Help us save £10,000 for our kids
After tax, Graham, a local government officer, brings home £28,807, while Alex earns £8,825 a year. The Smiths have a 5.8% fixed-rate mortgage with the Co-operative Bank and repay £723.35 a month. Their outstanding mortgage balance is approximately £110,000 and their home is worth around £300,000.
The couple have a total of £25,543 across seven savings accounts with various banks, several of which are earmarked for Rosie and Daniel's future. They also have an ISA each, with a combined total of £5,317.
Much of their savings come from a £45,000 inheritance received in 2008, followed more recently by an additional £10,000 inheritance. The Smiths have a child trust fund for each child with the Children's Mutual. Rosie has £1,059.91 in her CTF and Daniel has £443.71.
Alex and Graham have single life insurance policies with Legal & General. Alex pays a monthly premium of £9.60, while Graham has a monthly premium of £8.94.
Alex has a combined pension pot worth £15,779, but currently makes no contributions. Graham has a final salary pension scheme through work and contributes £233.85 towards it each month.
Alex says their main financial aim is to invest wisely for their own and their children's future without compromising their current lifestyle.
One of the Smiths' main objectives is to provide their children with the equivalent of £10,000 of today's money when they reach 18.
Francis Klonowski, an independent financial adviser at Klonowski & Co in Leeds, calculates: "With assumed inflation of 3.5%, £10,000 at 18 would mean £15,444 for Rosie and £17,583 for Daniel. If the Smiths maintain their current level of savings, the amount they set aside for each child would reach £33,728 and £36,850 respectively, assuming a cash growth rate of 3%."
He notes that the couple have been cautious in investing their inheritance up to now, as they didn't want to fall foul of the stockmarket's ups and downs. But they are now prepared to take more of a risk in return for higher growth.
Alex and Graham say they would prefer to invest in ethical funds, so Klonowski suggests they look at Triodos Bank, which is Dutch-owned but has a UK branch in Bristol.
"It offers a range of accounts to meet various ethical criteria, and its Young Saver account is worth considering for the children's deposits."
Klonowski advises them to take on additional risk gradually: "It's better to invest monthly rather than risking a large sum – so you buy units or shares in your chosen funds at different prices, and when there is a fall in value [of the units or shares] your monthly savings buy more."
The easiest way for the Smiths to gain access to the stockmarket is through stocks and shares ISAs. Until 6 April 2010, the ISA allowance is set at £7,200 each, of which £3,600 can be in cash. After 6 April, this will increase to £10,200 each, £5,100 of which can be put into a cash ISA.
"Alex and Graham should use their full cash ISA allowances," says Klonowski. "They shouldn't invest their present deposit accounts or their extra inheritance as there are a lot of potential demands for this money."
For example, the Smiths say they would like to do more work to their house and are likely to replace their car within the next three years.
Both Alex and Graham should also make wills at the earliest opportunity, according to Klonowski. Without a will, an individual's assets do not automatically go to their surviving spouse; they will be dealt with under the laws of intestacy as part of the deceased's estate.
"Even if the survivor eventually receives the assets, the process is longer and more complex than it would be with a valid, up-to-date will."
While both are covered by life insurance, neither of the Smiths have insurance to cover them if they fall ill.
Klonowski says: "They currently need both incomes to meet their normal outgoings, and if long-term illness forced either of them to stop working or reduce their earnings temporarily, they wouldn't be able to maintain their current standard of living or meet their plans for their children's future."
He suggests they set up income protection plans to provide the maximum cover – usually about 60% of their income. These should be written to age 60 and cover should commence after six months of illness.
This means that Alex and Graham will have to have a contingency fund in place to cover the first six months of reduced income, but deferring any payout will ensure premiums remain low.
They should also arrange a joint critical illness insurance policy to cover their outstanding mortgage.
The Smiths' mortgage is due to be reassessed in May this year. Klonowski says: "Rather than repay a large sum, they should use any surplus income to make larger monthly payments. They can hopefully arrange this through their new mortgage deal."
Under his final salary pension scheme, if Graham worked until 65 he would have a maximum pension of 40/80th of his final salary. If, however, he retired at 60, as he hopes to, he would get 35/80th, or £17,045 in today's money.
Klonowski says Graham should think about the penalties he will incur for taking the benefits before normal retirement age. Assuming 3% for each year, this would reduce his pension by 15% to £14,488.
His tax-free lump sum would also reduce – Klonowski estimates it would be £43,465.
However, he believes the Smiths can still accumulate enough for Graham to retire at 60: "From the age of 66 – when state pensions are paid – their total net income would be much higher than their expenditure, so the shortfall they will have to meet from their capital will only apply from ages 60 to 66."
Klonowski also advises Alex to move her combined pensions to a low-cost self-select pension plan, and use her business income to make regular contributions, starting at £100 a month.
The Smiths found Klonowski's advice very helpful. "It was painless but very thorough," says Alex. "He put a different spin on things. It's great to have someone looking at your finances from a more objective viewpoint."
Alexandra's To–Do List:
1. Write wills as soon as possible
2. Look into investment opportunities to suit increased appetite for risk
3. Set up income protection and critical illness insurance plans
4. Arrange a new mortgage deal with larger payments
Francis Klonowski is an independent financial adviser at Klonowski & Co in Leeds. Visit klonowski.advisernet.co.uk or call 0113 273 5255.
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).
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
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.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
Critical illness insurance
This cover pays out a tax-free lump sum if you become seriously ill. All policies should cover seven core conditions: cancer, coronary artery bypass, heart attack, kidney failure, major organ transplant, multiple sclerosis and stroke. You must normally survive at least one month after becoming critically ill, before the policy will pay out. Payouts are determined by premiums and premiums are determined by the severity of your illness, the less severe the lower the premiums.
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.