In your 40s? Use Tax Wrappers to turn £50k into £66k for Your Family

Your life’s rhythm is probably quite smooth in your 40s but your cashflow could remain tight. While you are likely nestled on the property ladder, with growing children and reliable earnings, you may value extra freedom. So your 40s will generally be about balancing long-term goals and shorter-term needs.

If you can beef up your regular savings then it might be sensible to spread this between pension contributions (£250 a month could compound significantly and reach £380,000 over 30 years1), building up a cash emergency pot (at least three months of outgoings), and some medium-term savings that could be drawn upon if required.

The same is likely true if you have a lump sum to invest of £50,000 or more (and have no outstanding costly debts to clear). If you want to balance your retirement savings, long-term savings for your children and funds to meet shorter-term goals, then you should think about splitting this lump sum across a few different pots.

While pension tax relief benefits are very attractive, you can’t access the fund in most cases until age 55 (due to increase to 57 in 2028). So if you need access to the money in the medium term – for example, to cover the costs of education or move to a larger family home – inaccessible pensions savings will not help.

An option is to split savings between a one-off pension contribution and investments within ISAs.

£50,000 of long-term savings for your retirement

If you are a higher rate tax payer (earning between £50,000 and £150,000 per annum) and have the relevant employment income you could pay £32,000 net into your pension and receive tax relief up to the basic rate of tax directly into the pension. This would increase the £32,000 contribution to £40,000.

As a higher rate tax payer you can then claim £8,000 back through your tax return so the effective cost of saving £40,000 into your pension is £26,000. This would mean you now have £26,000 remaining to make other savings.

Initial Cash Lump Sum £50,000
Net Pension Contribution £32,000
Tax relief paid directly into the pension +£8,000
Tax relief paid claimed in tax return +£8,000
Gross available pension contribution £40,000
Cash remaining for other savings £26,000
New investment total £66,000

How should the pension be invested?

In your 40s you will likely have at least 15 years to grow your pension investments before you access them. This means you can generally afford to take the risk needed to accrue higher returns, which can then be compounded tax free within the pension.

Assuming you are willing to see the value fluctuate from time to time in pursuit of longer-term returns, you should consider an equity focused investment. We have a preference for tracking funds that provide diversified and low-cost exposure to global equity markets.

Historic evidence shows how hard it is to pick an active manager who will outperform the market after costs, even in a downturn – fewer than 1 in 5 UK equity funds managed it over the three years to December 2018, according to research from S&P SPIVA2.

Instead of trying to second guess who the next star manager will be – and navigating the fallout if they fail – we prefer to invest more efficiently in market returns and compound higher net returns for clients as a result.

Invest the remainder:

£20,000 in an ISA for medium term saving

If you save £20,000 in an ISA it will grow tax free over time but can be accessed if required or used to help fund future costs such as childcare or family holidays. As this money might be needed at some point in the medium term (five years) it is important to make sure a balance is struck between generating capital growth and protecting the pot from short-term market fluctuations.

£3,000 in a JISA for two children

If you want to save for your children, a Junior ISA (JISA) is a great way to start. The £6,000 remaining could be saved into JISAs for your children – with tax free returns over 10 years – could increase in value by over 1.7 times to a value of over £5,170 for each child3.

However, it’s important to note that when you put money into a JISA for your child you have gifted the money to them and you can’t take it back. The child can only access the money when they are 18 and the JISA is converted into a normal ISA.

Alternatively, you could use the £6,000 to pay off a portion of your mortgage – whatever works for your own personal circumstances.

Making the money that you have work harder

Allocating your money like we have indicated above – by using tax breaks to turn £50k into £66k – takes advantage of the incentives available to investors. Using tax-free investments is just one of the factors you can control when investing (see the others here) and help us to deliver a financial planning and investment management service which aims to make a meaningful difference for clients.

Please remember that when investing your capital is at risk.

1 For a higher rate tax payer £250 net or £417 gross saved every month into a pension for 30 years could grow to £380,000 with an average annual growth rate of 5.6%.
2 Source: S&P SPIVA Europe Scorecard at end 2018. 19.7% of UK equity funds outperformed the S&P BMI Index over 3 years to December 2018, 26.5% outperformed over 10 years.
3 £3,000 invested for 10 years with an average annual return of 5.6% grows to £5,173.

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