of IHT saved for every £100 given. 

Alas Mike and Mary worry about Sarah dying before them, leaving them in a sticky situation. And the grandchildren certainly can’t be relied upon to do the right thing. (Sarah’s mum has provided a running commentary on how they’re not being brought up properly their entire lives.)

They aren’t even entirely sure about Stephen. 

Sadly, there’s a very good reason behind these worries. Sarah’s only sibling, James, died in a motorcycle accident in his late 20s. Untimely tragedy is not an abstract risk for this family. 

A way out of the inheritance tax trap

Sarah’s family then are in a classic wealthy middle-class income tax / inheritance tax trap.

But all the chatter about the injustice of the LTA removal when it comes to inheritance tax has motivated Sarah to do a bit of digging.

And now she has a plan.

Sarah’s plan for Mike and Mary

Sarah thinks there’s an opportunity to reduce the IHT burden on her parents estate, boost the family’s wealth, and at the same time, actually increase her post-tax income.

A triple-whammy!

For now, Sarah’s not going to worry about Labour’s threat to bring the LTA back. (Besides, some kind of protection would probably need to be put in place to make any such move politically palatable.)

Let’s first consider what happens if Sarah doesn’t bother doing anything – and everyone just ignores the eventual IHT problem.

£100 in Mike and Mary’s estate would be taxed at 40%, becoming £60 in Sarah & Stephen’s hands. When they die it would get taxed at 40% again as part of their estate, and ultimately becomes £36 in Amelia and Jack’s hands. 

Ahoy there, pension shenanigans

Enter Sarah’s alternative plan. She reckons it will enable her to restart contributing to her pension, reduce future inheritance tax, and, according to her sums, not leave the family out of pocket at all.

• She sets up a new SIPP, separate from her existing pension.
• Her mum and dad give her £48,000. (Unconditionally, without reservation, accompanied with a letter saying as such).
• She makes a £48,000 (net) contribution into the SIPP.
• She names her parents Mike and Mary as the beneficiaries of the SIPP.
• In the expression of wishes, she allocates the benefits to Mike (50%), Mary (50%), Stephen (0%), Amelia (0%) and Jack (0%) in the event of her death.
• She then instructs the pension trustees to allow Mike and Mary the option of forgoing the benefits in favour of other beneficiaries, if they wish. This covers the situation where they decide they don’t need the money when it comes to it. 

Sarah has solved her parents’ biggest concern – that she dies before them. If Sarah gets left-hooked by a HGV cycling to work, they get their money back, tax-free. (Indeed with a 25% uplift, because it got grossed up in the pension).

Sarah knows she should be able to do this for three tax years (including this one) before the next election potentially changes the rules again.

The Annual Allowance goes up to £60,000 next tax year, and she has ‘carry-back’ available from previous years to use before the 5 April 2023. 

Sarah runs the numbers. She’s got £60,000, grossed up, in her SIPP, and it has cost the family £30,000 directly. But they will also save the IHT on Mike and Mary’s estate.

So net of both income tax and inheritance tax this move cost them only £10,800!

Not bad. But there’s another benefit. The SIPP is outside Sarah’s estate as well.

The gift that keeps on giving

Ultimately, Sarah and Stephen’s estate will have an IHT problem, too.

In 30 years they are going to look very much like Mary and Mike (different politics, perhaps) and face the same challenges.

What if she included that latter IHT tax benefit of shrinking her estate via the pension move?

That’s another £11,520 saving.

Through this lens, getting £60,000 into the pension has come at a net cost of minus £720.

Sarah has created a £60,000 pot for the family, for basically nothing. That pot grows tax-free. Whereas Mike and Mary were paying income tax on the interest they earned on that cash they gave her, so another win. 

Sarah ponders for a moment why she’s the one coming up with this stuff, given Stephen works in ‘banking’.

Actually, perhaps she can persuade mum and dad to do the same with Stephen, if she gives them Limited Power of Attorney to manage the investments in the separate SIPP she sets up for him?

This would double the annual pension pot gain for the couple to £120,000. With three tax years before Labour gets in, that’s £360,000 in the bag. 

Best of all, every year, £36,000 of that is going to drop straight into their bank account after they’ve filed their tax returns. This is going to really help with the stretched household finances!

And for an extra kicker – if they can make these contributions as salary sacrifice they can reduce National Insurance (NI) as well.

They will save 2% employee NI, and their employers will save 13.8% employer NI.

Sarah works for a small, founder-run firm. It is perfectly happy to have her divert as much of her salary as she wants into her SIPP, and kick back half the saved employer NI in there as well.

That’s an extra £1,200 in her NI and £4,100 from her boss. Another £5,000, almost.

It’s the final countdown

Sarah’s aware she’ll need to be careful she doesn’t go over the Annual Allowance. (She can use her carry back to do this).

Her table is now completed as follows:

Alas Stephen’s employer is a lot less co-operative on the NI front. He can only use salary sacrifice to a maximum of 15% of his salary, only into the company sponsored scheme, and there’s no employer NI kickback. But he’ll still do the max – and then transfer the cash from the employer scheme into the specially segregated SIPP, which he’ll do once a year by submitting a partial transfer form. The rest he’ll do with a direct net contribution into the SIPP.

Sarah is feeling so pleased about this wheeze, she’s thinking of treating herself to a new handbag.

How will they get the money out of the pension?

As their daughter Amelia would say, spending the pension pot is a ‘future me’ problem.

The couple have no idea what marginal tax rate they or their beneficiaries will suffer on extracting funds from the SIPP. It very much depends on the circumstances under which they are doing it, and the rules at the time. Even their tax residency.

Their marginal tax rate could be anything from 0% to nearly 85% (the latter with the old LTA charge, inheritance tax, and income tax all compounded).

To Sarah, the manoeuvre still seems worth the risk, particularly as it’s not actually impacting her income at all.

Quite the reverse, it’s actually boosting it. 

Back to the real world

In case you’re wondering, I’m neither Sarah nor Stephen. Yes there are some echos. But our situation is quite different to theirs.

We’re a lot more frugal for a start, and we don’t have a dog. (All that hair and barking!)

That the tax system is structured such that it incentivises this sort of thing seems to me nuts. All the same, I wish them the best of luck. 

Quite a few people are asking me what I’m doing about my pension contributions – because I’m way over the (old) LTA.

You will not be surprised at all, if you’ve read any of my other stuff, that I’m setting my risk dial to 11.

I will max out pension contributions over the next three tax years and hope for a bull market. I’ll then hopefully take protection (if there is any) should the LTA be reintroduced.

My income is (un)fortunately below the annual allowance taper, and I have carry back I can use. 

Mrs Finumus’s pension, on the other hand, is way below the old LTA. We were maxing out her contributions anyway.

The complexities of the LTA are such that I’d guess it’s not a slam dunk that Labour will just revert to the old regime (ex-doctors) once in power. Nor do I think it’s likely they bring pensions into peoples’ estates. Pensions are trusts, and this would require the overhaul of quite a bit of trust law. It’s more likely they remove the pre-75 tax-free status, which has the optics of achieving the same thing, but is a lot less effort.

Nonetheless I’ll be voting for them. I’m in a Conservative/Labour marginal constituency, so there’s literally no other choice for me. 

I’m near the fag end of my career anyway. Is it too late to become a doctor?

If you enjoyed this, follow Finumus on Twitter or read his other articles for Monevator.