Wealth Check: 'What can I do if my saving for the future is out of tune?'
Saturday 03 June 2006
Andrew McLeod, 40, lecturer, London
Salary: A little over £31,000 a year.
Monthly spending: General living expenses amount to around £1,060 and Andrew contributes £162 to his pension. That leaves him around £65 of surplus income each month.
Debts: None, with a £120 overdraft limit at Abbey.
Property: Bought current home via a shared-ownership scheme and has a fixed-rate mortgage with Halifax.
Insurance: Mortgage protection and critical illness.
Pension: Member of occupational pension scheme through employer.
Andrew McLeod has been a sixth-form college lecturer in east London for the past five years. He's a member of the Teachers' Pension Scheme, which offers a good level of pension benefits based on members' salaries, but he is keen to know whether he is on target for a retirement income worth two-thirds of his income. If not, how should he boost his savings?
Home ownership is also a concern. Two years ago, Andrew bought 40 per cent of a property in east London through a shared-ownership scheme - the house is now worth around £170,000 and he wonders whether he should increase his stake.
Finally, Andrew is aware that he has no short-term savings for emergencies or other needs. Over the past 18 months, he has paid off a £1,500 overdraft with his bank, so could now be in a position to save some cash, but isn't sure where to start.
We asked three independent financial advisers for their suggestions: Justin Modray, of BestInvest; Ashley Clark, of Needanadviser.com; and Andrew Merricks of Skerritt Consultants.
"Shared ownership is an excellent way on to the property ladder," says Ashley Clark. Andrew owns 40 per cent of his property and this means he pays rent on the other 60 per cent. The combined cost of his £58,000 mortgage - £356 a month at 5.5 per cent a year - and rent on the 60 per cent share - £270 a month - is £626 a month.
"The question is whether it is better in the longer term to own or rent," says Clark. "To purchase the remaining 60 per cent will cost £105,000 with mortgage payments, on a repayment basis and based upon his current rate of 5.5 per cent, costing an extra £645 a month." While this is beyond Andrew's means, Clark recommends buying as much equity as he can afford, "before the next upward property cycle".
One option would be to do this with an interest-only mortgage. He should talk to Halifax about converting his existing lending - for which there may be a minor charge. In three years' time, when the Halifax fixed rate expires and penalties no longer apply for switching, Andrew must look for a better deal elsewhere, Clark says, ideally converting to a repayment mortgage at this stage.
However, Andrew Merricks takes a different view about Andrew's property dilemma. "Any successful investor spreads investments across more than one asset," he argues. "I don't think Andrew should increase his dependence on the property sector by plunging more of his money into this asset."
Merricks also thinks Andrew should not get hung up on the issue of rising house prices. "The easy money must have been made on property now," the adviser argues.
Justin Modray says Andrew should be pleased that he currently has a fixed-rate mortgage, because most experts think interest rates are set to rise over the next year or so. Andrew's monthly repayments will not be affected by such increases.
That said, there are cheaper deals available, the adviser adds. Switching now, while early repayment penalties apply at Halifax, is likely not to be cost effective, but likeClark, Modray is keen to stress that once the Halifax deal comes to an end he must look to move to a cheaper deal.
Andrew's first challenge is to build up an emergency savings fund, says Modray. This should contain at least three months' salary and the money must be held in an accessible account so it can easily be drawn upon.
Modray suggests a tax-free individual savings account (ISA) with Kent Reliance Building Society, which currently offers a rate of 4.96 per cent a year. Andrew can save £3,000 per tax year in this account.
"Andrew currently lives alone and has no partner or savings to fall back on in difficult times," adds Clark. "He should ignore the attraction of higher-risk investment with potential for greater returns, and losses, until his 'core' financial position is secure."
Like Modray, Clark suggests a cash ISA, though he recommends an account from Direct Line, paying 4.6 per cent a year.
All the advisers think Andrew may be able to free up more cash for savings than he realises. The fact that he has got rid of a £1,500 overdraft in just a year and a half shows that he is good at being disciplined about his finances. Now is the time to build up some nest eggs for the future.
Andrew's pension scheme will provide him with a guaranteed one-eightieth of his salary at retirement for each year of membership, explains Modray. "This is attractive as Andrew's pension is not subject to the vagaries of the stock market," he says. "He should ask the scheme for a projection of what he might expect to receive at retirement."
However, assuming that Andrew has been a member of the scheme only for the past five years, he is currently heading for a pension worth 25/80 of salary - less than half his target.
That means making additional savings - either to a pension scheme of one type or another, or to some other kind of investment.
Modray suggests stocks and shares ISAs - the maximum will be £4,000 a year if he also opens cash ISAs, or £7,000 if not - as the next investment option. "A well-diversified fund such as Midas Balanced Growth would be good," he says.
Alternatively, Clark suggests making additional payments into his occupational pension plan: "When Andrew can afford it, I suggest that he buys 'additional years' credit in the Teachers' Pension Scheme rather than setting up a private scheme."
Merricks points out a second issue. Andrew would like to retire at 60, when he can claim his private pension, but his state pension will only start when he's 66 under reforms announced last month.
He suggests bridging the gap by investing £100 a month in aggressive stock-market funds that invest in higher-risk - but potentially more rewarding - areas such as smaller companies, emerging markets or individual sectors.
These might be perceived as a dangerous way to save for old age, but Andrew has only just turned 40 so he has at least another 20 years of investing his cash.
"He has ample time on his side from these more volatile sectors to benefit from the longer term potential they offer," Merricks adds. "He should begin to reduce his risk in the seven years or so leading up to when he wants to access his pension fund."
One way to free up cash for savings could be to use an independent financial adviser to find a cheaper deal on Andrew's mortgage protection and critical-illness insurance policies, suggests Modray. He should bear in mind, Clark adds, that teachers get reasonably generous sick pay, so he may be paying for more insurance than he actually needs.
Benefits for teachers include 28 days of full pay if Andrew is unable to work due to ill-health. He would then be entitled to half pay plus statutory sick pay for six months. By arranging insurance that does not replicate this cover - essentially accepting a higher excess - Andrew is likely to be able to cut his costs.
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