Can we afford to retire at 65 and fund school fees?

Ryan and his wife are age 36. He earns £95,000 a year, or about £105,000 with bonuses. She earns £35,000 a year. They have children aged six and three.

Ryan and his wife's home is worth around £725,000 and has a £280,000 mortgage – their main outgoing. The mortgage rate is fixed for the next nine years and they are making over payments on it.

“We would like to retire at age 65 on an income of about £50,000 a year in today’s money,” says Ryan. “We also want the assets in our individual savings accounts (Isas) to have a large enough value to cover larger items of expenditure.

"The monthly contribution to my workplace pension, including what my employer puts in, comes to about £1,100. My wife plus her employer’s contribution to her workplace pension comes to around £600 a month. But her pension is currently only worth around £7,000 as she has recently gone back to work and started contributing to it. The pension contributions will increase in line with our salaries and I’d consider increasing mine further.

"I also contribute £150 a month to an employee share scheme and my employer adds additional shares worth £225. 

"We have £35,000 in NS&I Premium Bonds, equivalent to about six months of our outgoings, as an emergency fund.

"We want to send our kids to private schools for their secondary education and or help them to pay for university costs. We also want to give them money to invest, use as deposits to buy homes or start a business when they are age 18.

"I have been investing actively for about 18 months and, given our fairly long investment timescales, I’m prepared to take a decent level of risk to get better returns. I’d be prepared for our investments' value to fall by up to 20 per cent in any given year, although also follow the '10 month rule' (selling assets when their prices fall below their 10-month averages) with my fund holdings to try and minimise losses.

"I hold a low cost global tracker fund – Fidelity Index World (GB00BJS8SJ34) – as the core of my Isa, alongside smaller allocations to funds which I think have the potential to outperform the tracker. I contribute £300 a month to the core fund holdings in my Isa and hope to double this amount this year.

"I also have some direct share holdings I believe are value opportunities to indulge my interest in investing and provide capital growth. For example, I recently bought Rio Tinto (RIO), because I believe that it will make good returns as economies recover, and Driver (DRV), because it seems mispriced. I set target prices at which to sell direct shareholdings and recently sold Wynnstay (WYN) when it passed my 500p target. I had bought it for 325p per share. I won’t add any further direct share holdings until my existing ones have reached their price targets or are failing to grow. 

"I had intended to invest 70 per cent of the money set aside for our kids’ education, which I hold in an Isa in my own name, in equities with the remainder in bonds. But as inflation worries have hit bonds I’m not convinced that they will mitigate falling equity prices. So about 80 per cent of this Isa is in a global equities tracker held on a low-cost platform to keep costs down, and the rest is in cash. I contribute £300 a month to this Isa, putting as much as is necessary into each of the tracker fund and cash to maintain the 80/20 split.

"I have invested the money in my children’s junior Isas in Fundsmith Equity (GB00B41YBW71) because these accounts have a long investment time horizon and I like the idea of investing in long-term quality businesses. This fund has also performed well."

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

Chris Dillow, Investors' Chronicle's economist, says:

You seem to be saving enough. Your objective of an income of around £50,000 a year in today’s prices from when you are age 65 means that you must save around £20,000 a year in real terms for the next 30 years, assuming that you can earn a real return of 4 per cent a year on those savings. And you are doing this by contributing £1,700 a month to your workplace pensions.

Of course, there are lots of uncertainties. For example, what will investment returns be, will £50,000 a year be enough in 30 years’ time, will career progression enable you to save the necessary amount, might you want to retire earlier, and do you want to run down your wealth or preserve it to leave as a bequest?

But as a rough round number, I’d budget on saving £20,000 a year so your planned monthly contributions are right. But remember to update them in line with inflation, in addition to any provision you make for your children and paying off the mortgage.

You’re right not to bother with bonds, and not just because rising inflation might be detrimental to their returns. If central banks raise interest rates more than expected, bonds might sell off at the same time as shares. That would undermine their main function which is to protect investment portfolios from falls in equity prices. Also, western government bonds are on negative real yields which means that if there are no surprises – good or bad – they will lose money in real terms over the long run. Bonds' only function is to protect investment portfolios from the risk of recession or further falls in the long-term trend growth. But this insurance is very expensive.

I’m not very confident in Rio Tinto (RIO). It’s a cyclical play but there has been a warning that the cyclical upswing might run out of steam – the growth of the narrow money stock in China has slowed recently. This has led to slow growth in the country and weak demand for commodities. So are you confident that Rio Tinto could cope with disappointment on this front?

That said, this isn’t a reason to sell it in a rush. But as you have other cyclical assets such as Tullow Oil (TLW), International Consolidated Airlines (IAG) and smaller companies funds, I would be wary of adding more cyclical risk.

The attraction of Fundsmith Equity's holdings in long-term quality businesses is understandable. But is the quality of the businesses it backs now fully reflected in their prices? Will their monopoly power be weakened by competition or regulatory change? And do Atif Mian, professor of economics, public policy and finance at Princeton University, and his colleagues correctly argue that superstar firms have benefited more than others from low and falling interest rates, in which case they carry more interest rate risk than you might think?

I’m not sure that we can yet answer these questions definitively. Which is why you are wise to use a 10-month average rule. Although it often fails, it has the immense value of protecting investment portfolios from the nasty bear markets that often follow periods of over valuation, thus protecting against big losses.

Tim Latham, chartered financial planner at Equilibrium Financial Planning, says:

Assuming you have both been working since you were at least 30, you will be eligible for the full state pension from age 68. As you want to retire at age 65, there will only be three years in which the required income from your [private] pensions and investments will need to be £50,000. After this, the amount you need from your [private] pensions and investments will decrease to around £31,270.

The substantial withdrawal rate from investments that generates income without eroding capital is 4 per cent. This means that your pensions and investments will need to grow to a value of around £781,750 to to provide an income of £31,270 per year. As well as these investments, it is important to build a cash reserve of three to six months’ expenditure. Your pensions are worth about £72,000 and you have about £19,470 in an Isa, so saving surplus between now and when you retire is crucial.

As your wife has only just started pension contributions, I suggest taking her age and halving it to determine a good annual pre-tax percentage contribution. For example, someone aged 36 should aim to contribute 18 per cent each year.

As you are a high-rate taxpayer, you benefit from higher rates of tax relief by making higher pension contributions.

Although mortgage over payments are an important consideration, current low interest rates and the fixed nature of your mortgage mean that it might be better to invest the money currently spent on this over the medium term.

As a lot of the income from your Isa and other investments will be dependent on investment returns, it could be worth getting regulated financial advice on how to form a sustainable investment strategy, and ongoing advice as your circumstances change.

To effectively plan for your children's education costs, you need to consider the costs of private secondary education between the ages of 11 and 18, and university courses, which tend to be for three years in England.

The average private school fee is £13,700 a year and has been rising roughly 5 per cent each year since 2002. University tuition fees are £9,250 a year but, unlike school fees, you can cover this cost via student loans without impacting the student’s credit score. In many cases, it is more financially beneficial to take out a student loan than pay university fees outright each year.

Your current education fund of £20,775 is invested in a passive fund. But as the average cost of sending two children to private school for seven years is about £223,091, you may want to try a more aggressive investment approach to target higher returns. And as it is likely that you will have to fund some of the costs of private education from surplus earnings or reduced savings, this will impact your ability to save enough to retire on £50,000 a year at age 65. So you need more detailed analysis to weigh up the pros and cons.

Junior Isas are the most tax-efficient savings vehicle for children, and you can currently contribute up to £9,000 a year to them until the holders are age 18 and can access them. As your children are ages six and three, investing the component you hold in cash could boost the existing funds by around £450 per Junior Isa.

Junior Isas can be transferred into adult Isas as cash or investments when the holder turns 18. If the assets are to be spent on starting a business, a traditional Isa would be best. But if the assets are going to be used as a deposit to buy a home, I suggest a Lifetime Isa (Lisa). Contributions to Lisas are are boosted by the government, although if you withdraw the funds prior to age 60, other than to buy a home, it incurs a 25 per cent penalty.

If the assets within Lisas are likely to be used within five years cash is a safer choice. However, current levels of interest rates and inflation could erode the value of cash over longer periods.