Intro
I have spent some time over the last few days going through our assets and investments in detail so that I can map out a FIRE plan. I got a lot of value out of doing this and now have a much better handle on things, so I thought I’d share how I’ve approached it.
Some Terminology Explained
Before reading any further, let me cover some of the terminology I’ll be using in this article as some of it may not make sense if you are outside the UK.
There are two main vehicles for tax advantageous savings in the UK.
Pensions are free of tax on the way in (i.e. you avoid income tax) but are subject to income tax on the way out.
ISAs (Individual Savings Account) are almost the opposite of a Pension, there is no tax saving on the way in but they are free of income tax (and capital gains tax) on the way out.
There are pros and cons to both vehicles and the rules around pensions can get a bit complicated (not helped by the fact that the Government keep changing them).
Defined Benefit Pension – Otherwise simply called a DB pension or final salary pension. This type of pension, offered by your employer, pays you a guaranteed amount each year based on your final salary and how many years you were in the scheme. They are very rarely available these days.
Defined Contribution Pension – DC pension. This type of pension is simply one you/your employer pay into and at the time of retirement you get access to the funds accumulated. The amount it will be worth when you retire depends on stock market returns.
Self Invested Personal Pension – SIPP. A SIPP is simply a wrapper/vehicle for a private pension (like a DC pension). You choose which funds are invested in.
Individual Savings Account – ISA. An ISA is a tax-advantageous savings vehicle, you can hold cash or stocks and shares in them. You can only pay in £20k per person per year (as at 2023) but there is no limit on the size of fund you can build up and any gains are totally tax-free.
Positives:
Financial Situation
- Defined Benefit (DB) pension that pays an inflation-linked amount when I’m 60 in 10 years’ time (2033). This on its own will be just about enough for both MAFF & me to live on.
- MAFF also has a defined benefit pension that pays out when she is 60 in 15 years time (2038), but it isn’t worth much (maybe it will buy a nice holiday each year)
- We are both entitled to a full UK state pension, which will pay a combined (£21,200) when we are 68 (2041/2045)
- We have other DC pensions
- Cash savings and S&S investments
- We own our own house outright. No mortgage or rent to pay
- We have no debts
Lifestyle Situation
- We have no commuting costs
- We have no kids (that’s a positive in terms of finances, maybe not in other ways)
- We don’t need to leave an inheritance to anyone. I plan on spending the f’ing lot!
Negatives:
- The biggest overall negative with regards to FIRE is that we are ‘backloaded’. By backloaded I mean we can generate a small income today from our investments but a larger income than we absolutely need later in life.
- Both DB pension schemes are from the same employer. So if they go bust the pension goes with them. This is hopefully unlikely, as they are a huge global company, but it could happen. Fortunately, in the UK, there is something called the Pension Protection Fund, which is a government scheme that guarantees to pay you 90% of what you would have got
- MAFFs DB pension is worth a lot less than mine. Assuming I die before her then she will see a drop in income (she’ll lose my state pension and get 50% of my DB pension for the rest of her life). She’ll still be earning an ok(ish) amount just from guaranteed sources though + whatever income/SWR comes from our investments. So she’ll be ok
- I’m not sure I can really call this a negative but one thing I need to watch out for is that I could end up as a higher-rate taxpayer when I’m 60+. So I need to consider this when structuring my investments and sequencing withdrawals
- I also need to be mindful of the pension lifetime allowance. In the UK there is a £1,073,100 (in 2023) limit on how much your pension pot can be worth, anything over this amount and they really hit you for tax (like 55% tax on lump sums and 25% tax on income (on top of any income tax you already pay) !! ouch). It doesn’t help that the government keep playing with this limit, successively making it less generous.
The way the lifetime allowance is calculated on a DB pension is to multiply your expected annual pension by 20. I then have the value of my private pension, so I’m getting close to the current limit.
My FIRE Plan – More like high-level thoughts at this stage
I know we’ll be fine financially in 10 years time when my DB pension kicks in. I consider us very fortunate in that regard.
The DB pension was the best investment I’ve ever made in my life and I’m forever grateful to my much younger self that he didn’t do stupid and opt out of the scheme (I know people that did).
So what I really need to focus on is the next 10 years.
I know I could access my DB pension in 5 years time (when I’m 55) but I don’t want to do that as it would make a significant reduction in the annual payout.
I can also start accessing my DC pension in 5 years time when I’m 55 (I just sneak in ahead of the change in April 2028 from 55 to 57 to access your pension) and from a tax perspective, I would be better to take money from this vs our ISAs at that point in time.
I know from my Getting to Grips with my Outgoings exercise that we need £25k per year to live on (although I’m aiming to reduce that). I’m going to up that to £30k to allow for holidays etc.
Different Types Of FIRE
Although we only need £25k net per year to live on, that’s not the lifestyle I’m aiming to achieve. I want a bit more from life than just existing. So I’ve defined the different types of FIRE for us (yours will be different depending on your situation)
Lean FIRE – £25k p/a. This would be a realistic bare minimum income for us, we could get by on this. Life wouldn’t be terrible but it wouldn’t be great, we would really have to watch what we spend.
FIRE – £35k p/a. This would be a comfortable income for us. Certainly not lavish but we could certainly afford a holiday or two.
Chubby FIRE – £50k p/a. This is more like it and would give us a nice, very comfortable retirement.
Fat FIRE – £100k net p/a. Not going to happen without some very long bull market miracle, so I’m not going to think about it.
Update: Since writing this article I’ve written something much more detailed about FIRE Types, how much you need for a comfortable (Chubby FIRE) retirement, Fat FIRE etc.
Some FIRE Calculations
I’ve done some high-level calculations using the following assumptions:
- Average Annual Stock Market Return – 7%
- Safe Withdrawal Rate – 4%
- Annual Inflation – 2.7%
Today those calculations put us in the Lean FIRE category, in 5 years time when I can access my DC pension we move more into the FIRE category.
I then re-ran my numbers through the Safe Withdrawal Toolbox which is a much more sophisticated tool than my spreadsheet. You put your numbers in and it spits out a range of SWRs and their chances of failure. This confirmed that I had a 0% chance of failure at an SWR of 4.25% (which was reassuring).
Some Observations
I could, in theory, afford to FIRE today if I took the view that I could increase my Safe Withdrawal Rate above 4% for the next 5 years in our ISAs because I will be accessing additional pots of money via pensions in the future.
As I get older, because of our fortunate situation with pensions, we will earn a decent amount of money in our old age. So that is looking very promising even allowing for some headwinds making my assumptions optimistic (which at the time of writing I don’t think they are).
As I near 55 and I’m able to access my private pension, I probably need to go and see a tax advisor and work out the most optimal approach to accessing our investments so as to minimise my higher rate tax liability.
What I’m Planning To Do Next
Next step is to work out a well-balanced FIRE portfolio for each of our investment pots. At the moment our portfolio is all over the place, I want to sell all of our individual company shareholdings, exit some of our more ‘exotic’ fund choices and just come up with a simple, relatively low-risk portfolio with only a handful of holdings.
Other than that, I simply plan on redoing this exercise each year for the next couple of years to check back on my numbers and see how reality compares to a plan.
I think the value in having this spreadsheet and detail worked out is more to do with having something to check progress against each year and adjust accordingly rather than the forecast itself as that is bound to change.