In pursuit of Financial Independence

Peter Culnane, Head of Pensions

Financial independence can mean different things to different people but, strictly speaking, financial independence means having the personal financial resources to create your own income or capital to meet your requirements. The expression “financial independence” has historically been associated with wealthy individuals because the task and responsibility of seeking it did not apply to many individuals whose workplace pensions often ensured that they would have sufficient income in retirement.

The landscape over the last 30 years or so has changed dramatically, as most private sector enterprises have ceased offering their employees any form of guaranteed income in retirement. This demise in guaranteed pension arrangements, known as “final salary” or “defined benefit” schemes, has also transformed the workplace in terms of staff longevity and loyalty and led to a significant increase in the demand for alternate means of saving for the future.

The only workplace left that offers new workers any form of pension scheme that guarantees the eventual benefits paid, based on years in service, is the public sector. Whilst some private sector enterprises, typically in financial services, still have ageing workers who may have an element of guaranteed pension benefits, the vast majority of the island’s workforce are the first generation to have to face the significant challenge of, in the absence of historic guarantees, seeking financial independence.

Until an individual can achieve the ability to independently create some form of income, then they will have to rely to some degree on external financial means, such as employment. This, in turn, will inevitably lead to a significant increase in employees working later in life than they may have planned for. With the concept of “normal retirement dates” becoming surpassed by the requirements of employees to work later in life, the need for Government support in the form of education, sensible initiatives and continuing tax incentives, coupled with trusted independent financial advice from the private sector, has never been in greater demand.

Formal pension saving is just one of many options open to individuals seeking greater financial security as they get older, but most pension regimes enabled by governments around the world tend to lend themselves to the task more suitably, by design.

Jersey, like many advanced economies, has adopted a variation of the World Bank’s “3 Pillars” approach to providing a framework for pension provision amongst the population; namely:

1. The FIRST pillar is intended to provide a safety net for the elderly, financed through Social Security contributions on wages, in the form of a Government of Jersey Pension. Current rate of a fully funded single person’s state pension is £13,176 per annum;

2. The SECOND pillar is to supplement first-pillar pension benefits through contributions deducted from wages by employers into “defined contribution” pension pots for each staff member; and

3. The THIRD pillar is designed to comprise private retirement savings options, with Government involvement limited to regulation to ensure appropriate conduct and potential investor protection.

Whilst the first pillar is taken care of via Social Security deductions, many island residents do not qualify for the full amount as their contribution record in Jersey is not complete by the time they reach State retirement age, due to having not lived and worked in Jersey all their life. Contribution records can be checked via the Government’s Customer and Local Services Department, if anyone is concerned about a shortfall.

There are still a number of employees in Jersey, whose employers do not provide second pillar arrangements, but this is currently being addressed by Government, following the recent announcement of a commitment to introducing obligatory workplace pensions. A review of the island’s legal and regulatory framework for pensions has been underway for some time, with the aim of providing a more trusted environment for employers to fulfil the island’s second pillar requirements.

This leaves the third pillar for islanders to voluntarily take advantage of the flexibility of investing their savings in a manner that they choose, for example, in an environmentally sound manner, enhanced by the tax relief afforded. It is worth highlighting that £1 invested by an individual without tax deducted in an approved scheme is the equivalent of an immediate 25% return on the equivalent 80p invested in an individual’s net of tax income [assuming a tax rate of 20%]. That is also before the compounded effect of any re-invested income generated, that is also not subject to additional income tax.

Clearly, there are rules and thresholds that apply to all approved pension schemes that restrict when and how you may benefit and so it is vital that independent financial advice is sought to ensure that any approved scheme used, is suitable. The financial advisory community in Jersey remains buoyant and recognises the scale of the help that islanders need in planning for financial independence, with a significant amount of investment in technology and qualified staff in recent years, as was demonstrated during the recent pandemic.

Planning for retirement when you are young is always tomorrow’s problem, but if you have the discipline to save, however limited, on a regular basis, then task of doing so is spread over a considerable period a time and a significant part of the value eventually created is done so through compounded growth over that period. Furthermore, regardless of your age, saving regularly (e.g. monthly) enforces a different type of discipline; one that removes the emotion that many individuals experience when making investment decisions, particularly when markets become highly volatile. This method of investing is known as “pound cost averaging” on which much commentary has been made by the savings industry and has helped in yielding better returns over longer periods of time.

These disciplines can of course be applied to any form of saving or investment but, subject to suitability, use of an approved pension arrangement should be given close consideration as to whether it can complement or enhance the journey to financial independence.

In summary, when planning towards the goal of financial independence, don’t delay, maintain regular discipline, take independent advice and make the time to understand how tax relief can enhance your returns, where appropriate.