Wealth check: Help me plot a path through this low-rate world
A mortgage endowment shortfall and precious little savings – who's making plans for Nigel? Kate Hughes reports
Sunday 07 June 2009
Nigel Fletcher, 40, from Halifax, West Yorkshire, had once expected his endowment policy to cover the cost of his home. He now knows it will fall short by £12,000.
Undeterred, Nigel hopes to own his home outright within the next few years, but the logistics and warehouse manager decided to cash in his stocks and shares Individual Savings Account (ISA) that was earmarked for extra mortgage payments earlier this year as it had crashed in value due to the economic downturn. Although he is keen to save and has been overpaying his mortgage in a bid to compensate for the disastrous endowment, low interest rates are confusing his plans.
"I had intended to take out a cash ISA this year but the savings interest rates are lower than the loan interest rates," Nigel says. "I don't know what is best for these savings and future savings so that I can get the best value from them over the next seven years, until the mortgage is due to finish."
In the longer term, Nigel would like to retire early from work but needs a plan to get there.
There is no doubt that Nigel has some financial issues, thanks to poor financial advice and a run of bad luck, but things may not be as bad as they at first appear. "Like many people, he has experienced the downside of investments and been burned twice," says Adrian Lowcock of financial advice group Bestinvest. "As such, it is important to emphasise that the situation at present, especially with the endowment policy, will look bleaker. While there is still a risk that the investment may fall further in value, there is also a strong likelihood that in seven years' time it will have at least recovered some of its value."
But our panel of independent financial advisers warn that Nigel will have to review his approach to savings and investments if he wants to reach his goal of a mortgage-free life by 2016.
"Nigel has found that while investments such as stocks and shares and property carry a risk that the capital value can fall, savings accounts carry a risk that the capital may not grow fast enough, and can be eroded by inflation," says Marc Ruse of financial advisers Fiducia Wealth Management. "Interest rates are very low at present but Nigel should consider using his ISA allowances each year. When higher interest rates, inflation and capital growth return, the money invested today will benefit him in the future."
Mr Ruse adds that it's a shame that Nigel cashed in his stocks and shares ISA when values were low, crystallising his losses. This kind of asset-based investment should really be considered with an eye to the medium-to long-term future – at least five years – because it gives your money a chance to recover from a downturn when things get better further down the line. If he had left his money where it was, Nigel might have found his total was far more healthy in a few years' time.
"The higher the risk, the greater the potential rewards, but the reverse is also true," Mr Ruse says. "That means that with a few more years to go before the funds are needed, now may be a good time to be taking an adventurous approach with investments, while as the end of the mortgage draws nearer, risk could be reduced and a more cautious approach taken."
Mortgages and debts
Nigel has been saving and making extra payments on his mortgage, but the simplest way to handle debts is to line them all up in terms of interest rate and try to pay the most expensive debt off first. In this instance, that would be the career development loan of £1,500 at 5.9 per cent, which could be tackled using the extra money he has been paying towards his mortgage at 4.78 per cent.
"After that loan is paid off, the amount of spare cash Nigel has will increase," says Mr Lowcock. "So he can either go back to paying off the same extra on his mortgage or increase the amount. Nigel has rightly identified that cash ISAs give worse returns than the mortgage rate and, aside from having some rainy-day funds for emergencies, he should consider that it would then be more cost effective to pay off the mortgage at a faster rate.
"Paying off the mortgage is his higher priority. However, in focusing on that he may miss out on building up his pension and being able to keep his standard of living up in retirement."
Nigel wants to retire at around 55 years old with around £10,000 a year in income. But he is not convinced that a pension is worthwhile. He says that they offer poor value as it would take 25 years after retirement simply to get his capital back. "This is not the case, and he should reconsider his decision," says Alan Dick, of Forty Two Wealth Management.
"If he saves £200 a month, he will receive tax relief at 20 per cent on the premiums meaning that it will only cost him £160 a month from his own pocket with the taxman paying the balance. Therefore, even if he achieves no investment growth at all, his fund will be worth £36,000 at age 55. In order to accumulate this fund he will have contributed only £28,800. The profit of £7,200 is simply tax relief."
And if he can secure an annuity with a rate of just 5.25 per cent to convert his pension pot into a monthly income for the rest of his life, he would receive an annual pension of £1,890. It would take Nigel only 15 years 3 months to get his capital back even if his investments don't grow.
Nigel has a 66 per cent chance that he'll last until 80 – 25 years after retirement, which would give him significantly more in retirement income than he put in. And he even has a one in 10 chance of living to 97.
But there are downsides to a pension. The proceeds will be taxed as income when he retires. And nobody knows what annuity rates will be in the future. They may be higher or lower than current or expected levels.
But Nigel may have to give up on his dream of retiring at 55. "He may have sufficient state pension benefits to support his lifestyle from age 67 onwards. But he will have an income shortfall between retirement and age 67. The pension will pay a level income throughout life which will not give him the amount he needs at the time he needs it most, even though it may represent excellent value over his lifetime."
Nigel should think carefully about whether he really should retire at 55, or wait a few more years.
Do you need a financial makeover?
Write to Julian Knight at the Independent on Sunday, 2 Derry Street, London W8 5HF
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