As somewhat of a personal finance geek, I (Mr Way) have learnt a fair amount over the last few years. As a result, I wanted to share my specific take on saving for FIRE in the UK with you. I am not a qualified financial advisor and nothing in this article should be considered financial advice! This is simply a log of my own findings/opinions in the hope they may help you to do your own research!
Most of the information in this article will be based on my own situation as a full time employed basic rate tax payer. The advice will differ depending on your circumstances so do your own research.
You may well have more efficient ways of saving than I mention below. If so, please let me know!
Mr Way
There are many resources out there on how to save for financial independence. In my experience, most of these are US centric with their own tax and savings implications (401k, Roth IRA, healthcare etc). The general principles are very similar and can be broadly followed. But what about the UK FIRE saving nuances?
Obviously saving for FIRE differs from ‘traditional’ savings techniques because you need to access your money much earlier than traditional retirement dates (55+). If you aren’t planning to retire early, the best course of action will be very different.
Emergency funds
As any FIRE resource will state, you should first (assuming any credit card debt etc is paid off) accumulate an emergency fund to cover any unforeseen expenses. By its nature, this has to be easily accessible. It is generally advised that you keep 6-12 months of expenditure for this purpose.
Some options for your emergency fund are:
- Bank account savings accounts – these currently offer some of the best rates. They aren’t within the Individual Savings Account (ISA) tax shelter but for small amounts up to £1,000 the income is tax free anyway. See bank account savings website for the best current savings account rates.
- Similarly, many current accounts offer a regular saver with very high interest – ours are with HSBC and Santander and are currently 5%. Money can be cycled through these alongside other techniques.
- ISA account. This has the benefit of being within the ISA tax shelter but be aware you can only contribute £20,000 (valid 2019/2020 tax year) and this may be better used for retirement savings (via Stocks & Shares ISA) if you are in a position to max out the limit.
- Premium bonds. A government guaranteed scheme with an element of lottery thrown in. The money should be very safe here but with a current prize fund of 1.4% you can do better. Most useful if you fancy a bit of fun when checking prizes each month.
An emergency fund is not only important in giving you peace of mind in case of a layoff or medical emergency etc. But it also gives you the freedom to assess more options in life. Emergency funds are often referred to as ‘f*** you’ (FU) money for this reason. They allow you to not take any crap in your work and just quit if it isn’t working out. You can sustain yourself without your salary for 6-12 months so this gives you time to re-assess.
The UK Retirement Saving Basics
Once you have your emergency fund established, it’s time to move on to saving for your financial independence/early retirement.
The main UK savings vehicles are the ISA and the pension. Fundamentally, the aim is to minimise the income lost to taxation (legally!). This means making the most of the advantages of each of these tax wrappers.
ISA
An ISA allows you to save money after tax. Because the income has already been taxed before landing in your pocket, there is no tax when withdrawing this from the ISA in future. There’s no capital gains tax on anything you make within the ISA wrapper either.
Pension
A pension account allows you to save before tax. Any money drawn from the account in future is then taxed as income. Pensions come in a few different formats.
Defined Benefit (DB) pensions are where you pay into a scheme which gives you a prescribed benefit once the retirement criteria are met. For example you may receive 50% of your final salary at the age of 65. This type of pension was very common within the previous generation. Due to the cost of keeping these schemes going they are now much rarer. The main occupations in the UK with these pensions are in the civil service.
Defined Contribution (DC) pensions are the much more common alternative. These pensions usually involve investing in stocks and shares which will hopefully grow until your retirement date. Your employer will usually also contribute – more on this later.
There are also Self Invested Personal Pensions (SIPPs) which are similar to a DC pension but without the employer link. These accounts are administered yourself and give more freedom on where to invest etc.
Other
Other options include the Lifetime ISA (LISA). They are available for those aged 18-40 and allow you to contribute up to £4,000 per year. This money MUST be used for either:
- A deposit on your first house
- Retirement – accessible at 60
The big benefit of this account is that the government will give you a 25% bonus on your contributions. So if you max the limit, you’ll get £5,000 per year, but at a cost of £4,000.
This also counts towards your £20,000 ISA limit.
We haven’t used these accounts because we bought our house before they existed. As discussed above, our intention is to retire much before the ‘traditional’ retirement ages when this product could be accessed.
Our Golden Rules
There are a few general rules we follow in our approach to UK FIRE savings. Some of the main points are as follows:
Max. Company Pension Match
As mentioned earlier, most company pensions these days are simple DC schemes where you invest directly into a fund or group of funds. Often, your employer will offer to match your contributions up to a certain amount. Now that auto-enrolment is in force this is even more common, although many schemes go above and beyond the minimum employer contribution of 3% (valid from April 2019).
Say your company offers a match up to 10% (I wish, but not unheard of from peers), this is essentially a free salary boost. Say you earn £30,000 and your company match contributions up to 10%. For you to contribute 10% would mean £3,000 and your employer would also contribute 10% (another £3,000, this effectively increases your pay to £33,000). However the actual cost to you is much less as the alternative is to pay tax/NI/student loans etc. So you’re essentially getting £6,000 put into your pension at a cost of £1,900! This becomes even more beneficial if you pay higher rate tax as your take-home equivalent would be another 20% lower (40% tax bracket).
We think you should always max the company pension match proportion because not doing so is essentially throwing away an extra pay rise.
Important note – make sure you know where your pension is invested. Some companies set you up in an expensive fund by default and don’t really explain this to you (I’m currently trying to get my employed to be more open about this!). You usually have a choice, so assess what’s available and try to aim for a cheaper alternative.
ISA for Early Retirement Savings
Due to the restrictions on pension accounts (only accessible once state pension age reached) as well as their susceptibility to government meddling, our choice for the majority of our savings is Stocks & Shares ISA accounts. We intend to access our savings before state pension age so need the flexibility offered by an ISA (i.e. easy access and no tax on withdrawal). This is our main strategy for our FIRE funds and since we have an emergency fund already, almost all of our savings are going here. we won’t go into which broker you should use because this guide by Monevator is as good as it gets! They update it regularly too.
As we said in What is FIRE? we intend to amass ~25x our annual expenses in these accounts, which should allow us to live off the proceeds indefinitely. This strategy has its doubters, who think 25x may not be enough. As we are likely to still make some form of income in retirement, we are comfortable that this will be sufficient.
Don’t Pay 40% Tax!
Although neither of us are in the position to pay higher rate tax yet (those earning over £50,000 from April 2019) we have thought about this for future reference. To us, it would not make sense to contribute to an ISA with income taxed at 40%. In retirement we are almost certain to pay basic rate tax. Therefore paying 40% tax on the income, to save 20% tax later (ISA withdrawals are tax free) would not be efficient.
In case either of us earn over the 40% tax bracket, we plan to put all of this into pensions. We would then get 40% relief on these contributions meaning a £600 contribution actually becomes £1,000 in your pension, before any growth!
Other Considerations
Other things to consider when creating your FIRE plan are as follows. Again, we will update these as we learn more! If in doubt, do your own research and/or ask a specialist.
Mortgage Overpayment
As you can see in our monthly spending we regularly over-pay our mortgage. Strictly speaking, this isn’t the most efficient use of our money because we could (on average, usual caveats apply) earn more if it was invested.
This was a decision we made when first buying our house. Initially, we wanted to overpay so we qualified for a lower loan to value mortgage when our initial deal expired. This gives you access to much lower interest rate mortgages. We achieved this but continue to overpay as we are keen to pay off our mortgage in time for achieving early retirement. This will give us options:
- Live in our home mortgage free – much reduced living expenses and the peace of mind of being debt free!
- Sell the house and use the extra money to further fund our travels during early retirement – use the income from this money to pay rent elsewhere.
This is also a hedge against future increases in interest rates. Although they’re currently very low, they could rise in the future and we don’t want to be stuck with a big fat mortgage at high interest.
Consider Inheritance Tax Planning
Another consideration for long term planning is inheritance tax. The rules can get quite complex but something we are considering is that any money within a pension can be passed on free of inheritance tax if you are over 75. We aren’t including our pension pots in our FIRE fund calculations. Hopefully we won’t need the money in these accounts and can pass them on to family when we die.
Healthcare
We have the NHS – but where are you planning to retire to?
In the UK, we are lucky to have free use of the NHS for our medical needs. This reduces a significant burden when saving for FIRE as healthcare needs in this country are taken care of. This is a huge benefit which we often take for granted. When reading US based FIRE blogs you start to realise just how expensive health care can be!
However, if you don’t intend to live in the UK after retirement, this needs careful consideration. You may still need to allow for health insurance in your retirement budget if you plan to move abroad. The NHS is only available for use by those who are tax resident in the UK so if you live abroad and no longer qualify as a resident this needs factoring in.
NI contributing years for state pension
In all of our calculations we ignore the state pension. The terms of this are often changed by governments and we believe it would be short-sighted to base our projections on the current system. It is possible that something like means testing could be applied to state pensions in future, meaning those who have saved sensibly would suffer the most. While we hope to receive some amount of state pension (we have paid a significant amount in after all!) this will simply be a bonus!
Regardless of this, another consideration for UK FIRE seekers is national insurance contributing years. Because of the nature of FIRE, many of us hope to work significantly shorter careers than is expected by the system. This means we may not reach the 35 years of NI contributions required to receive full state pension. The minimum is 10 years and the pension amount tapers between.
There is also the option to make a ‘voluntary contribution’ to your NI record. This involves paying an amount per week. For 2018-2019 tax year this is £14.65 per week for Class 3 contributions. Find out more about the different classes here.
As you can see this gets complicated quickly. We aren’t worrying about it too much at the minute as we are both still working and gaining NI years. However, it may be revisited if/when we reach early retirement!
Phew
If you got this far, well done! Are there any other avenues you have explored in your approach to UK FIRE savings? I’d love to know what your strategy is. I’m still learning so hopefully we can all help each other be more efficient in our savings!
It is so lovely to read a UK-based FIRE blog. As you say, it is scary to read all those US ones about high healthcare costs. We are so lucky to have the NHS, despite its faults. I am one of those fortunate people who has a defined benefit pension, although I didn’t have a full time job until I was 32. In some ways I am in two minds abut pensions. It is great that your employer contributes, but the fact that the money isn’t accessible until you’re at least 55 is in some ways frustrating. For me (soon to be 50) it isn’t that far away, but if I was in my twenties I would give serious thought as to how much to put into my pension as opposed to stocks and shares. It may be free money from your employer, but if you can’t draw on it until you’re of traditional retirement age, it isn’t that useful.
Thanks Sam 🙂
It’s a huge relief to have the NHS. You’re right, the numbers people quote for healthcare costs in the US are crazy.
Pensions are a funny one for us FIRE types. As you say, it isn’t too far away in your situation, but being in my late 20’s it’s a long time to lock the money away. My approach is to put that minimum match away but ignore it in my FIRE fund calculations. I don’t miss the small amount I contribute and at least there will be an extra pot there for the future – either for medical costs in old age or just to pass on in my estate. Seems worth it to gain the employer match in my mind, but obviously others may prefer to go all out to fund their ISA instead.
Good to hear another perspective on it, I like seeing how things differ for other people’s circumstances.
Mr Way
You mentioned an emergency fund in case you have a medical emergency – does the NHS hold you responsible for part of the medical bill or is that just to cover other expenses if you are out of work due to a medical emergency? Healthcare cost here in the US can be crippling. I will have to read up some more on these Premium “Lottery” Bonds – sounds interesting. : ) Cheers!
The emergency fund would be to cover a couple of things:
a) as you say, cover expenses in case you can’t work.
b) pay for private treatment if preferred – the NHS is wonderful but sometimes waiting times can be very long and hospitals cramped etc. Would be nice to have that option even if not required.
Premium bonds don’t give a great return (in the form of prizes), but are a safe haven for short term cash holdings as they’re backed by the Treasury. And there’s always the (very) outside chance of the £1m prize! I forgot to add a link to them in the article so will do that now!
Thanks for the comment 🙂
Good to read a post on this from a UK point of view.
While you do make mention SIPPs, I think in combination with ISAs, they can play a bigger part in any FIRE plan. Just because you won’t be able to access them in your 40s, or whenever you reach FI, surely you will still need money when you hit 55+? This is where SIPPs might come in.
Your money is taxed before it goes into the ISA, so is tax-free if when you withdraw it; you get tax relief when your cash goes into a SIPP but it’s taxable when you withdraw it. However, keep your SIPP withdrawals under your tax allowance (currently £12.5k) and you won’t pay any tax.
At least this is what I’m hoping to do, ie live off both ISA and SIPP tax free, until when my company pension and then the state pension starts paying out and I will have to pay tax. (Having paid 29 years NI, I believe that I will be getting a state pension!).
As you’re so young, perhaps it’s something to consider at a later date.
Thanks for the comment Weenie. Great to hear another input on this.
That’s a really good point you raise about SIPPs. I had personally prioritised ISA at this stage because I want to have as much as possible to withdraw at early retirement age. If/when I reach higher rate tax band I’m aiming to put all of that into pensions so I guess that will help.
Thanks again for your input 🙂
Like the thread and comments. I was also thinking could have mentioned SIPP. Even as a basic rate tax payer you get an immediate 25% uplift.
Say save 40k into a pension you get tax relief of 10k added shortly after. You get capital gains on both ie on the tax relief as well. Put it in an index fund or fixed interest or both.
Under current rules can access at 55. On flexible drawdown, say you come to retire and have 200k, can take 25 % tax free. Then balance at taxable rate. Say 12.5k over 12 years below personal allowance. 200x 25%=50k. 150k /12=12.5k. Then that’s all tax free as well. I think it’s the best return going except for a workplace pension.
Thanks for the comment Adam. I guess I brushed over SIPPs too quickly!
As I said to Weenie, the early access of the ISA was the big thing for me. SIPPs are definitely a good deal for a lot of situations though.
I’m a higher rate tax payer and optimising the split between isa and pension contributions (or paying down mortgage) is an interesting challenge. While I will almost certainly be better off financially paying more into a pension and less into an isa, this will do me absolutely no good if I want to be FI before 57. As such it becomes an optimisation problem, where I need to consider the number of years between target FI age and pensionable age of 57, such that the isa will bridge the intervening years – note that I won’t necessarily use the safe withdrawal rate for the isa as I only need it to last a finite number of years until I can draw the pension (which I will employ a SWR on). One other benefit of pension income is that the first 25% is tax free (and none of it is subject to National Insurance), such that when you then also factor in the personal allowance (which is separate and in addition) you really can be in the position of paying very little tax if you only draw 4% each year (assuming you have not exceeded the lifetime allowance, and if you have then you can afford the extra tax!). I might attempt to derive an optimisation formula for isa / pension split – could get complicated but sure it’s doable, at the moment I a just manually reviewing scenarios in a s/s to get around the right split.