RUNNING your own business can be very
worthwhile. You determine your work patterns,
there’s less of a limit on your earnings and you
are master of your own destiny.
Individuals in your position, however, need to be
very diligent in planning ahead for the rainy days that
will undoubtedly come. More importantly, you’re
more than
likely going to
want to retire
at some point
and that
means
creating some
form of
future income
stream.
Statistics from the National Association of
Pension Funds published in December 2012 indicate
that many in their 50s are “sleepwalking into their old
age”: 60% were found to have not thought about the
length of the retirement that needs to be financed,
and one in four aged between 50 and 64 needed to
save an extra £60,000 before retirement to realise the
income that they need or expect.
Now consider that the employed have the “safety
net”, albeit limited, of unemployment benefit,
healthcare, redundancy payments, perks and so on.
It’s all frightening stuff.
You need to think about how you’d maintain
yourself for, say, six months, if income were to drop, and beyond if you don’t want to work until you drop.
LONG-TERM
Pensions
A pension is a tax-efficient method of deferring
income that through investment should (hopefully)
grow. Clearly, the longer the pot has been paid into the better it should be
because not only will
more have been paid
into it, but any peaks and
troughs in the market
should have been
flattened out.
It doesn’t take a
degree in economics to know that smaller amounts regularly paid over a
longer period of time will be more rewarding and
less painful on the pocket compared to the efforts
required of late starters.
Hargreaves Lansdown offers the example of 22-
year-olds saving 10% of their
£26,000 salary. With a healthy 6%
growth in the investment, they’ll realise a pension pot of £523,000.
Starting at age 30, the pot would
only be £313,000 and starting at
age 40 the pot would be a paltry
£156,000.
A key change that both
employers and employees need to
be aware of is pension auto-
enrolment. It’s a change in the law
that is being rolled out over the next five years that affects those aged over 22 earning
(at present) more than £8,105 a year.
Effectively, those affected will be automatically
enrolled into a workplace pension where employers
will need to contribute at least 3% of employee
earnings. Employees can opt out if they want to. By
February 2018, all employers and employees will be
part of the scheme. More information is available
from the DWP website at http://bit.ly/wQVkgw.
Pensions are tax-efficient – employee
contributions are given tax relief at the employee’s
highest tax rate and businesses can offset
contributions against corporation tax – and the pot
will grow in a fund that is largely tax-free.
In retirement, individuals can take 25% of the
pot as a tax-free lump sum. The remaining balance
must either be used to buy an annuity – a guaranteed
regular income for life – or they can leave the money
invested, at the whims of the stock market, and make
regular withdrawals. This is, of course, more risky.
In general, money paid into a pension is restricted
in that it cannot be touched until age 55 at the earliest (under tax
law). But for employees, where an
employer makes a contribution to
the pension it should be a “no-
brainer” that the pension route is
the way to go.
ISA
One alternative to a pension is an
ISA. Unlike a pension, money is
paid into an ISA without any tax
relief. However, the investment grows and is paid tax free. Further,
and this can be an important part of
the calculation for someone who is
effectively self-employed, it’s a discrete
investment that can be tapped into for
an emergency – say extreme financial
distress or the need to
buy urgent lifesaving
medical treatment –
without having to wait
until retirement.
There are two types
of ISA: cash and
stocks and shares. At
present you can invest up to £11,280
per year in an ISA, of which no more
than £5,640 can be held in cash. Any
unused allowance in each year is lost.
It’s worth knowing that the interest
rate on cash ISAs varies and tends to
be higher around the start of the tax
year when the providers want to attract
investors.
There’s a very good guide from
Moneysavingexpert.com (see
http://bit.ly/hiLA0r) on the dos and
don’ts of an ISA.
Mortgage
Depending on the rate of interest on
any mortgages that you have, it may
make sense to make over-payments
rather than relying on paying the
mortgage off over the contractual term.
Let’s take the example of someone with a £125,000 repayment mortgage
over 25 years on an interest rate of
5%. An extra £100 per month will clear the mortgage five
years and four months
early, saving some
£22,384 in interest.
On the same
mortgage, an over-
payment of £500 per
month will clear the
mortgage 13 years and
11 months, early saving £43,084 in interest.
Work the numbers
for yourself and your circumstances
with an online calculator at
http://bit.ly/10BhaqK.
Also consider an offset mortgage
that offsets any savings against the
outstanding mortgage balance, thus
lowering the interest owed. However,
offset mortgages need discipline if
you’re not to lose track of debt or
savings.
Of course, part of the equation is
whether you can spare the cash, what
else you need the money for and also
the rate of interest different
investments return.
If you’re lucky enough to be on a low standard variable rate (say 1 or 2% above base rate) because your fixed rate expired, then over-paying your mortgage may
not yield results
that compare
favourably to
other
investments (say
ISAs). This is
where you need
advice from a
decent financial
adviser.
SHORT-TERM
Save for tax
Those running their own business
have the added benefit of being able
to use the tax system to their
advantage. Why? Because unlike the
employed who have tax deducted by
employers at source, the self-employed
and companies pay tax and VAT in
arrears.
Since the tax needs to be paid no
matter what – the penalties for not
paying aren’t worth thinking about – it
makes sense to put all of the money
aside so that it’s ready for payment on
demand. However, that cash can be
made to work.
General savings
Sadly, interest rates aren’t great as a
result of the government’s injection of
very cheap cash into the banking
system which means that banks don’t
need to pay as much to attract our
savings. However,
savingschampion.co.uk offers a suite
of tools to help you get the best rates
for your cash.
Other options include opening a
Lloyds Vantage current account (you
can have up to three of them). Paying
in at least £1,000 per month will earn
you 3% on the full balance if the
account holds between £3,000 and
£5,000; First Direct offers 8% on
regular deposits of between £25 and
£300 per month – note that the
account is annual; and Santander 123
not only pays interest of 3% on the
full balance if the account holds
between £3,000 and £20,000 but also
pays varying amounts of cash back on
certain direct debits. There is,
however, a £2 per month account
charge.
Card tart
Also consider being a “card tart”
where you constantly take advantage
of interest-free credit cards. You’ll
need to be disciplined to put the
“spent” money on one side in a good
interest-bearing account, and diarise
when the interest-free period ends so
that you pay the bill in good time.
As an example, finding a card that
gives you £5,000 interest-free over one
year can give you an extra £120 (after
tax). At the time of writing, the best
deal is from the Halifax and offers 0%
on spending for 17 months.
On a balance of
£5,000 you would net
£191 (after tax) in interest.
Again, you can work it all
out for yourself at
http://bit.ly/13GMZND.
Find a good adviser
Few of us are expert
enough or endowed with
sufficient time to know
how to invest properly.
Indeed, experts themselves still get it
wrong when their crystal balls fail.
However, they will certainly have a
better steer on what’s good and bad,
knowledge of the terminology and the
facts and figures to establish which
investments based on past
performance have done well.
Advice isn’t necessarily cheap and
it certainly isn’t free. While you may
not have been handed a bill from your
adviser for anything you’ve bought in
the past, you’ll have certainly been
paying a behind-the-scenes
commission from the investment
holding company to the adviser each
month from your payments.
But that arrangement changed on
1st January 2013 as the market saw the
introduction of the Retail Distribution
Review (RDR) by the FSA. Simply
put, the RDR aims to reinvigorate
trust in financial advice by ensuring
that independent advice is just that:
that investors can identify and
understand what they’re being offered;
that commission-free bias is removed
from the system with advisers not
influenced by their commission; and
that investors can see precisely what
advisers are being paid.
What does this mean? You will
now be paying for advice through an
up-front fee and so should have
confidence in the products
recommended knowing that the
adviser is not getting any commission
(except for mortgage and insurance
advice where the old system still
operates) on any recommendations.
How do you find a good adviser?
Ask around for recommendations but
make sure that you look for an
“Independent Financial Adviser” – it’s
a legal term with a distinct meaning.
Alternatively, two websites –
vouchedfor.co.uk and unbiased.co.uk –
will help you find someone you
should be able to trust. Certainly don’t
speak to a given bank or building
society as they can only sell their own
uncompetitive products.
Lastly, a government backed
organisation, the Money Advice
Service, offers plenty of free and
independent advice and guides. See
http://bit.ly/PBrjMc. It’s well worth a
root around.
Whatever you choose to do, you
must do something. The State will not
provide.
