Save thousands by planning ahead
Whether it’s a last-minute weekend away, an invitation to the newest restaurant in town or a surprise visit from friends or family, life has a wonderful habit of throwing up unexpected events. But while these surprises often involve unexpected expenses too, there are plenty of key events for which you can plan financially.
It makes sense to be financially prepared for the ‘biggies’ like buying your first home, starting a family or retiring. Having cash ready to hand means you won’t need to borrow so much, so you will save on interest charges. More importantly, it will leave you free to focus on the positive elements, rather than worrying about whether you can afford it all.
The first big financial event most of us will face is leaving home. The sense of independence can be liberating, but it comes with a number of financial responsibilities, such as paying the rent and household bills, as well as finding the cash for food, clothes and entertainment.
Working out a budget is key to dealing successfully with your new-found freedom. List your income and then your expenses, starting with the essentials such as rent, utilities, council tax and food; anything you have left is spending money.
“It only takes a couple of minutes a day to monitor what you’re spending,” says Martin Bamford, chartered financial planner at Informed Choice. “Keep an overview of the bigger picture too. Do you pay for your car insurance annually? Should you save for a holiday?”
He also recommends you leave a bit of room for manoeuvre in your budget: “If every penny is accounted for, there’s no room for error or an unexpected bill.”
Even if money is tight, it’s worth trying to put some aside in case of an emergency. The amount you’ll need to save will vary, but Julie Bayley, independent financial adviser at Keswick IFA, advises: “Think about how long it might take to get another job, and try and save enough to cover this period.”
As well as giving you protection against potential ‘nasties’, your emergency pot could also fund future plans such as buying a car or a mortgage deposit.
Nick O’Shea, director of Canterbury-based IFA Pharon, recommends keeping your emergency pot in savings-style products so you can access it whenever you need to. “Use your cash individual savings account allowances first, then consider other tax-efficient savings vehicles such as NS&I savings certificates,” he says.
Putting money aside in this way could save you hundreds of pounds. For example, if you save £200 a month to buy a car in an ISA paying 3%, you would have £4,952 after two years. On the other hand, according to the AA, if you took out a loan for this amount, you would repay £245.83 a month at an APR of 15.9%.
This would cost you £5,899.92 – that’s £1,099.92 more than if you had saved the cash.
Getting on the property ladder
Getting the keys to your own home represents a major step in life. “It’s worth saving for a decent deposit,” advises Ray Boulger, senior technical manager at John Charcol. “Rates start to increase if you want to borrow more than 75% of the value of a house; you could end up paying a couple of percentage points more on your mortgage.”
Boulger also recommends beefing up your credit rating: “Get on the electoral roll; take out a couple of credit cards and regularly clear them; and keep an old current account open to show your track record.”
Protection is also important, particularly as your home could be at stake. Chris McFarlane, head of protection at LV=, recommends income protection and critical illness cover and life insurance: “Check what you get from your employer first. But the younger you are, the cheaper the premiums.”
For example, a 25-year-old male non-smoker would pay £10.29 a month for income protection at £750 a month, and a 45-year-old non-smoker, £21 a month.
Moving in together
Getting married or moving in with a partner is another stage in life that can benefit from financial planning. One of the most common causes of arguments between couples is money, so it can make for a more harmonious life if you’re upfront about finances from the start.
Just about every financial product is available in a joint version, but it’s not always the best option. “If you have a joint debt, like a mortgage or credit card, both parties are jointly and severally liable for it. If one of you defaults, you’ll both end up with a bad credit record,” warns Boulger.
Another product that can be less advantageous as a joint plan is life insurance. While it’s sensible to take insurance out to ensure your partner is looked after if you should die, it’s often better to take it out on a single life basis.
“A joint policy will be slightly cheaper than two singles, but you’ll only get one payout,” explains Owen Temple, director at Eldon Financial Planning. “This is fine if you’re covering a debt such as a mortgage; otherwise, it’s usually better to take out separate cover.”
Amandeep Gill, a partner at law firm Davenport Lyons, recommends a pre-nuptial or post-nuptial arrangement: “Post-nuptial financial arrangements carry more weight legally, but couples are increasingly taking legal advice on both pre- and post-nuptial arrangements. It helps to set clear expectations and makes people think through the legal consequences of marriage.”
For either arrangement to be accepted by a court, both parties must have first sought independent legal advice. “The cost depends on the amount of work involved, with each arrangement tailored to the needs of the couple,” adds Gill.
Marriage can also bring financial pluses. With two of you sharing the bills, there’s likely to be more spare cash, and it’s prudent to invest some of this for the long term.
“Take advantage of each other’s tax allowances,” says Temple. “If you’re married, capital gains can be passed between spouses to reduce the tax bill. And put savings and investments into the name of the person paying the lower rate of income tax.”
Starting a family
Children are a serious financial commitment; LV= calculates the cost of raising a child to the age of 21 as £194,000. “Start thinking about the financial implications before you have children,” advises O’Shea. “Look at how much maternity pay you would get and start budgeting for any loss of income now.
Mortgage holidays are widely available - although they’ll add to the overall cost of the loan, they can give you valuable financial breathing space.
Once your baby’s arrived, it makes sense to start saving for their future too. Even if they don’t go to university, the chances are they’ll want help with a mortgage deposit or new car.
Child trust funds no longer receive the government contribution they used to, but you can still use one started before the government announcement in May to save for you child.
Next year the government plans to launch a junior ISA, but details are yet to be released on the maximum you will be able to put in each year.
Until then, you might want to invest for your child in your own name, using your ISA allowance where possible.
There can be all sorts of reasons for seeking a divorce, but whatever drives you to separate, there are almost always finances to unravel.
A solicitor will help divide any assets such as the house, pension and investments in a way that’s fair to both parties. Your children’s interests will be taken into account and, in most cases, maintenance will be paid to the parent assuming the main responsibility for their care.
Maintenance may also be awarded to one of the ex-partners, especially if they gave up a career to bring up the children.
When it comes to splitting assets, Bamford recommends getting financial advice alongside legal advice. “Solicitors will often look at the pension in terms of the transfer value, but this isn’t very accurate,” he says. “An IFA will be able to give you a much better understanding of the value of your assets.”
You will also need to separate any joint assets. Remember, both of you are jointly liable for any debt, so you both stand to gain a poor credit record if one of you defaults.
It’s relatively easy to get a bank account, savings plan or credit card transferred into your own name, but you might find it harder with products such as life insurance.
“If you’ve had a joint life policy, we can offer the option to take the same cover on a single life policy under our guaranteed insurability option,” says McFarlane. “However, it will cost more than you paid for your half of the joint policy.”
Finding a mortgage can be even harder, especially if there wasn’t much equity from the marital home. “It can be like starting all over again,” says Bamford. “But if you sort out your budget, this can help you get back on your feet financially.”
Easing into retirement
One of your key concerns as you approach retirement will probably be the size of your potential income. But with annual contributions capped at whichever is lower, your annual earnings or £255,000, there should be plenty of opportunity to catch up.
“There’s some debate about whether you should put as much as you can into your pension or not,” says Bob Perkins, technical manager at IFA Origen.
You should make sure your pension is secure. “If you’re a few years away from retirement, start switching your pension fund into cash or low-risk investments to protect it from stockmarket falls,” says Perkins. And when you’re in the last year before taking an annuity, he recommends putting it entirely into cash and fixed-interest securities.
It’s also worth checking your partner’s pension provision. “Both of you will get tax allowances in retirement, so if you spread the pension, you’ll receive more untaxed income,” says Temple.
And don’t just take the annuity your pension company offers you. “There’s a wide range of enhanced annuities now, which give you a bit extra for anything from a serious health condition to your postcode, so shop around,” says Temple.
Don’t overlook other savings and investments, either, when considering your retirement income. For example, an equity income ISA will produce untaxed income, and you won’t need to worry about capital gains tax if you do cash it in.
Preparing for death
Death is the one great certainty for all of us – but if you’re financially prepared, this will make life a lot easier for those you leave behind. Bamford advises: “Make a will that reflects your wishes, and ensure that the relevant people, who might be your partner, children or solicitor, understand your financial situation.”
You may also want to consider how your death will benefit the taxman. Inheritance tax is payable at the rate of 40% of assets over the nil-rate band (£325,000 in 2011/2012).
“The introduction of the transferable nil-rate band between married couples and civil partners has lessened the problem significantly, but many people are still facing IHT bills,” says Perkins.
However, there are ways you can reduce the bill, including annual exemptions such as a gift of up to £3,000 in any one year and wedding gifts. “Don’t overlook gifts out of your income – as long as they are regular and don’t affect your standard of living, they can be a good way to reduce your estate,” adds Perkins.
If the value of your estate is only dented by these steps, you can set up a trust scheme to ensure your assets go to a loved one without creating an IHT liability, but these are very complex vehicles, so make sure you get financial advice.
You will also need to ensure your partner is left with enough to live on after you die; increasing your savings or taking out life insurance could help bump up their future income.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
The cash equivalent transfer values (CETV) is an assessment of the total accumulated cash value of a pension you will be able to take out of your existing pension and move into a new one should you change employers or decide you want to move to a more flexible scheme with greater benefits and lower administration costs. The transfer value will depend on the trustees of the pension fund assessing your contributions and investment growth to determine the transfer value, which may have to be certified by the scheme’s actuary.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.