Many Britons could be looking to retire early as the appeal of the 9-to-5 starts to wear off, especially given the recent economic and health implications of the Covid-19 pandemic. But the issue is more than just retiring early. It’s also being able to afford the lifestyle you would normally live. So, how might you get there?
Stocks and Shares ISAs
ISAs were introduced in 1999. Currently, there’s a maximum subscription allowance of £20,000 per adult per tax year. Individuals can divide this in across a Cash ISA, a Stocks and Shares ISA, a Lifetime ISA (maximum of £4,000) or an Innovative Finance ISA.
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I believe every UK resident should learn more about the different types of ISAs available to them, with an emphasis on Stocks and Shares ISAs, which offer tax-efficient benefits for investors.
Individuals can usually invest in three ways:
- With a lump sum only, from a year-end bonus, for example. This method gives the portfolio a longer time for growth during the year.
- For those with irregular income, an initial lump sum, followed by top-up payments works best.
- With regular (usually monthly) payments, which can be set up automatically by direct debit.
How to pay for retirement
The main mistake most people make is not knowing how they will pay for retirement. One suggestion is that you’ll need between half and two-thirds of the salary you earned before retirement. A safe range would be between £24,000 and £28,000 a year. This amount assumes that you don’t have any mortgage or rental payments to make in retirement.
Let’s assume that starting at age 65, you’ll need £28,000 per year and you expect to live for another 25 years after retirement. Let’s also leave your potential State Pension or any other private pension income aside for now.
One way to calculate how much in savings you’d need is to multiply £28,000 by 25. The result is £700,000. This calculation further assumes that the £700,000 will earn no interest income.
In other words, if you’d like to finance your retirement fully with your savings, simply multiply the amount you’d need per year by 25.
You may also be entitled to the State Pension or have other streams of income.
Becoming a millionaire by retirement
My Motley Fool colleagues point out that the stock market returns about 6% to 8% annually on average. An important part of that return comes from dividends.
Research also shows that investors who purchase dividend-growth stocks and reinvest the dividends to buy more shares are likely to see considerable growth in their savings.
Let’s assume that you’re now aged 30 with only £100 in savings and that you plan to retire at 65.
You decide to invest that £100 in a FTSE 100 tracker fund now and make an additional £7,000 of contributions annually at the start of each year. You have 35 years to invest. The average annual return is 7%, compounded once a year. At the end of 35 years, the total amount saved becomes £1,036,462.
In retirement, you can simply draw down, say, 4% of your portfolio for your expenses, which should theoretically be covered by your investment returns on the portfolio holdings. If those long-run averages hold, you shouldn’t need to work again and can live off your investments.