Long-term approach
Financial worries or just looking for better value for money? Consumer champion Fergus Muirhead can help You need to estimate how much you’ll spend in retirement to figure out what you should save
QI AM looking for some advice as I would like to invest each month for 15-20 years and need a suitable vehicle.
I’m looking to have regular monthly contributions and also be able to be able to supplement with capital sums. I’m 39 years old and would like this investment to help with my retirement. I’m a member of my company pension scheme, and pay into that every month. Jane Strachan
ATHIS is one of these questions that has no correct answer but lots of different options and permutations of options that would all be beneficial to you. It also deserves more space than we have available each week so I’m going to continue the answer to this one next week as well. Today, I’ll look at some of the places you might put your money and next week I’ll look at how it is actually invested wherever you decide to put it, and how you can then access it when you get to retirement. The best, but probably most difficult, starting point is to consider when you would like to retire and how much of an income you think you will need at that point.
The reason that is so difficult is that most people find it hard to figure out wheat they will earn and spend next month, never mind in 20 years’ time.
The simplest way to think about future earnings is to apply a rate of inflation to your current earnings and project forward at that rate.
So if you think that inflation will be five per cent next year and you earn £25,000 this year, then you will earn £26250 next year if your wages rise with inflation.
Now I know that they haven’t been doing that in recent years but it is a sensible place to start. Once you know what your income will be at retirement you can, with a good guess, work out how much you will spend.
You might calculate that your spending will be half of your working spending because your kids have grown up and moved away, or your mortgage is paid off.
This is not always very scientific but it’s a starting point.
Once you know how much you need every year, you can figure out how much you will need in total to produce that amount.
So if you want an income of £15,000 in 20 years’ time, you might decide that you need a pension fund
of £300,000 to produce that amount – if you take an income of five per cent of the fund.
So now you know you have 20 years to build up that kind of fund, you can work out how much you need to invest every month.
You now need to decide where you are going to invest. You already have a pension with your employer which is great news and you might just want to add to that.
You are allowed to invest up to 100 per cent of your income into a pension every year, up to a maximum of £40,000, although lower allowances might apply for higher earners.
You can also go back a few years and use unused allowances if you haven’t contributed the maximum in previous years, and that might help when it comes to investing the capital sums you mention.
The advantage of a pension is that it is very tax efficient and you should get tax relief on any investment you make at your marginal rate of tax, so an investment of £1000 should effectively cost you £600 if you pay tax at 40 per cent.
The downside of a pension investment is that you can’t access the money until you are at least 55, but this figure is likely to increase, and most of the money you take out of a pension is potentially taxable.
So you might want to consider splitting your investments and putting at least some of it into an ISA.
You can invest up to £20,000 a year into an ISA and, while you won’t qualify for tax relief on the money you pay in, you should be able to take as much of it out whenever you like without any liability to tax on any gains that you have made on your investments.
I’ll look next week at where your money is actually invested in an ISA or person and why, depending on where you invest, you might want to make sure that you keep some of your savings readily available in a deposit account in your bank.