Hello and welcome back to Mortgage Advisor on FIRE. This week I tackle a reader request, and look at pensions. Also, a brief look at HS2. It is only a brief look because once I start on Tory incompetence, I find it difficult to stop. Also, the usual financial updates, and another disappointing property viewing. First, the Quote of the Week:
Quote of the Week
HS2 is going to be a national embarrassment, even more so than it already is. Faster connections between the northern cities of Manchester, Birmingham, Sheffield and Leeds is just not needed. Sheffield to London, on the train, can be done in a fraction over two hours. Under HS2 the same journey could be done in around ninety minutes. Am I the only one not seeing a huge amount of value for money here?
This project was conceived with the idea of improving access to the capital from the north. It was supposed to make commuting easier when travelling for work. However, Covid has demonstrated how easily the transfer to remote working and video conferencing could be completed. In an age where climate change is a hot topic (maybe not the best way to phrase it), I don’t see the sense in pushing forward with a plan that has limited benefits for a huge cost. I keep thinking that the government must see sense, but then I remember this is the same government that got Brexit wrong, championed herd immunity, fucked up using Excel to keep important Covid data, and spent eye watering sums of money on useless PPE contracts and an inadequate test and trace system.
How does the Tory party, and Johnson, still have any support or credibility?
I’ve been so tired this week. I’ve not been sleeping well, and whilst that is normal for me, it just seems to be affecting me more recently. I’m also having some truly batshit crazy dreams. One recent example was when I was running through a forest trying to escape Godzilla fighting a giant Tom Cruise. I don’t believe that dreams hold any sort of mystical meaning, but I think it’s possible dreams could point to anxieties that you have. I’m not consciously worried about a smackdown between Giant Tom Cruise and Godzilla, but maybe I should be?
I had the second part of a scan at the nuclear medicine department of my local hospital. Nuclear medicine sounds awesome, but I have not yet developed any superpowers. If I could have any superpower, it would probably be telekinesis. I’d love to think I would use this power for good, and noble causes. However, based on the fact I love to wind people up, I would probably end up using my power to mess with people.
Life is just boring right now. It feels as though we’ve had two years of just waiting for Covid to be over. I am itching for a holiday, and to sit by the sea with a cool breeze blowing in. There is a place in Malta, in the old capital M’dina where you can sit on the old city walls. I can’t remember the name of the restaurant, but you can just sit there with a pizza and a beer, and just look far into the distance. As M’dina is elevated, you can see across much of the island, and then out into the Mediterranean. I never get tired of that view.
Approximately two-thirds of the working population in the UK pay into a pension, yet there seems to be a fundamental lack of understanding of what pensions are. Most people understand that you pay into a pension, and then at retirement you receive an income. However, this is like a person knowing that a car moves on wheels; there is no understanding of the mechanisms underpinning a pension, or in the example of a car, how the turning of the wheels is powered.
So, what is a pension?
According to Wikipedia: “A pension is a fund into which a sum of money is added during an employee’s employment years and from which payments are drawn to support the person’s retirement from work in the form of periodic payments.”
According to Nutmeg: “A pension is a tax-efficient way to put money aside for later in life, to provide income for when you retire.”
These definitions explain, in basic terms, what a pension is. However, there is no explanation of how a pension works.
There are, broadly speaking, two types of pension; defined benefit (DB) and defined contribution (DC). With a DB pension, sometimes called a final salary pension, you are told what the end benefit will be if you contribute to the pension. Contrary to what some believe, a final salary pension does not mean you receive your final salary amount as an annual pension. The amount you receive will be based on a calculation, where your length of service (in years) is multiplied by your final salary. The resulting figure is then multiplied by a fraction, which could be 1/40, 1/60 or 1/80, or any other fraction, and this is known as the accrual rate, i.e. you accrue 1 point for each year of membership of the scheme.
An example of how this is calculated:
If you have an accrual rate of 1/40 and your salary is £35,000, in the first year you will have built an annual pension of £875; 1/40 of £35,000. After twenty years service, you will have built an annual pension of £17,500. Using the same figures, but with an accrual rate of 1/80, you would have an annual pension of £437.50 after one year, and £8,750 after twenty years service.
DB schemes are less common now as they are expensive for companies to honour. The benefit to the employee is a commitment from the business that could last for decades, whereas in the past this may have only been a commitment for a few years.
The other, now more common pension, is a defined contribution scheme. In a DC pension you build up a pot of money through regular deposits. This pot is then usually invested in funds, unit trusts, individual stocks and other financial instruments such as bonds. The idea is that the value of the investment grows over time, and at retirement the fund value is used to purchase an annuity; in simple terms, an income for life.
Most pensions offered by employers and most SIPPs are DC. With this type of scheme, the value of the pension can be calculated at any point; it’s just the sum total of the value of the underlying investments. So, when you want to transfer the pension from one provider to another, common practice is to cash in the investments, and then transfer the amount to the new provider in the receiving currency. Then, the money can be allocated to the investments the person wants. On a side note, if the market dramatically shifts mid transfer, this can be a very good thing or a very bad thing. If you cashed in one hundred shares for 50p per share, but then the share price drops to 25p per share, you could in theory double your shareholding. Trying to time this is something I would not recommend under any circumstance.
So, a DC scheme is simple to value and to transfer. What about a DB scheme? A DB scheme has no intrinsic value, because you are paying for a benefit, not a product. Think about it in these terms; a DC scheme is a savings pot. A DB scheme is like a subscription, and the longer you subscribe the better the service you receive.
In my experience, it’s rare for it to make sense to transfer out of a DB scheme. If you want to move your pension from your old employer that offered a DB scheme, to your new pension provider that only offers a DC scheme, there needs to be a way to value the DB scheme. This is where the Cash Equivalent Transfer Value (CETV) comes in. There are a series of calculations that determine the CETV, which are modified depending on length of service, and time until retirement, for example.
Pensions are a total mystery to many people. I think this is why, when you ask a group of people to explain their pension, they can only tell you the absolute basics of their provisions. If you are in the UK and you are under the age of fifty, I would not be relying solely on the state pension. There will never be a better time to start planning for your retirement than right now.
Note: before taking any action with existing pension policies, or taking out new pensions, please seek independent advice that is based on your own circumstances. There might be more appropriate ways for you to save for retirement.
A Brief Interlude
I’ll never hide this blog behind a paywall, but it does cost money to run the site. I spend a minimum of six hours each week writing the blog, and maintaining the other parts of davidscothern.com. It is a labour of love. However, many of you have asked how you can show your appreciation. I set up a Buy Me A Coffee page but the main feedback was that you couldn’t pay by card. Well, now you can! My page now supports card payments and Apple Pay. So, if you want to show your support and appreciation for the content I create, please buy me a coffee.
2021 Goals – to be achieved by 31/12/2021
1 – Reduce weight to 92.8kg. (Current weight 122.6kg).
2 – Finish 104 new books. (Current total: 106).
Premium Bonds: £19,400.00 (up £400.00 from last update).
Stocks and Shares ISA: £43,691.50 (down £243.23 from last update).
Fuck It Fund: £2,100.00 (up £400.00 from last update).
Crypto: £861.42 (down £144.84 from last update).
Pensions: £52,151.84 (down £183.57 from last update).
Residential Property Value: £210,058.00 (no change from last update).
Buy-to-Let Property Value: £135,550.00 (no change from last update).
Total Assets: £463,812.76 (up £228.36 from last update).
Credit Card: £106.21 (down £328.72 from last update).
Residential Mortgage: £167,164.52 (no change from last update).
Buy-to-Let Mortgage: £93,000.74 (no change from last update).
Total Debts: £260,271.47 (down £328.72 from last update).
Total Wealth: £203,541.29 (up £557.08 from last update).
Investment Income in 2021: £3,450.39 (target £5,000).
The first post after payday always sees a nice boost to my Premium Bonds and Fuck It Fund. My shares have been temperamental in the last week, with daily fluctuations swinging from substantial losses to impressive gains.
Now that my girlfriend is coming up to her first full wage since starting her new job, we should see some of our joint finances stabilise. We’ve increased our mortgage payments and the credit card should start having a zero balance from week to week once Christmas is over.
The decision to pay the mortgage off faster was a tough one. On one hand, debt has never been so cheap. However, rates are almost certainly going to start increasing. Our mortgage is now £50,000 higher than when we started in 2012. Once we have secured a second BTL property we should be able to remove our residence from the equation, which would mean no further advances. This should mean we can start to hammer the mortgage and see some equity built in time for us to sell once we hit FIRE.
By the time the next part of this blog goes live, we will have transferred our BTL management to a new agent. This will be a massive relief. Our current agent is utterly and completely useless.
I had hoped that by now we would have found our second BTL, but the viewings we’ve recently completed have been disappointing. We attended a viewing last week that was a real effort to get to. We were both tired from work, and it was a lengthy journey. The property looked great online, but in person it was a huge disappointment. It would have needed approx £20,000 of work to bring it up to spec. I don’t know what agents achieve by hyping up properties, only for viewers to be disappointed.
I have some time off work coming up, so I’m hoping that I’ll be able to take in some more bookings and find our next investment.
You can now find all my social media pages by checking out my Biolink at bio.link/davidscothern.
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Finally, have a look at Darren Scothern’s fantastic blog at darrenscothern.com.