Why the 5 Years Before Retirement Are So Important (You’re closer than you think!)

when you get into your 50s the age at which most people think about retiring you may feel that for you retirement could not seem further away because your retirement pot is nowhere near as big as you expected it to be at this stage of your life but I want to show you just how quickly you can turn things around and why if you do the things that I'm about to show you you should expect to double your retirement pot in the five years leading up to retirement or without needing to save any more money than you already are hello and welcome back to the channel if you're new here hi my name is James I am a financial planner and this is a place where you can learn to make smarter financial decisions there are three reasons why the final five years before retirement is where all the magic happens the first of those is compound growth Einstein famously once said that compound interest is the eighth wonder of the world he who understands it earns it he who doesn't pays it it's a simple concept but one that the human brain struggles to visualize I'll demonstrate this with an example if I offered you a million pounds today or one p that doubles in value every day for 30 days which would you choose one million pounds is a huge amount of money but do you think that one p that doubles every day would be worth more than a million pounds after 30 days well obviously it is because otherwise I wouldn't be using this as an example but let's just look at that Journey on day one you'd have 1p day two two P day 3 4p by day 10 you'd have five pounds Not Great by day 15 so you're halfway through you still only have 163 pounds by day 20 a third of the way through 5242 pounds by day 25 167 000 pounds which is a big increase but with only five days left we're still a long way off a million but this is where it gets nuts by day 30 it would have grown to five million 368 000 pounds this gets me every time when you break it down into the individual steps it seems obvious it doubles on that final day adding 2.6 million pounds but it's the compounding effect of that growth rate day after day that really catches You by surprise but at first it's barely noticeable and you would be forgiven for thinking that nothing is even happening but suddenly you get all of this explosive growth right at the end but that's just the perspective because of course it's been growing at the same rate all along many things in life are as a result of compound growth small incremental changes that at first don't seem like they're having much effect but snowball into huge results over time the most obvious example of these is with investing of course you're never going to be able to find an investment that doubles in value every day investing is a much longer term game where you're going to see results over decades not days but exactly the same process applies this is the return of the MSC AI World index a global stock market index going back to 1975. if you had invested ten thousand pounds at the start of this so 48 years ago that would now be worth 1.7 million pounds we can see by the similar shape of this graph that this is as a result of compound growth over this period the global stock market has grown at an average rate of a little over 10 percent per year but for the first few years or even decades it may have seemed like you're making no progress at all ultimately a 10 return on ten thousand pounds isn't that exciting but 10 on a million or that'll get your attention and it's as you approach retirement that you actually start to feel the effects of compound growth taking hold but even with a 10 growth rate we're not going to double our money in five years so how is this possible well it's actually a very simple formula that I'll demonstrate with an example John is 55 and between him and his wife they have 200 thousand pounds invested 150 000 pounds in pensions and fifty thousand pounds in Isis and they want to double that by the time that they're 60. what are the two factors that are going to make this happen number one investment growth and number two how much they can save between now and then over this time period the global stock market has grown at a compound rate of just over 10 per year remember that's not 10 every year 10 is an average and the actual journey to that return has been very bumpy so let's assume that John is not as lucky or has invested more conservatively and achieves an average annual return of seven percent this is the formula if you want to double your money over five years with a seven percent investment growth rate you would need to save 10 of the value you started with each year so if you're starting with a hundred thousand pounds you would need to save ten thousand pounds each year if you're starting with 200 000 pounds you would need to save twenty thousand pounds per year and so on think about how much you have invested right now in pensions Isis and other investment accounts if you want to double that over the next five years you would need to save 10 of that figure each year of course that's my no means guaranteed and will depend on how you're invested and what happens in the markets but it's a simple guide that you can use now you might be thinking great James that's a neat little formula but how the hell am I supposed to save 20 000 pounds per year well this brings me to the second reason why the final five years of retirement are so powerful most people in their 30s 40s or even early 50s feel nervous by the fact that they are not able to save as much as they would like maybe you've got kids at home that are costing you an arm and a leg or you're still paying off your mortgage and you don't have much left over at the end of the month this can be demotivating and can make you feel like you're being left behind but you need to realize that this is totally normal most people find themselves in this position in the middle of their lives when their costs are high and income is tight especially now given that mortgage rates have gone through the roof but there will come a time probably in your 50s where you are in your Peak earning years when you finally pay off that mortgage and your kids leave home and you find that you are able to save more than you ever thought was possible let's say that Jon has just finished paying off a 200 000 pound mortgage that was previously on a 4.5 interest rate he would now have an extra 1 100 pounds of spare monthly cash flow that's thirteen thousand three hundred pounds per year a big chunk of his 20 000 pound Target and I'm going to show you how he can now get to that Target without having to save any more money because it's here in those last five years of retirement that pensions really come into their own in the UK a private pension is the most tax efficient tool that you have for Building Wealth the only downside is that you can't access that money until 55 at the earliest but John is already 55 so that's not a problem so for John he wants to be putting as much into his pension as he can if John made a 13 300 pound contribution into his private pension he'd get 20 percent pay basic rate tax relief added on top by hmrc leaving him with 16 660 pounds in his pension which is good but it's still not 20K so as an alternative way of getting this money into a pension John could instead ask his employer to sacrifice his salary directly into his pension before he receives it and reduce his take-home pay by Thirteen thousand three hundred pounds per year leaving John with exactly the same free cash flow as when he was paying off his mortgage but by doing this not only will he be saving on income tax but also National Insurance with this additional saving being paid into his pension now this is only possible if your employer uses a salary sacrifice pension but this is the most common type of pension and if John did this by the end of the year he would have nineteen thousand six hundred pounds inside his pension three thousand pounds better off than if he'd made the contribution himself there's one last tip to get him over that Target by choosing to sacrifice his salary John is also saving his employer money because they end up paying less in employers National Insurance so John should ask them if they would be willing to pass that saving on to him and pay it into his pension which seems fair some companies might pass on all of their ni savings some might not pass on any at all but let's assume that they decide to split the difference and put 50 of their tax saving into its pension this would leave him with 20 958 pounds in his pension at the end of the year so there we have it just by diverting the 13 000 pounds of cash that he was previously paying towards his mortgage into his pension John is now able to save an extra 21 000 pounds per year and with a bit of luck this should enable him to double his retirement pot over the next five years but remember this is in addition to the other savings that he's already making by default between John and his employer he's already putting eight percent of his salary into his pension each year which adds four thousand pounds to this figure and we're not done yet John currently has 150 000 pounds in his pension and fifty thousand pounds in Isis the advantage that Isis have is that you can access them at any time but given that John is now 55 and can access his pension if he needs to it would be more tax efficient for John to use his ices to make even larger pension contributions to be most efficient he would need to spread these contributions over a number of taxis and make some contributions in his wife's name but this would turn his fifty thousand pounds of Isis into 62 500 pounds inside pensions so after years and years of feeling like he's behind just saving the default into his pension in just five years John is able to turn his two hundred thousand pound retirement part into 250 000 pounds in the last year alone that has added 50 000 pounds of value this is why the final few years before retirement are so important and shows just how quickly you can turn things around what's so great is that all of this is happening without John needing to put aside any more money than he already was all he's done is divert the cash flows that were going into his mortgage into his pension but this is where it can fall down given that you've probably been paying off your pension for the last 25 years it's tempting to give yourself a break and maybe spend some of that extra cash that you have which is fine as a one-off but if you let your lifestyle creep up and consume that extra cash flow on an ongoing basis this is not going to work and you are really going to struggle to get your spending back down with interest rates higher than they have been for a long long time more and more of our income is going towards servicing our mortgages and if there is any Silver Lining to this it's that when we do finally pay that mortgage off or when interest rates full you are going to have an even larger proportion of your income that you can seamlessly redirect towards investing in the Years leading up to your retirement you should be dramatically increasing the amount that you have invested with a majority of this going into your pension but there is no point putting all of that money into your pension if it is not invested correctly which is why you now need to watch this video here where I teach you everything that you need to know to assess how your pensions are currently invested and how to set them up for success in retirement I'll see you there

Channel: James Shack

Views: 258,523

Keywords:

Id: ECOCa6FS8C8

Length: 11min 40sec (700 seconds)

Published: Mon Aug 28 2023