It might not have quite the same poetry to it, but just as the old Chinese proverb says, “a journey of 1,000 miles begins with a single step,” the journey to a comfortable retirement begins with a few minutes of annoying paperwork. Really, no good savings plan can be undertaken without the right accounts in which to deposit savings. And be warned: You’re going to need more than just a savings account.
First thing’s first
Do you have an emergency fund yet? If you’ve ever read the Book of Job or watched the local news, you know terrible things happen to very nice people, so you should absolutely have at the ready an emergency fund that will cover at the very least three months of you (and your family’s) expenses. This — along with eliminating any large credit card bills — must be undertaken immediately, to prevent having to rely on high-interest credit in the event of an emergency.
One piece of advice: make this nest egg a savings account, money market account, or savings investment account, that’s totally separate from your checking account since it’s awfully tempting to transfer savings into a checking account to cover bills. (So no, Netflix being suspended never counts as an emergency.)
Retirement savings plans
We’re generally not super-fans of financial aphorisms, but “pay yourself first,” is a solid exception. It simply means that, every payday, before you buy the first round of drinks for your freeloading coworkers, you should first put money away for your future. After your emergency fund is taken care of, move on to funding only “tax-advantaged” savings plans; tax-advantaged simply means that by either allowing your investments to grow tax-free or allowing you to defer paying taxes until retirement, the government is essentially handing you free money. Here’s our own financial aphorism: “Grab as much free money you can.” So where should you look first?
Employer pension plans:
If you’ve got a full-time job, there’s a pretty good chance your employer will offer a defined contribution pension plan, meaning they’ll agree to either contribute a set amount or match a portion or all of whatever you contribute towards your retirement. These contributions will generally bring about excellent tax relief opportunities. So between the government tax breaks and employer contributions, it’s like being deluged with money from a two-headed shower. If you earn less than £150,000 you’re currently free to contribute as much as your entire salary, up to a maximum of £40,000 a year into your pension. (This number reflects the total of both your and your employer’s contributions.) You should absolutely contribute as close to the maximum as possible; auto transfers from your paycheque will ease the discomfort of having the amount lopped off the top.
If you aren’t offered a pension at work, you should immediately fund a SIPP, which will provide you similar tax relief as a workplace pension, or an ISA, a tax-free savings account before looking to park your savings anywhere else.
Savings plan formula
Those looking to create an overall masterplan for their finances would do well to consider the 50:30:20 rule, which provides a roadmap to create comfort — even wealth — for your future retired self. The first step is to figure out what your take home, or net pay, is then divvy it up this way.
- 50% goes to needs. This is the non-negotiable stuff, including rent or mortgage payments, groceries, and monthly health insurance premiums. This one tends to be the toughest one for younger people; recent studies have shown that millennials devoted a full 45% of their income to rent before turning 30. So understand that these are just guidelines meant to help you, not turn you into a blubbering ball of anxieties. Just do your best.
- 30% goes to wants. This here is the fun percentage, the one who shops for clothes, vacations in sunny climes, dines out, may even drink one-too-many on a Friday. All non-necessary expenditures fall under this umbrella.
- 20% goes to savings. Though this percentage may be listed last, don’t forget what you learned above: “Pay yourself first.” So even before paying rent, you should first concentrate on using this 20% to eliminate your credit card debt, building an emergency fund, and putting as much as possible into your tax-advantaged retirement accounts.
How much should you save a month?
Ideally, you should be saving 20% of your net pay every month. If you carry no credit card debt and have 3 months of emergency expenses saved, this 20% should either go towards your work retirement account or deposited directly into a tax-advantaged pension or retirement account.
Weekly savings plan
Let’s discuss some real figures. If you’re making a salary of £65,000, you’re making about £1,250 a week gross, and you bring home around £750 after taxes. Twenty percent of that is £150 a week. Manageable, no? If you’re not already taking that 20% off the top by contributing to your pension at the office, you could easily link your checking account to a solid interest-bearing savings investment account that can serve as your emergency fund, or else send that money straight into your own self-managed pension.
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