I contribute a hell of a lot into my pension… If it ever slips out at work I’m met with guffaws and weird looks.. “You’re only 27!”, “That money will be STOLEN by the government!”, “You’re a weirdo!”. A horrifyingly large number of people don’t contribute anything into their pension, but the worrying thing is, even a lot of people in our FI/RE community also contribute small amounts or nothing at all into their pension, choosing to stick with things like ISAs or property.
I had someone comment on my last savings report asking how I intend to stick with my FI number when I can’t access my pension until I’m 55. I went into an off-road ramble in the comment response which ended with “I should probably make a post about this.”, so here it is! When retiring before your pension age, how do you last until you can withdraw your pension?
Why Pensions Are Awesome
First things first – Pensions in the UK are absolutely bloody awesome. There’s no other country which I know of that offers tax savings as good as this. If you’re in the higher rate tax bracket, contributing to your pension via salary sacrifice would instantly save you 42% of what you deposit from 40% income tax and 2% National Insurance savings. If you throw a student loan into the mix, you can add another 9% savings onto this, saving a total of 51%! Remember, this is a guaranteed return. If this was an investment fund and it stated – “Deposit £10,000 and it will instantly turn into £15,100!” people would literally be running over their Grandma’s trying to invest, so why aren’t more people doing this?
The awesomeness doesn’t even stop there. Pensions function in the same way as ISAs with their gains being completely tax-free. All that extra money you earnt from your 51% gain? It can now joyfully compound and the tax man won’t come after you for a penny. Oh, and the limit is £40,000 per year!! That’s more than double the $18,500 which Americans can contribute into their 401(k)s (their pension equivalent). Even if you weren’t a higher rate taxpayer, you would still save 41% in total as you’ll save an additional 10% with your National Insurance savings. Also, remember compound interest? You’re getting this extra money as soon as you invest, not when you retire. That extra 51% will be merrily compounding all of the way until your retirement. This could quite literally mean the pension depositor has amassed millions more than the devout ISA only’er. This generosity is bound to be stopped at some point. There are already talks of the Government scrapping the higher rate savings in favor of a 20% flat rate across the board. You should all be making the most of this whilst you still can!
But I Can’t Access Anything Until I’m 55?
Yes, that’s right – you can’t actually draw anything out of it. In fact, it’s completely out of bounds until you reach the ripe old age of 55. But, unless you’re planning on dying before then, you should probably still be depositing – you’ll be that age someday. You don’t want to be snatching 51% of insta-savings and years of that compounding from your future self. But you want to retire way before 55. So, what should you do?
Well, you build a bridge.
A pension bridge is what you can use to safely carry you over the (hopefully) long gap which will be your early retirement until you can reach traditional retirement age and gain access to your hefty pension pot. Your bridge – like a pension, can be any type of pot. It could be an after-tax investment portfolio, an ISA, or even just a bank account, the only difference is it can’t be locked away, you need to be able to draw down from it straight away.
Bridge pots can be a lot smaller than your pension pot. This is because it’s only got to get you to your pension pot, it doesn’t matter if it depletes whilst getting you there; your bridge can be falling down as you run over it! Your pension will be compounding, untouched, through-out all of your early retirement years, so it will make up for all of the extra you’ll be drawing from your bridge pot anyways.
Let’s Get Down To Business
What better way to explain this concept than with a real-life example. People – like the commenter, don’t see how I can have enough to retire with as I’m plunging so much into my pension. So, let’s use my exact figures as of this post and assume these things:
- My current ISA pot is sitting at £11,759.75.
- I continue to deposit £1000 per month into my ISA.
- I do this for 6 more years (rounded up my FI date from 5.7 years).
- My expenses in retirement are 10k per year.
Now let’s take these figures and fast forward 6 years into the future where a joyful SavingNinja is rejoicing and flipping his employers the finger as he hits his FI number. Using the newly added compound interest calculator in the Saving Ninja Super Spreadsheet, I should have £103,681.75 sitting in my ISA account. I’ll be 33 years old and I’ll need this pot to last me for 22 years until I can unlock my pension fortune. Ouch.
Adding my ISA pot of £103,681.75 into the also newly added Drawdown Calculator (seriously go check out the spreadsheet), it tells me that I’ll run out of money in 16 years and 2 months…Shit. That leaves me 5 years and 10 months off accessing my pension pot. What’s 49-year-old SavingNinja going to do? Eat beans and search down the back of his sofa? Maybe take up the pole? Well actually – there’s one more thing that we’ve forgotten to think about.
Yes…House equity. People should most definitely be including house equity in their pot. If you have equity inside of your house which you could easily remortgage to release and still pay the same expenses, this is an asset! My 10k expenses are including my mortgage payments. In 6 years time, I could easily remortgage, take that equity, and pay the exact same mortgage fees, keeping my expenses at 10k per year. If I paid my mortgage off, my expenses would then lower by the same amount as the income I would have earned from releasing the equity. A house is basically just an alternative bank account.
So – adding my existing house equity of £26,887.50 into the pot and 6 years worth of £258.75 payments. My ‘house bank account’ equates to £45,517.50. I can (and should) happily add this onto my bridge pot. This brings it to £149,188.881, a pretty decent amount. Let’s go and put this back into the drawdown calculator.
37 years!2 This money should last me until I’m 70! I should definitely be able to leisurely cross the bridge and happily bask in the pension valley with lots of years to spare, and the awesome thing is – all of the time which I’ve spent crossing the bridge, I’ve not been touching my pension pot. This has been compounding away happily without anyone touching it. In fact, your remaining balance wouldn’t even have changed if you did have access to your whole pot. You’ll have exactly the same left. It doesn’t that you took 4% annually of only your ISA instead of 4% annually of your ISA and pension combined. You’ve still got the same final sum. The only thing that matters is that you made it to your pension without running out of money.
So, What Should I Do?
It’s simple, download the Saving Ninja Spreadsheet and play with the compounding and drawdown calculator. Choose a figure which you’d like to invest in an account which you can access whenever you want (like an ISA), compound it for the number of months it will take until you reach your desired total pot, then pop that figure into the drawdown calculator. If the calculator is showing too few years, decrease your pension contributions and increase your ISA contributions. But don’t forget to add your house equity to the drawdown pot!
Some Final Points
Remember, this is the FI/RE community. We plan to retire whilst we’re still youthful. For most of us, retiring won’t actually mean stopping work, it may just mean changing tact. I don’t know many 33-year-olds who want to go on a never-ending cruise for 50 years. They’ll be yearning to do something – and a lot of ‘doing’ results in earning. You should expect your bridge to be filled with at least some earning. This will mitigate your risk even more. If you’ve managed to amass some passive income streams before you retire – which I thoroughly recommend – this will also lower your reliance on a pension bridge even more.
If there’s one thing which I want you to take away from this post the most, it’s this – Save into your bloody pension. Don’t ignore it, the instant returns are insane. It doesn’t matter if you’re 18 or 30, you’ll be that age someday. If not, you’ll have a thankful spouse or another nominee which will inherit your pension and be glad that you took that 51% instant gain! Most countries even have a pension treaty, so if you moved to the USA the IRS wouldn’t come after your money. This is not the case for ISAs, they’d be on it like hounds, it’s tax-free status means nothing over there.
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What’s your ISA/Pension split? Do you include house equity in your FI number? Join the conversation below.
- They may actually be way more equity than this if the house value goes up, which hopefully after 6 years it would have done. But you also can’t ignore the fact that it also could have gone down (think 2008).
- If you can’t get your equity into a tax-efficient wrapper, this figure may be a bit lower as the drawdown and compound interest calculator will assume that you’re saving in tax-exempt accounts and will therefore not deduct tax.