Help me save for early retirement
Clare Walker, 29, from Weymouth in Dorset, works as a fashion merchandiser for high street store New Look, and takes home £1,953 a month after tax.
She repays £660 a month on her £165,000 mortgage with Halifax, which is on a fixed rate of 4.39% until August 2008. She lets a room to her sister who contributes £238 a month.
Clare has outstanding debts totalling £9,100 across three credit cards, which she repays at £260 a month. She has £3,000 saved in a cash ISA with Nationwide, £300 in an internet saver account with Sainsbury's Bank and another £300 in an equity ISA with Fidelity, to which she contributes £50 a month.
Clare recently joined her company pension and contributes £63 a month, which is matched by her employer with £80 a month. "I'm not sure if my pension is invested in the best funds," says Clare. "My overall financial objective is to clear my debts as quickly as possible and save for an early retirement."
Andrew Westcott, director of Independent Financial Solutions in Weymouth, agrees with Clare that her priority should be to concentrate on paying off her credit card debts. "Clare has a net annual income of £25,662 and expenditure of around £20,158, which leaves her with a surplus of £5,504 to meet her goals of clearing her debts and saving for an early retirement," explains Westcott.
Clare currently pays £260 a month off her credit card debts, and Westcott recommends that while continuing to repay her debts simultaneously, she should also overpay on each card, in descending order of APR, to clear the whole debt in 24 months. He calculates that Clare can achieve this by increasing the £60 a month she currently repays on her £1,600 M&S Money card (3.9% APR) to £210, in order to clear the debt in eight months.
Then she should redirect the £210 to her £5,200 Egg card (0% APR) to increase the repayment to £330 a month, to clear the debt in 13 months. And finally, she should roll the £330 into her £2,300 Virgin Money card (0% APR) to repay £410 for two months until all her debts are cleared.
"This is providing she transfers the two 0% interest rate balances to other 0% cards at the end of their terms," adds Westcott.
Next Westcott turns his attention to Clare's investments. They have determined that she is a "motivated investor" and willing to accept a higher-than-average level of risk, which is completely appropriate considering her age. However, at the moment, her investments are overly cautious as they are mostly in cash, with £300 invested in the Invesco Perpetual High Income Account through her equity ISA.
"Clare does need to keep some of her money in cash so that it's accessible in case of unexpected expenses," says Westcott. Most experts agree that it is advisable to build up between three and six months salary as an emergency fund, so with her savings currently standing at £3,300, Clare needs to continue to contribute to her cash savings.
Increase the risk
Westcott suggests, however, that she move the £300 invested in Invesco Perpetual into a higher risk holding. "A portfolio that would suit Clare's profile would hold 50% in UK equities and 8% in UK corporate bonds, with the remainder split between American, European, Japanese and Emerging Market equities," he explains.
Westcott recommends the Barclays Global Investors' Global Equity 50/50 fund, which could return an estimated 6.71% a year, compared with her current growth estimate of 2.53% a year across all her savings and investments. "Although her investments may be affected by the volatility of the world stockmarkets in the short term, in the longer term it will provide a better return," he adds.
Clare has utilised her £3,000 tax-free cash ISA allowance for 2007/2008, but not the £4,000 equity ISA allowance, so Westcott recommends she increase her £50 monthly contributions to £150 in order to take advantage of tax-free investing.
Clare's current mortgage with the Halifax is fixed at 4.39%, which is a very competitive deal, given current interest rates. Although at the moment, it looks as though her repayments will increase when she comes to remortgage in August 2008 - despite speculation that rates will fall, Westcott doesn't anticipate Clare will struggle.
So as Clare's goal is to retire early, Westcott says paying off her mortgage early should be a priority and suggests she consider increasing her repayments by £75 a month for the next five years. "This could shave £18,657 in interest off the loan, assuming her overpayments grow at 6% each year."
Although Clare has no dependents, Westcott recommends she makes a will so that her estate is distributed as she wishes on her death. Furthermore, he advises her to buy life insurance to cover the cost of her mortgage and credit cards. "For a 29-year-old non-smoker such as Clare, it would cost as little as £6.04 a month for a level term assurance plan to cover her debts," he says.
Meeting current financial commitments
Possibly of more importance to Clare at this time in her life, is cover to ensure she could meet her financial commitments if she fell ill and was unable to work. She currently pays £20 a month for a short-term accident, sickness and unemployment benefit plan with Pinnacle Insurance, which would pay out £800 a month - equal to her mortgage payment plus 25%.
However, Westcott says: "This would not meet Clares household expenditure, and she would be faced with a shortfall of around £565." It will also only pay out for a maximum of 12 months. Instead, he recommends that Clare takes out an income protection plan, which would cost approximately £12 a month and pay out a proportion of Clare's salary after a deferred period of between 12 and 26 weeks, until she retires or is able to return to work.
Westcott says that Clare should also take out critical illness cover to pay out a lump sum if she suffered a more serious illness such as cancer or a stroke. He estimates this could cost as little as £9.70 a month.
Westcott calculates that Clare's current pension arrangements may only give her £2,912 of income each year from the age of 65. On top of this she would receive annual state pension provision of around £7,571. "If Clare wants to retire early and receive the usual pension provision of two-thirds of her working salary, she will need a retirement income of £21,120 per year, so there is a large shortfall at the moment," says Westcott. To achieve her desired retirement income, Clare would need to increase her pension contributions by £419 a month. This is something she can consider once she has cleared her debts.
Finally, Westcott believes that Clare's worries about the suitability of her pension fund are relatively unfounded as her current portfolio has an estimated potential growth rate of 6.06%, which is quite adequate.
"However, like her ISA funds, Clare's pension fund could contain more emerging market equities and UK bonds in its mix to increase growth," adds Westcott. He recommends she switch out of the BGI Deposit and BGI Global equity 70/30 funds that she's currently invested in and pays into the BGI Global equity 50/50 fund instead.
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There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
Term assurance provides cover for a fixed term with the sum assured payable only on death. Term assurance premiums are based primarily on the age and health of the life assured, the sum assured and the policy term. The older the life assured or the longer the policy term, the higher the premium will generally be. There are generally two types of term assurance. Level term assurance premiums are fixed for the duration of the insurance term and a payment will only be made if a death occurs during the insurance period and with decreasing term assurance, life cover decreases during the insurance term reducing the cash payout the longer the term runs and this is reflected in the premium.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Generally thought of as being interchangeable with insurance but isn’t. Assurance is cover for events that WILL happen but at an unspecified point in the future (such as retirement and death) and insurance covers events that MAY happen (such as fire, theft and accidents). Therefore you buy life assurance (you will die, but don’t know when) and car insurance (you may have an accident). Assurance policies are for a fixed term, with a fixed payout, and unlike life insurance have an investment aspect: as a life assurance policy increases in value, the bonuses attached to it build up. If you die during the fixed term, the policy pays out the sum assured. However, if you survive to the end of the policy, you then get the annual bonuses plus a terminal bonus.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.