“What if I told you that you could retire in your 40s?”
Though this opening gambit may sound like a line from The Wolf of Wall Street it’s actually a key tenet of one of America’s fastest growing phenomenon. FIRE (Financial Independence Retire Early) is growing at a rate of knots. Whilst early retirement is the dream of many… I write this article with a hope to save at least one soul from a later life of poverty.
FIRE is a movement that centres around some fairly simple concepts. If I were to explain FIRE in two sentences they would be:
Right from your first job spend less (considerably less!) than you earn and invest your savings sensibly.
Once you've accumulated 25 times your annual outgoings (as a 'rule of thumb’) you can afford to retire.
The principle of targeting savings of 25 times your annual outgoings is based on the idea that this amount, if sensibly invested, should sustain your outgoings through your lifetime. Economists and Financial Planners have long craved the definition of a 'safe withdrawal rate' – a percentage amount that can be taken from a retirement portfolio without risking running out of money. Many studies have found that an initial drawing rate on capital of 3-5% (then adjusted for inflation each year) would be unlikely to exhaust any portfolio of stocks and bonds in a (historically) normal duration retirement.
So, what’s the problem?
People are living longer. A lot longer.
Many studies on the notional safe withdrawal rate have been based on a retirement lasting 30 years. However, over the last hundred years or so for every ten years we have lived, life expectancy has increased by two to two and a half years*.
For a couple aged 40 today, this means there is a 50% chance that at least one of them will be alive at age 97! A 57 year retirement is rather different to a thirty year retirement when it comes to financial planning…
Looking at historical investment returns if that 40-year-old couple were to have retired at any point from 1915 onwards, and at retirement set about drawing 4% of their portfolio, they would have run out of money 76% of the time based on today's life expectancy. Even if they waited until age 50, they would still have run out of money 68% of the time.
Be wary the internet forum peddling snake oil…. it’s likely not the safest source of retirement planning advice. Above and beyond the general longevity risks, early retirement creates some further significant headwinds:
The State Pension
Retiring early can have a huge impact on an individual’s State Pension entitlement. To qualify for the full New State Pension, £8,767.20 for 2019/20 Tax Year, an individual needs to have 35 full years of National Insurance Contributions. Retiring early can lead to a reduced entitlement to this valuable benefit, increasing the strain on your own assets.
For most, pensions represent the most tax-advantageous fashion to put money away for your retirement… though under current legislation they can’t be accessed until you turn 55. This age is going to creep a little later, too, as the State Pension age increases. Why does this matter? Because retiring before then means you may need provision in other ‘wrappers’ like ISAs, which are funded from ‘net of tax’ income. Top-rate earners in the UK receive just 53p in the £ on their final earnings for the year, so making meaningful headway here is almost twice as hard as with pension.
I could keep going, but you probably get the point by now!
What should I take from this?
As a Chartered Financial Planner it is hard to criticise the aspiration to spend (considerably) less than one earns. I breathe the necessity of making appropriate provision for the future, and spend more time than you could imagine fretting about how many people in the UK are not.
In summary, be very careful when making major life decisions based off 'rules of thumb'. When it comes to the biggest financial decisions you will ever make be sensible, seek professional advice.
The value of an investment with St. James's Place will be directly linked to the performance of funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.
*Lynda Gratton, Andrew Scott – 6 February 2016