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Q&A: Planning for early retirement
By Hannah Ricci
The profile
Gerry and Lesley Bond live in Eastleigh, Hampshire, with their children, Thomas, 17, and 14-year-old Kate. Gerry, 47, is a programme manager for an IT company and earns around £3,190 a month, while Lesley, 49, works part-time as a personal assistant for her local authority and takes home £380 a month.
The Bonds have a £162,000 outstanding offset mortgage with First Direct on their £475,000 home, which they repay at £1,128 a month. They repay £405 a month on a personal loan with M&S Money which was used to buy a car and have two credit cards that are paid off in full every month.
Gerry and Lesley have a number of investments but no cash savings, with £15,440 in an equity ISA with Henderson into which they make contributions of £150 a month; two endowment policies currently worth £29,000, and £17,300 stock options in the company Gerry works for.
The Bonds have managed to pay £58,000 off their mortgage over the past two years from inheritance, selling an endowment policy and compensation from endowment mis-selling. "We would like to clear the mortgage completely in 2010 and plan for early retirement," explains Gerry. "So we want to review our finances to see if this is feasible."
Expert's advice
Philip Pearson, a partner at P&P Invest in Southampton, says the Bond's first priority is to build up an emergency fund as they currently have no cash savings available should an unexpected expense crop up. "Ideally, this should be equal to three months salary, so around £10,000 should be set aside," says Pearson. "Cash ISAs (individual savings accounts) are an ideal home for a contingency fund. They provide low risk with tax-free returns and up to £3,000 can be invested by everyone each year."
The current best deal is from National Counties Building Society, which pays 6.26% for a minimum £1 deposit. "The account provides a high degree of flexibility with instant access without penalty," adds Pearson. "A cash approach is preferable to relying upon investments in times of an emergency, as encashment of invested funds may not coincide with favourable market conditions."
With paying off their mortgage ahead of time a top priority for Gerry and Lesley, Pearson advises reviewing their endowment policies with Standard Life and Winterthur. "Both appear to be providing poor value for money with low bonus rates, which are considerably less than the rate of borrowing." However, before surrendering these policies, Pearson suggests looking at the option of selling them. There are companies that deal in traded endowment policies (TEPS) and if the Bonds are able to sell their policies they could get up to 40% more than the surrender value in return.
"The proceeds should be used to immediately reduce the mortgage debt," says Pearson. "I also advise Gerry to exercise his £17,300 of share options and put this sum towards the mortgage as well." Pearson also recommends that the Bonds increase their mortgage repayments by £200 a month which is affordable to them, and together with the estimated £46,000 lump sum payment, will reduce the repayment term by seven years.
Pension providing for early retirement
Next Pearson looks at Gerry's ambition to retire by the time he is 60. "Gerry would like to have a minimum £2,000 income each month in retirement for himself and Lesley, and I estimate that a fund in the region of £880,000 is required to achieve this, indexed against inflation."
Pearson says the current level of pension provision - into which he contributes 15% of his salary and his employer puts 9.5% - is significant and will go a long way to meeting this required fund. "However relying on an occupational pension scheme as the sole means of financial security in retirement is a high-risk strategy," he says.
So Pearson advises the Bonds to start regular savings into an equity ISA alongside the pension. "This is partly being achieved already through their Henderson ISA where they invest £150 a month, but this savings commitment needs to increase to at least £500," says Pearson. "By doing so there will be a good expectation of accumulating a fund in the region of £120,000 by age 60 which will meet the pension shortfall that currently exists."
Reducing risk
Pearson says Gerry needs consistent returns on his pension and ISA investments in the region of 7% net to achieve his target retirement income. "The best way to achieve this growth is through a balanced portfolio that diversifies risk across different assets types, including cash, fixed-interest, commercial property and equity funds," explains Pearson. Gerry is currently wholly invested in international equity funds, which, while providing the potential for high returns over the medium to long-term, is risky with high levels of volatility in the short-term.
"I advise Gerry to reduce the current level of risk, and because it is unlikely that his Henderson ISA is sufficiently diversified - he should transfer to an ISA with Skandia Selestia, where he can redistribute his funds at zero charge," adds Pearson. "The plan will give access to over 900 funds across 67 investment groups."
Gerry's occupational pension scheme offers little choice in fund selection, so Pearson suggests he considers 'lifestyling' his pension - which means reducing the exposure to equities in favour of fixed-interest and cash as he nears retirement. "This will protect the fund against short-term volatility and the risk of it dropping in value just before retirement."
Lesley does not have a pension and while Pearson suggests she consider joining her local authority pension scheme, as Gerry's pension pot is so significant, he says a better option could be to diversify their disposable income by Lesley contributing to the equity ISA instead.
Gerry has adequate life insurance through his employer, so Pearson finally turns his attention to the Bond's wills and estate planning. "Although the issue of inheritance tax may seem a long way off, Gerry and Lesley should consider planning for this now," says Pearson. "As they easily exceed the current nil-rate band of £300,000, the first step to mitigating this liability is to change the ownership of their property to tenants in common which will allocate half of the property to their separate estates."
The next step is for both Gerry and Lesley to seek legal advice to update their wills to incorporate a discretionary trust, to receive the full value of each spouse's estate up to the nil-rate band. Pearson also advises writing Gerry's life insurance in trust, to ensure the funds will go direct to Lesley should something happen to Gerry, and not fall into his estate.
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