Once you have a solid monthly budget in place and have some money saved in case of emergencies, you can put your disposable income to good use for long-term financial goals.
What your long-term goals are will depend on your personal situation, but you would typically think of them as being at least a decade away or so. That might include retirement planning, for example, or saving money towards your children’s university tuition.
In the very long term, you may also want to consider inheritance tax, and how to pass on the maximum amount possible to your beneficiaries.
Increase monthly contributions and take advantage of tax-sheltered accounts
For long-term goals, the earlier you start investing the better. This is principally due to the power of compounding, where you earn interest on your interest. So strong is the power of compound interest, that Einstein reportedly called in the eighth wonder of the world.
Another important way to leverage the power of compounding is to increase the amount you set aside each year. As we show in the chart below, paying in more each year can make a massive difference to how much you eventually end up with.
Invest more, get much more
Notes: This hypothetical scenario is for illustration purposes only and doesn’t represent a particular investment or its expected returns. It assumes annual returns of 6%, while monthly returns are assumed to be the geometric averages of these values. Contributions are monthly and are made at the end of each period. Balances reflect the value at the end of each period. The chart doesn’t account for taxes and management or platform fees.
In our hypothetical example, three households opened an investment account to fund a goal in 30 years. All three initially contributed £10,000 to the account but the second added a monthly contribution of £500 while the third contributed £500 monthly but also increased their regular investment by 5% each year. For simplicity, we have assumed a fixed rate of return of 6% each year, compounded monthly.
When you are saving for a long-term goal, remember to shield any investments from tax. Otherwise, you will have to pay capital gains tax on any gains, as well as income or dividend taxes.
You may benefit from tax relief on your contributions into a pension. The government recognises that pension contributions come from post-tax income, so essentially gives you the tax back when you pay into a pension. For basic rate taxpayers, the government will give you back 20p for every 80p contributed, while the figure rises to 40p for every 60p contributed for higher rate taxpayers. Don’t forget that your employer may also match any savings into your workplace pension.
Pay down lower interest debt
When thinking about multi-year goals, you also need to work out how longer-term debt fits into the picture. This can include mortgages, for example, or some types of student loan plans1.
Whether it makes sense to repay comparatively lower interest rate debt early - like a mortgage - depends on a variety of factors, including the interest rate and what you might expect to make investing instead. For most people, achieving a balance between taking advantages of tax-advantaged investments and mortgage repayments is what matters.
Remember to factor in how tax might reduce your investment returns too. If you invest outside of an ISA or pension, for example, you may have to pay capital gains tax, which would reduce any gain by 20%. Maximising your wealth is also not the only consideration. Repaying your mortgage offers the certainty of avoiding interest expense, while investment returns are unknown.
How will you pass on your assets?
Many people will also be thinking about inheritance tax, and how they can pass on the maximum amount possible. Inheritance tax is only levied on estates with a value of more than £325,000, with this limit known as the nil-rate band (NRB). There is also a residential nil-rate band (RNRB), which gives you an additional £175,000 free of inheritance tax if you are passing on your estate to your direct descendants.
Transfers between spouses and civil partners do not attract inheritance tax, with the unused percentage of your NRB and RNRB passing to your spouse on death. This means that a married or civil partnership couple can effectively pass on assets worth £1,000,000 without an inheritance tax liability3. In addition, a self-invested personal pension (SIPP) is not included in your estate as it is a type of trust.
Beyond that, there are a variety of ways you can minimise inheritance tax, including giving away assets, certain types of investments or taking out insurance to pay for an inheritance tax liability. This is a complicated area of financial planning, however, and regulations often change. You should seek financial advice when trying to mitigate inheritance tax.
Feel financially better
Now that you have finished our series on financial wellbeing, it’s time to take matters into your own hands. Have a look at our proposed checklist below to complete your financial wellbeing. For even more help around investing and financial wellbeing, keep up to date with our latest articles.
A suggested checklist: Make progress towards your long-term goals
1. Increase monthly contribution and take advantage of tax-sheltered accounts.
a. Are you claiming tax relief?
2. Pay down lower interest debt.
3. How will your assets be affected by inheritance tax?
1 We recommend finding out more about the repayment terms and interest rate of your individual student loan plan before you take any action, particularly as your debt may one day be written off.
2 Capital gains taxes apply to investments held in a General Investment Account. You may need to seek specialist advice to help you manage your tax affairs and any declarations you need to make.
3 Inheritance tax rates and allowances are current for the 2023/24 tax year. You should speak to a financial adviser if you are unsure about potential inheritance tax liabilities.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Please be aware that pension and tax rules may change in the future and the value of investments can go down as well as up, so you might get back less than you invested. You cannot usually access your pension savings or make any withdrawals until the age of 55.
Any tax reliefs referred to in this article are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.
This article is designed for use by, and is directed only at, persons resident in the UK.
The information contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this article does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.
Issued by Vanguard Asset Management Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.
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