Compounding Your Retirement

Retire Like a Rock Star

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.” ― Albert Einstein.

There is just one snag with the principle of compounding interest. By the time you truly understand its power you are too old to take the true advantage of it. This is one of nature’s cruellest tricks. But what about if there was a life hack, an investment genius move, that could allow you to benefit from decades of compounding interest even if you are already going grey? A trick that would allow you to spend money like it was going out of fashion in your later years, giving not one care for your kid’s inheritance. Interested? Of course you are.

According to the Resolution Foundation, under 35 years olds today will on average inherit from their parents at the age of 61. A surprisingly high number, but it is this length of time which will give us the life hack which we need. An example which allows you to have an absolute blast in retirement and still leave a good inheritance to your kids. Let’s do an example to make it clear, I think you will enjoy this. It might change your life.

Let me introduce you to two families, The Browns and The Whites. Both families are very similar. The parents are 50 years old and each family have three teenage kids. Both families have done very well in life, made great investments and now both have a good asset base as they near retirement. Both sets of parents want their kids to get a good inheritance. There is one small difference between them. Mr & Mrs Brown are ultra cautious and spend very little. Think clothes from Sue Ryder and holidays in Skegness.

Mr Brown enjoying his money

Whereas Mr & Mrs White have decided that their retirement years will be their best. They are soon to give up work and ready to fully unleash the bank account and retire disgracefully holidaying year-round. But what about their kids? The White’s eldest child has just turned 18 at which point Mr & Mrs White do something quite incredible.

Their 18 year-old opens a Self-Invested Pension Plan (SIPP) on their birthday and Mr & Mrs White gift them £48,000 into a global tracker fund within the SIPP. The government tops this up to £60,000. Nice. Mr & Mrs White are not monsters, they do the same for their next 2 kids as they reach their 18th birthday. Here’s how things pan out for the kids:

Each kid’s SIPP Initial Investment - £60,000

Average rate of Growth - 10.24% (ave of the MSCI Global Index since 1978)

Years Invested Until Age 61 - 43 years

SIPP Value when age 61 - £4.22 million

So, by the time the White’s kids reach the average age of inheritance (ie 61) that SIPP pot which was set up for them is now worth a staggering £4.22 million. Even with inflation over that 43 year period, that SIPP pot would be worth over £1 million in today’s money assuming an average inflation rate of 3.3% (that’s the average over the last 43 years). It’s just Einsten’s eighth wonder of the world at work but could that also benefit Mr & Mrs White? This is where this story gets good but first we need to check back in with the Brown family.

Mr & Mrs Brown, as they near retirement, start spending less and less. Holidays in Skegness have become a luxury. They have saved and invested well over the years and they pool all their assets and invest their pot of £2.5 million in a safe investment fund earning 5% pa, spend hardly nothing on themselves and when they retire they spend hardly more than their state pension. They want their kids to have a good inheritance - this is their goal. They live for another 43 years to age 93, their investment fund grows to an impressive £20.3 million, £12.2 million after inheritance tax, the kids do very well and get just over £4 million each. So the same inheritance as the White family, everyone does well. There is one big difference in this story. We need to talk about Mr & Mrs White.

Once the kids are left home and have their SIPPs set up, Mr & Mrs White go about the task of living life to the full and dying with zero. They have the same £2.5 million asset base as the Browns and invest into a moderate risk drawdown fund this gives them £100,000 per year to spend for the rest of their lives. They use the state pension merely for upgrades to flying Business class. It’s all very Seychelles rather than Skegness. If they live ‘til they are in their 90s then they will die with zero of course. However they may even live just long enough to see their eldest kid access their inheritance from their SIPP, something the Brown’s will of course never see. They will have a huge feeling of smugness.

Mrs White, still managing to get and and about in her 90s

So there you have it. Utilising the most powerful investment tool at a time in your life when you truly understand its power. Instead of paying millions in inheritance tax like the Browns, the Whites used the kid’s tax relief (even before they starting paying income tax themselves) to put their SIPP on rocket boosters at the earliest time possible. This one simple life hack funded a great retirement and ensured your kids an equally great inheritance.

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What Will You Do?

Matters like retirement planning and inheritance are very personal, the story and the Whites and the Browns is just one that hopefully helps you consider the best way of planning your through-life investing, how you will spend retirement and what you will leave behind. A simple demonstration of the power of compounding interest over a lifetime with a sum initially given rocket boosters of tax relief at the start. Einstein was right about the power of all this, he should have stuck to personal finance advice rather than mess about with nuclear physics.

PS - Apologies for not mentioning property once in this blog and not even bothering with a graph. Usual service will resume.

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