[UK] Case study: What to do with surplus income?

[Nadia Edits]

Situation: I’m a WFH freelancer on a single income in the UK, no kids, no car. I’ve been on a low income for a long time, so my net worth is poor. I almost ran out of work and money altogether last summer. Since then, I’ve worked hard to boost my income to an average of £2700 a month net (after taxes, national insurance and student loans) which leaves me with a surplus that I’m keen to use wisely. I’ve hit the limits of my financial literacy and would value any advice.

Monthly budget:
£511 mortgage, rent and service charge on my shared ownership flat
£150 groceries and toiletries
£114 council tax
£76 electricity
£40 water
£35 occasional bus travel
£26 life/critical illness insurance (cancel?)
£22 internet
£16 budgeted to replace laptop every 3-4 years
£11 occasional train travel
£40 miscellaneous small costs (phone, dentist, eye test, subscriptions, etc).
And the real luxury spending:
£150 dining out/bars/socialising (reduce?)
£60 hobby (cancel?)
TOTAL: about £1250

This leaves about £1450 a month for savings. I put £300 a month into my SIPP, £120 a month into my S&S ISA, £100 a month into overpaying my mortgage, and excess money was diverted to my emergency fund until recently.

Assets:
£6k 6-month emergency fund in an easy-access 3.71% interest account.
Self-assessment tax savings are in a separate 3% interest account. I have my current tax liabilities covered and some more on top.
£13k SIPP is invested in various recommended Aviva funds. The SIPP does not get any employer contribution (alas), but does receive 20% tax relief. Performance was -3% in the last two years, which is painful when inflation is running so high.
£18k Hargreaves and Lansdown S&S ISA is invested 50% L&G UK 100, 25% Vanguard Ex-UK Equity and 25% Vanguard 80% Equity.
£102k in my 50% share of a shared ownership flat.
TOTAL: £139k

Liabilities:
£34k mortgage at 1.8%, fixed for 4 more years with another 13 years to run after that.
£22k student loan, which will be written off in 13 years.
TOTAL: £56k

Questions:

• Given the monthly surplus, what should I focus on—overpaying the mortgage, paying into the ISA or paying into the SIPP?
• What should I know about asset allocation? I picked these funds after reading Ramit Sethi’s book, but it was a long time ago and I don’t remember exactly why I chose what I did. I want to invest as passively as possible.
• Can I realistically plan to buy the other half of the flat for around £100k, increasing my housing costs to probably £850 and extending the term to maybe 35 years? It seems insane to borrow four times as much at a far higher interest rate, but I don’t want to be at the mercy of rent and service charge forever.
• Should I cancel my life/critical illness insurance? I have no dependents and could sell my flat and move in with family in an emergency.
• Any idea when I could realistically retire? I will not be able to access my SIPP until age 55 or the state pension until age 68, so my ISA will need to cover any early retirement gap. I’m finding it hard to estimate what my early retirement budget would be when future housing costs are such an unknown.
• Anything else I should know?

Thank you in advance for your thoughtful comments.

[zolotiyeruki]

Since most of the residents of this forum are US-based, it's going to be a bit harder to find useful advice. 

For the ignorant (like me), how do you have both a mortgage *and* rent on your flat?  Most USians are used to one or the other.

One thing to consider about prepaying the mortgage:  if you still owe money, you're in the same legal position whether you owe 30k GBP or 1 GBP.  I have seen several people recommend that, if you wish to pay off the mortgage more quickly, you invest your extra income until it grows to a sum large enough to eliminate the mortgage entirely.  That way, your own equity in the home is less at risk in case it loses value and you have to sell.

Most folks around here just stick with simple broad market, low-fee index funds.  They're a pretty reliable long-term investment.

Who is the beneficiary for your life/critical illness insurance? If it's intended to help your (non-existent) dependent family in case you as the breadwinner are taken out of action, then it's a bit silly to keep it.

[Nadia Edits]

Thanks for your reply!

For the ignorant (like me), how do you have both a mortgage *and* rent on your flat?  Most USians are used to one or the other.

Shared ownership is a part-buy, part-rent model of home ownership for low-income local people who can't afford to buy homes at the market rate. I legally own a 50% share of my flat and the other half is owned by a not-for-profit housing association. I pay a mortgage on my half and rent/service charge on the other half. I can’t be evicted without cause, and I can buy the other 50% share from the housing association (called "staircasing") if I can qualify for a mortgage on it.

If I don’t staircase, I’ll be paying rent on the other half even in retirement, but perhaps I’m worrying unnecessarily about this—the rent is capped and should be affordable.

You make a good point about overpaying the mortgage. I sort of hate the mortgage and gain satisfaction from cutting it down, but that’s money that could go into the stock market. My mortgage allows me to underpay in future to the value to which I’ve overpaid in the past, but I’ve already overpaid so much that I could just stop paying for 6-9 months.

Who is the beneficiary for your life/critical illness insurance? If it's intended to help your (non-existent) dependent family in case you as the breadwinner are taken out of action, then it's a bit silly to keep it.

I agree, I don't need life insurance. (I'm the beneficiary; my adult relatives would inherit via my estate if I died.) It came with the package when I took out critical illness insurance to cover unlikely but catastrophic scenarios—my policy will pay out £100k if I’m diagnosed with cancer, for example. As a freelancer, if I'm too sick to work, I won’t qualify for employer benefits or statutory sick pay, so the outlook would be bleak. I guess it’s an unlikely scenario, and even if it happened the insurer would try their best to deny the claim.

Perhaps I’ve been overly cautious and should just focus on those index funds. I appreciate the insight.

[InterfaceLeader]

You might have more luck posting in the UK Discussion forum, where you'll get more UK specific advice.

Congratulations on increasing your income so much.

I personally wouldn't overpay the mortgage, particularly as its fixed for another 4 years. I would focus on your SIPP (maybe review the funds) as that seems quite low compared to your ISA. Some people approach it as SIPP + State Pension from 68, SIPP alone 55-68, and ISA ??-55. And figure out an amount they need to cover each of those periods.

[Nadia Edits]

I personally wouldn't overpay the mortgage, particularly as its fixed for another 4 years. I would focus on your SIPP (maybe review the funds) as that seems quite low compared to your ISA. Some people approach it as SIPP + State Pension from 68, SIPP alone 55-68, and ISA ??-55. And figure out an amount they need to cover each of those periods.

Thanks for the tips! I'll definitely review the funds the SIPP is invested in. All I remember is that the pension firm had a "guided setup" that asked me about my appetite for risk and then directed me to certain funds. It definitely doesn't seem to grow like my ISA does.

(Did you know the normal minimum pension age is going up? Looks like I won't be able to access my SIPP until age 57, which means the ISA will have to do some heavy lifting before then.)

[Kwill]

There are a few UK-based people here.

I have a shared ownership flat but with a slightly different setup because my employer owns the other part, rather than the housing association. I chose to overpay as much as I could for the five years I've owned it because I thought that reducing my existing mortgage would put me in a better position to qualify to take out a big enough mortgage to buy out the other part. In the end, I'm not sure if that was the right decision because I'm now selling the flat and moving to the US to take a different job. Overpaying reduced the amount of interest I paid, and I'll get back what I put in because the flat increased in value. But if I had known I would be here five years instead of thirty, I might have done things differently.

[Nadia Edits]

I have a shared ownership flat but with a slightly different setup because my employer owns the other part, rather than the housing association. I chose to overpay as much as I could for the five years I've owned it because I thought that reducing my existing mortgage would put me in a better position to qualify to take out a big enough mortgage to buy out the other part. In the end, I'm not sure if that was the right decision because I'm now selling the flat and moving to the US to take a different job. Overpaying reduced the amount of interest I paid, and I'll get back what I put in because the flat increased in value. But if I had known I would be here five years instead of thirty, I might have done things differently.

Excellent point, thank you. I like my neighbourhood, my city and my friends, but it's not impossible I might want to move some day, especially as I have a fully remote job. I do dream of living somewhere more rural some day, but I don't want a car - rural places can be so car-dependent.

PS: Congrats on your new job and move back to the US.

[Nadia Edits]

I made the jump to Vanguard today:

• The woefully underperforming pension is now invested in a Vanguard target date retirement fund, currently set to retire at state pension age, although I might move that date up.
• And the S&S ISA is invested in the Vanguard Developed World Ex-UK Equity Index.
• I also cancelled the mortgage overpayment and diverted it into the S&S ISA.

I'm debating if I should take out a Lifetime ISA to take advantage of the 25% uplift the government provides. However, you can't take that out until you're 60 (unless you're buying your first property, which I already have). I see the different retirement options are sort of staggered - the state pension kicks in at 68, the LISA would be accessible at 60 earliest, and the SIPP will be accessible at 57 earliest. If I want to retire before that, it's all on the S&S ISA.

[Affable Bear]

I cant remember why but when I looked at LISA's when they came out they didnt make sense over a SIPP or ISA unless you are a first time buyer.. Worth a look I think but something put me off them and I dont remember why!

I think your income to expenses ratio is fantastic, it is a struggle to hit 50% of your take home that you can save/invest (potentially more if you are using the tax advantages of a SIPP) thats hard enough in itself congratulations!! You have mastered the art of frugality and I think you are now seeing the benefits of increasing your income. If you can bump your income even higher and hit 60/65% you could potentially have enough to retire very quickly! Although do remember to keep a nice work life balance as it is a marathon not a sprint and you dont want burnout.

I am 33 and my wife is 27 and we are both personally putting significantly more into our S&S ISA than our pensions/SIPPs but once we are a bit older and in our 40s we will probably start putting a lot more into our pension/SIPP, hopefully at that age we have had a few wage rises and can benefit even more from the tax advantages.

It is a difficult balance, your SIPP will have a lot longer to compound over time plus an additional 7 years while you are living off your ISA so you can get away with not putting as much in at the start. Your ISA will need to be more aggressive in general otherwise you wont have enough to bridge the gap but if you have enough time it should have some time to compound allowing you the ability to pump your pension for a few years before you retire. 

[Nadia Edits]

Another good month, bringing in about £2900 after tax.

I think your income to expenses ratio is fantastic, it is a struggle to hit 50% of your take home that you can save/invest (potentially more if you are using the tax advantages of a SIPP) thats hard enough in itself congratulations!!

Thanks for the kind words! I admit I'm not always as frugal as this budget suggests—I definitely overspent a bit this month with an extra dentist appointment, additional bus travel, and some unnecessary food spending. That said, I've always been a low spender with low-cost hobbies.

You make great points about feeding the ISA now and the SIPP later. I'll plan to prioritise the ISA for now so I can continue to dream of early retirement.