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We have focused on pensions in a reasonable amount of detail, which is a necessary evil when discussing the topic of retirement. Of course, this is only one piece of the jigsaw. There are so many other tools that you can use to plan your retirement. In this post, I want to touch on these as well as focus on the accumulation stage. It might be you are reading this close to your retirement and think this is of less use to you. You should read on for three reasons: First, you will find a number of planning tools here that can help you improve your retirement, even if you haven’t got the time to maximise them as well as you could have if you had started earlier. Second, you’ll probably find that you are actually already using some of the tools and, by tweaking them, you can boost the income you can create for yourself and the flexibility with which that can be taken. Finally, if you have children, godchildren, nieces or nephews, I would encourage you to share this with them. It might just save their financial lives!
Cash-Based Savings: The Buffer Account
Savings can be kept in everything from savings accounts to Cash NISAs, National Savings Certificates and even Premium Bonds.
Whilst it makes good financial sense to keep an emergency fund in cash-based savings, it doesn’t make sense to keep large sums there. In these forms, your capital stays as it is, and you receive interest, or occasional winnings in the case of Premium Bonds. You can access your cash at different time frames, but the capital stays as it is. Whilst in these solutions your capital doesn’t appear to be at risk, there is a hidden risk that many people forget: Inflation.
If you are receiving 1.5% interest, but inflation is currently running at 2.5%, your money is actually falling in ‘real value’. What you can buy with that money is gradually becoming less and less each month and year. Historically, you could expect a savings account to keep pace with inflation, but that’s not been the case since the Credit Crunch in 2008 and is unlikely to change that soon. If you view the inflationary value as staying put, the following chart shows how inflation has eroded your savings since 2009:
This assumes no tax was paid on this amount, so if the money wasn’t in a NISA, the picture is dramatically worse. Over this five-year period, your savings would have lost around 8.2% of their value in real terms. Whilst this relationship between inflation and savings remains, your money is guaranteed to fall in real terms. If your money was in a savings account instead of a NISA, your interest received in your pocket is likely to only be 1.2% or 0.9%, meaning this drop is even greater. Whilst it appears as it your money is growing, albeit slowly, it is actually falling in terms of what you can do with it.
One factor to bear in mind here is the measure of inflation you use. The government have, in recent years, opted for Consumer Prices Index (CPI), whereas many people look at Retail Prices Index (RPI). Whilst CPI is a more convenient measure for politicians, the main difference between the two is that RPI includes costs associated with housing, making RPI a better measure to go by. Generally this is higher than CPI, so when you hear that inflation has fallen to 0.5%, be aware that your inflation is probably a bit higher.
With Premium Bonds, instead of getting a set rate of interest, you get winnings. There is no set rate of return, but the average rate of return is less than 1%. The chance of winning the £1M prize is less than that of winning the lottery. These are useful and fun for short-term buffer money you need to leave in cash, but for long-term investments they are unlikely to deliver you much value.
These kinds of accounts are usually best for short-term savings, your emergency fund, or for situations where you need access to the cash regularly and quickly. Typically, you should keep between three and six months expenditure in these types of accounts, so that you always have access to capital when you need it. However, if you know you are going to build an extension to the house next year, it will probably need to be more. You’ll have to accept that this money will probably fall in real terms, but it is really the only option for your buffer fund. We’ll look more at how this can be managed and split up in the chapter on The Richest Man in Babylon. Whether you in a pre-retirement or post-retirement stage, these accounts are still important, but it is also important that you don’t get lazy and leave everything here, because if you do, as hard as you are working to put more in, inflation is working to take more of it out!
If possible, you also want to prevent the tax man from taking a bigger bite out of your money, so you want to keep this growth tax-free. NISA allowances enable you to do this, as do some National Savings Certificates and Premium Bonds.
Getting older might make you feel like you are slowing down. Do not be fooled into thinking this is cognitive decline, you have so much information in your brain that it takes more time to access it! You can be stronger and happier in your retirement than ever before. Life is an adventure, you can expect change and embrace it. Learn the right time to retire, how to boost your retirement income and create your dream retirement. Follow your dreams and love what you do!
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The Final Salary Hook