Editor's Comment: Why financial planning is not rocket science

A few days ago I received a rather gloomy press release, which revealed that although a large majority of people are not confident in making financial decisions regarding their retirement, only 8 per cent actually consult an expert.

'Greater personal responsibility for retirement planning, combined with increased levels of economic and political uncertainty, mean people need professional financial advice more than ever,' intoned Aegon's pension director, Steven Cameron. 'In fact there are few people who wouldn't benefit from financial advice at some point in their lives, especially since the introduction of pension freedoms.'

Now, a cynic might observe that Aegon, as a provider of retirement products sold through advisers, has good reason to encourage us all to consult the experts. But it's hard to argue against the need for everyone to take sensible, well-informed financial decisions at critical times such as retirement.


However, 'greater personal responsibility' doesn't actually have to mean forking out hundreds, or thousands, of pounds for someone else to tell you how to organise your finances.

Of course, a professional might well bring finesse, and could no doubt add value for wealthier households with more complex financial arrangements, or where estate planning is an additional factor.

But many people are not in that boat, and for them the information needed to make and realise a reasonably robust plan is all out there - we just have to be bothered enough, and brave enough, to marshal it and crunch the numbers.

That, I discovered in the course of a chat in the pub recently, is exactly what my friend Louise - queen of Making Things Happen - has done.

Moreover, her ambitious starting point is that she wants to retire on the same level of income as she takes home (net of tax) at present. I took a steadying swig of merlot and quizzed her further.

Would this involve working until she's 80, taking a second job, inheriting a convenient nest-egg or downsizing to a shoebox on the cheatin' side of town? Not in the slightest, she replied. Would she very kindly share her plans? Happy to oblige, she said.

So, without going into all the nitty-gritty: Louise - who, incidentally, is not a financial journalist - plans to stop working at 66, on a target total net income of £36,000.

She's assuming there are no further changes to the opportunities for tax-free income, and is working on the basis of dividend yields averaging 3.5 per cent.

She reckons that to make her retirement plan happen, the total capital she needs (spread across her taxable equity account, pension, cash and Isa) is around £620,000.

She currently has £400,000 in total, so she has to achieve growth and savings of £27,500 annually over the next eight years to hit her target nest egg.


Sounds a lot. But pension contributions (her own and her employer's) plus tax relief will account for a total of £17,000 a year of that sum.

She rents out a room in her home under the government's tax-free rent-a-room scheme, which provides £7,500 annually, and she is also saving £6,000 a year from earnings - twice as much as she strictly needs to - in the hope that she will reach her target pot earlier than anticipated and can retire early.

Given that capital growth is not actually factored into these assumptions either, there seems a reasonable chance of that.

Working out a target annual income, the amount of capital in total you'll need to generate that income, and how to build such a capital sum in the given timescale, are key elements of any retirement plan of this sort.

But Louise is not one to do things in a half-cocked fashion. She has worked out that if she organises her finances efficiently, she'll be able to generate more than £31,000 of that £36,000 income free of tax.

Around £26,500 will come from a combination of tax-free income from the room rental (£7,500), assuming she continues it into retirement, dividends from her Isa (£5,000), which by then will have been built up to around £145,000, plus payouts from her non-Isa cash and equity accounts (also due to be boosted in the coming eight years) to utilise the £1,000 tax-free personal savings allowance and the £5,000 tax-free dividend allowance respectively.

Additionally, the new state pension of £8,000 a year can be offset against her personal allowance of £11,000.

To generate the balance, around £9,500 a year, she calculates she'll need a pension pot of £300,000; on a drawdown rate of 3.5 per cent, that will generate £10,500, of which she can take a quarter, £2,625, free of tax each time.

A further £3,000 a year can be set against the remaining personal allowance.

The balance, under £5,000, will be taxable at 20 per cent, to provide a net income of just under £4,000 - hitting her pension pot income jackpot. She'll have paid around £1,000 in tax.

My point in recounting Louise's financial plans is not as a blueprint for others to learn from; as she says herself, 'there are other ways to square the circle. This is just the way I am doing it'.

It is to illustrate the fact that no matter what the advisers would like us to believe, financial planning is not rocket science.

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