How to retire at 55
Early retirement is something most people dream of, but what does it actually take to achieve it? James Connington finds out
Warren Buffett’s wealth may be enviable, but working full time at the age of 87 is something few aspire to. For most, retiring early and maintaining a good standard of living is the ultimate financial goal.
Achieving that aim doesn’t require a job in investment banking or a great aunt with a hidden fortune, but it does need careful forward planning and a dedicated approach to savings and investment. Schemes offering “guaranteed returns”, or social media adverts for surefire trading strategies, are not the answer. There are no shortcuts to building long-term wealth. It takes patience, discipline and a basic grasp of financial knowledge.
So what exactly do you need to do to retire early, and how much do you need to do it?
The Daily Telegraph has devised a plan for retiring at 55 with a portfolio capable of delivering £15,000 a year in today’s money in dividend income, for three starting ages: 25, 35 and 45.
We have been conservative in all of our estimates, so this plan is realistic – and the amounts required are not sugar-coated. This is not something all will be able to achieve, although the same plan could be used to target a smaller number.
We assume this is in addition to a company pension taken at the same age, and the state pension, which would kick in later. Together, these add up to a substantial income. At present, someone with a company pension pot of £400,000 could buy a standard annuity paying out just over £17,000 annually from 55 (or £10,200 with a 3pc annual increase built in). Add in the state pension, and you get a £30,000 to £40,000 annual income.
Here, we focus on how to build up an additional portfolio for extra income. But don’t neglect your company pension: take full advantage of your employer’s contributions, maximise what you can put in to benefit from the upfront tax relief, and check how it is being invested. Read more about this at telegraph.co.uk/go/mypension.
Where to build it
There are numerous “wrappers” you can use to hold the portfolio you build. The main options are a stocks and shares Isa, or a self invested personal pension (Sipp) – or a combination.
The advantage of a Sipp is that you receive upfront tax relief, so you will have a greater amount of money invested to start with. When you want to withdraw the money, the first 25pc can be taken tax-free, but the rest will be subject to income tax at your regular rate (after the tax-free allowance, currently £11,850 a year).
There is a total limit of £1.03m for all of your pension pots, above which you will be taxed punitively. This money will also be inaccessible until your mid-50s. Philippa Gee, of Philippa Gee Wealth Management, said: “Usually a personal pension, such as a Sipp, is accessible from 55, but this will soon rise to 56 and then eventually 57.”
With an Isa – where you can put in up to £20,000 annually – you receive no tax relief upfront, but don’t have to pay any tax on the money you take from it. You can also choose to start taking income from it at any time, so there is far greater flexibility.
With money invested in both Isas and Sipps, there is no tax to pay on capital gains or dividends earned within the account.
Mrs Gee said: “It is about creating maximum wealth over time, using the initial tax efficiency of pensions, compared to the lifetime tax efficiency of the Isa.”
She also pointed out that pension pots are more inheritance tax-friendly, meaning if you expect to have money left over to pass on, you should use up money in an Isa before a pension pot.
How to build it
We have made a number of assumptions. To reach £15,000 of annual dividend income, we’ve assumed the eventual portfolio will yield 4pc at retirement, without eroding capital value. This means that if you had £1,000 invested in funds or shares, the portfolio would be able to pay you £40 through dividends, and the £1,000 would remain invested.
Next, we’ve assumed inflation will be 3pc a year – meaning the amount required to meet the goal increases over time – and that in each case the individual is starting from zero.
Today, to deliver £15,000 in dividend payouts would require a portfolio of £375,000.
Once inflation is considered, in 30 years’ time the 25-year-old will need to target a £36,400 income from a £910,000 portfolio to match £15,000 today. To retire in 20 years from now, today’s 35-year-old will need £27,000 from a £680,000 portfolio, and in 10 years, the 45-year-old will need £20,000 from a £500,000 portfolio.
Gavin Haynes, of wealth manager Whitechurch Securities, has provided sample portfolios to help you reach a large enough pot by retirement: one for the 25-year-old and 35-yearold, who can take a greater degree of risk due to the greater length of time they will be invested, and one for the 45-year-old, who should take less risk.
While the investment is in its growth stage, before you retire and switch its focus to income, you could expect potential returns of 6.3pc per year for the riskier portfolio based on
the past 25 years. For the lower-risk option, expect potential returns of 5.7pc. These are not guaranteed.
To achieve the required portfolio size by 55, the 25-year-old would therefore have to invest £890 a month. The 35-year-old would have to pay in £1,450, and the 45-year-old £3,160. These figures don’t account for the differences in tax relief between an Isa and a Sipp.
The latter two scenarios are unrealistic for most, given that a very large pot has to be built rapidly.
Starting early is the biggest factor in growing a large retirement pot. A person who began at 21 would need to put in £725 a month to reach the required pot size.
Overall, the 21-year old would end up paying in a total of £296,000 by the age of 55. That rises to £319,000 for the 25-year-old, £347,400 for the 35-year-old and £379,000 for the 45-year-old.
‘It’s about creating maximum wealth over time, using both pensions and Isas’