|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.