Turn the downturn to your advantage
It’s no secret that the UK economy is in dire straits. After years of strong growth, the credit crunch in the US triggered economic meltdown around the globe, pushing stockmarkets into freefall, sending businesses to the wall and putting more and more people out of work.
The figures for the UK economy don’t make for pleasant reading. The FTSE All-Share has plummeted from its 2008 peak in May, and despite a rally this year, was still down by 33% at the end of June. We’ve also seen major names, such as Woolworths and MFI, disappear from our high streets – victims of the recession. And in the job market, the latest figures show that 2.44 million people were unemployed in the UK at the end of June.
But, while these are certainly worrying times, there are a number of ways you can turn the current doom and gloom to your advantage. In this article, Moneywise brings you some useful financial planning strategies to help you survive the recession and boost your finances.
YOUR OWN ECONOMY
Whatever the state of the global economy, the way you handle your personal economy is likely to have a much more significant effect on your financial wellbeing.
“Look at your spending habits,” says Bob Perkins, technical manager at Origen Financial Services. “There could be ways to make savings that will free up some spare cash.”
The best way to get an objective view of your financial affairs is to draw up a budget showing your income and outgoings. There are plenty of online tools to help with this, including Moneywise’s own budget planner.
Armed with the figures, it’s possible to identify areas where you can make reductions. For example, you could cut back on luxuries such as dining out, beauty treatments or takeaway coffees, or downgrade some of your spending by shopping in a cheaper supermarket or buying more ‘own label’ foods.
Once you’ve freed up some extra cash, consider tackling any debts.
“Get rid of your debts. Without the interest on these, you’ll really notice a difference to your finances,” says Ray Boulger, senior technical manager at mortgage broker, John Charcol. “Pay back your most expensive debt first. Although it might be difficult to increase repayments on an unsecured loan, there’s nothing to stop you paying off your credit card as quickly as you can.”
In addition to reducing your outgoings and clearing debts, it’s a good idea to review the financial products you own.
“You can save plenty of money by shopping around,” says Cathy Neal, senior researcher at Which? Money. In particular, it pays to do this with your insurance.
“You can usually save money with a new insurer when you come to renew your policy,” she says. “Use a few of the comparison websites to get the best deal, as they do hold different rates.”
Comparison sites - including Moneywise's Compare & Buy service - are useful for this, but one or two players, notably Direct Line and Norwich Union, don’t put their details on these sites, so get quotes directly from them.
As well as cutting the cost of the products you use, check whether you’re wasting money paying for services that you don’t need.
“Mobile phone cover is pointless; your phone could be covered by your home insurance,” says Neal. “Likewise, ID theft insurance can cost as much as £90 a year, but it won’t stop your identity from being stolen, and if it is, you can get your money back anyway through the Banking Code.”
Also on Neal’s hit list are extended warranties, because of the small probability of actually needing to claim; excess insurance, which is designed to pay the excess on another scheme, but can cost more than it would to reduce the excess on the original scheme; and payment protection insurance, which, as well as being limited and full of exclusions, can be more expensive than income protection insurance.
Packaged products can be another unnecessary drain on your finances. For example, in exchange for a monthly fee of anything up to £17, you can get a current account with a variety of extras, such as discounted loans and insurance, travel insurance and ‘money-off’ white goods.
“It’s fine if you use these features – for instance, older people might get value from the travel insurance. But most people don’t use enough to cover the monthly fee,” says Neal. And even if you do use the features, you’ll often find cheaper and more comprehensive deals on standalone products.
GET A SAVINGS HABIT
With the base rate so low it’s easy to ignore your savings and the paltry interest rate they’ll receive. But, according to Kevin Mountford, head of banking at moneysupermarket.com, you’ll be handsomely rewarded for paying them some attention.
“Although rates are low, the gap between the average rate and the best rate is wider than ever. If you have a balance of £10,000, bagging the best rate can be equivalent to earning an extra £400 a year,” he says.
Some of the best rates are available if you’re prepared to leave your money tied up for a year or more. But Mountford says it’s not necessary to lock up your money. “Instant access accounts have become much more competitive recently,” he says.
Also, use your tax-free cash ISA annual allowance, if you haven’t done so yet.
Falling house prices and the credit crunch have taken the sheen off the property market, but for many homeowners the current market conditions offer fantastic opportunities.
“A sizeable minority of people will be on deals that allow them to take advantage of the low base rate,” says Boulger. These include people on base rate trackers, as well as those with low standard variable rates.
“These people are in a great position to overpay,” says Boulger. “But this is only worth doing if other more expensive debts such as credit cards are cleared first. Additionally, it’s much harder to borrow now, so if you’re planning a major purchase in the next few years – for instance, a new car – you might prefer to put the money into savings so you can access it later.”
However, overpaying can seriously reduce your mortgage term. As an example, a couple borrowing £150,000 on a 25-year tracker repayment mortgage at 1% above base rate would have been paying £966.45 a month last July when the base rate was 5%.
A year later, with the base rate at 0.5%, their monthly repayments would have fallen to £599.90. Overpaying by this amount – an extra £366.55 a month – would reduce their mortgage by more than 10 years and save them more than £130,000 in interest.
Lower property prices are also good news for those trying to buy their first home. But, although affordability is less of an issue, it’s still not easy, says Boulger. “The big problem is finding the deposit,” he explains. “The best deals require a deposit of at least 25%.”
Parents and grandparents are helping with this – figures from the Council of Mortgage Lenders show that around 80% of first-time buyers under the age of 30 had help from their parents.
On the positive side, first-time buyers hold fantastic bargaining power in the current market.
PAMPER YOUR PENSION
Focusing on your retirement plans could be another way to avoid the current doom and gloom, especially as now could be the perfect time to pay into your pension. “The stockmarkets are at a low point,” says Laith Khalaf, pensions analyst at Hargreaves Lansdown. “They could go lower, but it’s a fantastic time to invest compared with 18 months ago.”
He recommends directing any spare cash, perhaps freed up as a result of reduced mortgage payments, into your pension. In addition to benefiting from future growth, tax relief on pension contributions will top up the amount you pay in by 20% for basic-rate taxpayers, or 40% for those in the higher-rate band.
As an example, if you have a £100,000 variable rate interest-only mortgage and the base rate cuts have been passed on, you could save £4,833 in mortgage payments between October 2008, when the first cut was made, and January 2010 – assuming there’s no change in rates.
“Pay this into your pension and it will be increased to £6,041 with tax relief. After 25 years’ growth at 6% a year this would be worth £25,536, which would buy a 65-year-old man an annuity paying £1,849 a year,” explains Khalaf.
INVEST FOR GROWTH
The ‘buy low, sell high’ mantra also holds true for your investments, and with markets still depressed, now could be an excellent time to top up your portfolio.
“Although equities have performed well in the last couple of months, there’s a sense that they will go higher in time,” says James Davies, investment research manager at independent financial advisers, The Chartwell Group.
Given current market conditions, Davies believes that it might be worth considering investing in a recovery fund. As the name suggests, these funds invest in companies that are in difficulty or out of favour but are showing signs of recovery. Among his recommendations are Investec UK Special Situations, BlackRock UK Special Situations and M&G Recovery.
“If you’re bolder you might want to go for a smaller companies fund,” he adds, recommending the Standard Life UK Smaller Companies fund and Old Mutual UK Smaller Companies. “There is a greater risk that small companies won’t survive the recession, but it’s during the downturns that the smaller company stars begin to emerge.”
Davies also recommends drip-feeding your money into the stockmarket with a regular savings plan. “This allows you to benefit from a volatile market, as you buy more units when the price is low,” he adds.
RETIRING IN A RECESSION
Among those badly hit by the recession are people in retirement. Although any income you may have from an annuity will be fixed, if you’re relying on your savings to supplement this, the falling interest rates could leave you short.
“It’s difficult,” says Bob Perkins, technical manager at Origen Financial Services. “If you don’t want to take any additional risk, then all you can do is make sure you’ve got the best rate. If this isn’t enough, you’ll need to take some risk to increase the level of income.”
Structured products are an option. While these present a risk to capital, this is often linked to a significant fall on the stockmarket – which might not be so likely, given current market levels.
Another option open to people in retirement is equity release. Also known as ‘lifetime mortgages’ or ‘home reversion plans’, these schemes essentially allow you to borrow money against the value of your home, with the debt repaid from the sale proceeds following your death.
Equity release can free up capital for a lump sum or regular payments, but with property prices low, the amount you’re able to release will be reduced too.
TRIM YOUR ESTATE
Falling property and share prices mean that fewer of us may have to worry about leaving an inheritance tax (IHT) bill, but for some people the recession could be a great time to undertake some estate planning.
“If you’ve got assets such as property or shares that you can afford to give away, then it’s an ideal time to do this,” says Perkins. “As values have fallen, you will be using less of the £325,000 IHT allowance (the nil rate band) if you put them into trust. Also, whether you give away these assets through a trust or directly to family or friends, any growth in value will be immediately outside your estate.”
There could also be capital gains tax advantages if you give assets away in the current climate. Although tax at 18% will become payable on any profit you’ve made if you give an asset away, with values depressed, this might not be as much as it would have been a couple of years ago, and you may be able to swallow it up with your annual allowance, which currently stands at £10,100.
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.
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.
Income protection insurance
If you can’t work in the event of sickness or illness, income protection insurance aims to give you an income, with the amount of income set by you up to 75% of your gross (before tax) income with the premiums varying by how much of your salary you want to cover, as well as your age and health and when you want to start receive any payouts. Any payouts from income protection insurance are tax-free and usually continue until you recover, reach your selected pension age or the period of cover specified in the policy comes to an end. Income protection insurance does not cover redundancy but you can buy it as a bolt-on.
A loan in which the borrower pays only the interest on the sum borrowed for the life of the mortgage but, at the end of the mortgage term, they still owe what they originally borrowed as this remains unchanged. The advantage of an interest-only mortgage is the monthly repayment is considerably lower than for a comparable repayment mortgage. Lenders generally insist the borrower also invests in an endowment, ISA or pension savings policy that, on maturity, is intended to pay off the capital loan.
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
Unsecured loans mean the loan is not secured on any asset you already own, such as a house, car or other assets and so is a riskier prospect for the lender. Therefore, they usually come with higher interest rates than their secured counterparts, are less flexible and levy high redemption penalties. Most “personal” loans are unsecured.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
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.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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.
A term to describe financial products or ‘plans’ that help older homeowners turn some of the value (equity) of their homes into cash – a lump sum, regular extra income, or sometimes both – and still live in the home. There are two main types of equity release: lifetime mortgages and home reversion plans (see separate entries for both). Whichever type you choose, you borrow money against the value of your property, on which interest is charged, and the loan is repaid when the house is sold after your death.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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.