Back when I was resident in mainland UK and not in the Channel Islands, I wrote a piece about splitting investments between ISAs and pensions.
Where your taxes go
With a new government in place (this time it’s a red one, last time it was a blue one, but for planning purposes it’s just a rotation of names and faces) there has been much talk about pensions.
Most of it refers to the UK state pension, which is something I actually do qualify for at the very moment but don’t really expect to actually receive. Paying state pensions and other pensioner benefits makes up 48.1% of welfare spending in the UK and are expected to be 55% in 2024-2025. Given that welfare is 24.9% of government forecasted spending for 2024-2025, that means we’re looking at 13.7% of all government spending to be made to pensioners in 2024-2025.
Understandably, if you’re a government and you need to sort out some kind of fiscal surplus to plan for the future, directly spending 13.7% of your money on economically inactive people isn’t an easy pill to swallow.
Most tax money is spent on people that can’t/ don’t pay in
I’m not making a moral point here – this is a fact.
Below is a graphic produced by HM Gov on gov.uk as updated August 2024.
You can see that if you want to invest in big ideas and benefit future generations (which is kind of the whole point of maintaining a country), your best options to free up a surplus are to somehow trim either or both of social care and healthcare budgets.
Obviously, cutting disability benefit would be a philosophical shift that I don’t (and presumably the government doesn’t) want to make.
So, logically, one of the easiest ways for the UK government to do this is to push some of these expenditures back on people who can afford not to have them. A mere 5% cost reduction in each of these departments would free up £29.1bn (based on the infographic), more than is spent on housing and community amenities that directly benefit your economically active people.
If you’re investing wisely, you’re probably going to be in that 5% cost reduction
Ignoring any cries of morality and fairness – I’m not interested in that for my planning – the fact is that if you’ve been doing any kind of investing for a couple of years you’re mathematically in a better financial position than your peers.
You’ve kept your spending low, lived within your means and invested a surplus for future planning. Your neighbour might have done none of these things, and justifies the cost of a new car every three years and designer clothes for their kids, but doesn’t have that same liquid investment pot. A £10,000 bill will hurt you, but you can pay it; a £10,000 bill will bankrupt your neighbour. You’re financially better off, even though you may not enjoy the same standard of living.*
*There are holes in this example so big you could drive a truck through them, but it’ll do for the illustration. I truly believe that spending more does not correlate to a higher standard of living. I’m happier and healthier living on my boat than I ever was in a house and I live like a minimalist.
When we’re looking at means testing, your portfolio of assets makes it look like you’re the person who can afford to pay their own share.
Which means that any cuts and budgetary measures are more likely to be aimed at you.
What this means for state benefits and FIRE
Unless radical change is made and taxes are levied at higher rates, it seems pretty likely that anyone on their financial independence campaign is going to lose access to (or have a much reduced access to) state benefits in the future.
I plan this in by assuming that the state pension isn’t coming my way and that I may need to subsidise my own healthcare.
As an aside: in the Channel Islands we don’t have the NHS anyway so I have health insurance (which is presently an employee benefit) and pay privately for dental work. My point is that if/when I return to mainland UK I’m presuming my access to healthcare is likely to be at a cost to me.
More importantly, I think that private pensions are likely to be looked at, too.
Why I think private pensions may change
The problem with the current system is that, as identified above, most tax money is spent on people that can’t contribute economically via taxes. Or, at least, not to the same degree.
While it’s totally appropriate for a 75-year-old to continue to practice accountancy or law, which are desk-based jobs where things don’t have to change much over time. It’s a lot harder for them to do any job that relies on manual labour or knowledge of technology.
Obviously, that’s a generalisation, but these stereotypes exist for a reason.
Even if we assume that pensions are means-tested, it’s not unreasonable to assume that your older population needs more support with healthcare than your young, fit and active population.
The point is that your average government can’t carry too many older people in your country that aren’t paying taxes, so they’re going to look at ways to make sure there are more people still paying in than not.
Can’t we just make more people?
The traditional way to do this is to encourage population growth. Problem with that is that it’s a reality of our times that fewer kids are being born. In the UK, last stats from 2022 show that we’re on 1.49 kids per woman (because, you know, men can’t give birth). If we were going to replace the population at current levels we should be on 2.1-2.4 kids, so even without immigration if we wanted population growth we’d need to seriously encourage babies.
Whether rightly, wrongly or totally irrelevantly, it would be a losing bet to rely on population growth to keep things going.
Which means we’re down to the last two solutions…
We need to take more in taxes annually or tax people for longer
Life is pretty expensive for most people and we’ve raised the expectations of living standards so much now that I don’t know if the UK population is ready to go back to public libraries, rolling electricity blackouts and make-do-and-mend, which is what would sustain taking a bigger tax from peoples’ pay.
There’s also a problem that if people have less to spend your government can’t rely on VAT income and the effects of inflation that reduce government debt in real terms, even assuming that trade continues to be viable within the country and jobs are unaffected.
So I don’t really see more taxes in the future as being on the government planning list. Well, not meaningfully anyway. The odd 2p per pint of beer, a bit more on cigarettes and vapes perhaps, but probably not on direct wage deductions.
Which means we need those same people to be paying for longer.
Delaying pension drawdowns is in the government’s interest
Most people will use a pension as their means of becoming financially independent. People tend to look at retirement as an option when their pension pot is big enough to make retirement affordable, rather than retiring first and asking questions later.
The government is therefore likely to disincentivise any kind of early use of pensions
How do you stop people deciding to access their pension early?
Your options are:
- Reduce how much can be in the pension, so they choose to wait longer themselves; or
- Change the rules so they can’t access the pension earlier even if they want to.
I’m willing to bet that the government – whether this one or future ones – will do both of these things in my lifetime.
What I’m doing
Short version: meet employer matches, go hard on my regular investment account.
Remember that I don’t have access to ISAs in the Channel Islands, otherwise I’d use that instead of a regular investment account (often labelled as a General Investment Account or GIA by providers).
I’d be a fool not to contribute at all and lose my employer contributions
My employer offers 5% salary matching, so I pay 5% of my wages in and they add 5%. If I don’t pay this in, they don’t hand this to me, so I’d lose it.
It’s also quite a modest pot, so if the pension rules were to delay or restrict access I wouldn’t be too caught out.
My pension contributions are made with pre-tax earnings, but deductions are likely to be taxed as income. I’m also unclear on my local pension rules and may be compelled to buy annuities with the pot later, which are absolutely taxed as income, but this wouldn’t be a concern if I was to be in the UK.
My investment account is the main workhorse
I have two of these: one with robo-investor Wealthify and one that’s a lower cost Lloyds Sharedealing account in which I choose funds for myself.
There are no real tax advantages to be had (although there’s no capital gains tax where I live) compared to a pension pot, but what I gain is control.
I don’t see it being likely that any government will seek to prevent investment accounts in general. That would probably cause issues with capitalism generally, and as capitalism (albeit of various flavours) is the only real game in town for how countries run their economies.
Other stuff
It’s probably because of my skepticism about pensions that I have allocations in gold, start ups and crypto (well, mainly Bitcoin at the moment).
If I were a higher rate taxpayer in the UK (not a concept in Channel Islands), a 40% effective tax benefit on contributions would probably be a greater benefit that would dwarf the potential gains to be had with riskier (or alternative) assets. Or, at least, it would if I thought I could rely on getting it.
This is something to bear in mind when you read my posts because it colours my approach. If you think I’m being too pessimistic about government intervention or relying on markets, you probably won’t understand why I look beyond pensions and public equity index funds. However, if you understand why I’m distrustful about relying on the status quo, you’ll hopefully appreciate why I look around at other asset classes.
Readers will spot that I haven’t mentioned real estate. I don’t own any of any kind. This because of the burden of maintaining real estate while living on a boat and looking to travel, which means that I’d basically need to have a very low level of leverage before I made any income from property. This in turn means I’d need to basically have enough capital to buy a property nearly outright, and I haven’t committed to that (at least, not yet). I think real estate is a good investment, it’s just not practical for me and my lifestyle.
Pros of my approach
I gain control. Rule changes and the tinkering of governments barely affect me.
If I move to another country, decide to abandon financial independence and buy a big house somewhere, get seriously injured and have a hit to my income, I have readily available assets that I can sell off to prop myself up.
This means in turn that I can take more risk with my emergency fund, since the fund only needs to sustain me long enough to be able to draw down from my non-pension portfolio.
Weaknesses of my approach
By not maximising the tax advantages of investing pre-tax income, I’m taking a hit to the size of my pot. I’m effectively missing out on 20% of potential contributions, which sucks to think about. There’s a price to everything.
For me, the control is a greater advantage than the tax benefit
I value having control, ownership and freedom of my situation way more than a 20% tax incentive.
Accordingly, while I save 5% of my pre-tax pay into a pension, I’m saving a little under 50% of my take-home into my general investment accounts.
Decide for yourself
I can’t advise you on your situation.
As I’ve said many times on this blog: financial planing is personal and there’s no “best fit” plan for everyone. I’m hoping that by sharing my thoughts you’ll be able to use that kind of analysis to make your own plan for financial independence.
I’m not even 40 years old yet and I have a very cynical view of what present and future government intervention aged is likely to do to my planning over twenty or more years. You might be 50 and reasonably optimistic that things won’t change before you start getting access to your pension.
As a reader of this blog, I’m confident that you’re not the kind of person who blindly follows a “finfluencer” on the internet.
My hope is that this post has given you some food for thought as you plan your own financial independence campaign.
My financial independence campaign continues…
