Covid 19 has been devastating in so many ways, but it has least made people concentrate on the essentials.
This includes our finances, as we’ve realised that some things we felt we couldn’t possibly do without have proved to be dispensable after all: whether that’s the cup of coffee on the way to work or regular takeaway meals.
If you can still live without some of these treats as life returns to normal, it could mean surplus income at the end of the month and it’s important that you think about what use you can put that to.
If you’re under the age of 55, with years of working life left to build on your managed funds, you’re classed at Reeves as an Essential Client, because it’s essential that you save for retirement, with money put aside now achieving so much more for you in later life.
So, it’s important to review your income and expenditure to identify how much you can realistically save.
Compound interest is the most powerful force in the universe,’’
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This is a fundamental truth of saving. Compounding works as interest or dividends earned are added to the capital, increasing the amount on which future income is earned, further growing the pot and always building the momentum of your snowballing savings.
Last month, we identified the Growth Stage, when the foundations of your retirement fund are laid down and this is when you can take full advantage of Einstein’s powerful force - by putting money into a pension or an ISA.
For the majority of clients looking to accumulate wealth through regular savings, there are two tax efficient investment vehicles that we commonly recommend: ISAs and pension funds. Both are capital gains tax free and in both any income generated from investment is tax free. With an ISA all withdrawals are also tax free, whereas with pension, income tax is payable on any withdrawals (after a 25% allowance). However, payments into a pension fund receive a 20% tax relief bonus, with additional tax relief potentially available for higher and additional rate taxpayers. The annual allowance for an ISA is £20,000 for all UK residents; the basic annual allowance for a pension is the lower of gross relevant earnings or £40,000 but this can be affected by personal circumstances.
Let’s take the examples of two clients, Oliver and Margaret, both 45 years old.
Oliver regularly pays £100 a month into an ISA. Assuming a modest annual growth rate of 2.5%, including all fees, after 10 years, this would be worth £14,874 and, after 20 years, £30,933.
Margaret, on the other hand, pays her £100 a month into her pension fund and at the same growth rate, thanks to the tax relief, which boosts her contribution to £125, after 10 years this is worth £17,022 and, after 20 years, £38,872.
So, the returns from pension fund savings are significantly greater than from ISAs and the gap between them widens with time, but that’s not to say there is no place for ISA’s in your savings plans. The accessibility of assets in an ISA could be valuable, if you’re saving for a specific objective, such as a child’s university education.
Another advantage of making regular contributions to a savings plan is that it irons out the fluctuations of the market. Ideally, you would buy on the dips and not the peaks, but that’s extremely difficult to get right even for professionals. By investing regularly, you will take advantage of an effect called Pound Cost Averaging, which means that over time, the value of your investments should rise with the overall average rise in investment values, added, of course, to the value of dividends and interest earned - that powerful compounding force again.
If you think Reeves can help you with a regular savings plan, get in touch and we will arrange a one-to-one interview to get all the facts about your situation so that we can tailor an appropriate solution. This will result in formal recommendations in the form of a Suitability Report which we will also discuss with you.
This way, you’ll be able to control your finances and not let your finances control you.
This article is for information only and should not be construed as advice or a recommendation. The investment strategies mentioned are examples only and may not be suitable for your particular: circumstances, tax position or objectives. Please seek independent financial advice before taking any action.
Investments carry risk, capital invested may go down as well as up and you may not get back the original capital invested.