A former pensions minister has warned against the practice of relying on your home to fund your retirement. Steve Webb, writing in a report for insurers Royal London, described this practice as a “downsizing delusion” and suggested that up to three million people could be endangering their standards of living during retirement by relying on such an approach over retirement savings.
The principle behind this method of preparing for retirement is this: an individual or, arguably more often, a couple own a family home, with multiple bedrooms, in which they brought up their children. After their children have flown the nest, this property will be considerably larger than they really need. When they retire, they plan to downsize, selling the multi-bedroomed family home and moving into a smaller property which better fits their needs, but has a considerably lower value on account of the size difference. The difference, in theory at least, they will then be free to pocket as a lump sum to help fund their retirement.
A number of households are reportedly placing a fair amount of emphasis on this as a way of preparing financially for retirement. In many cases, more traditional methods of saving for retirement such as pensions and income-generating investments are being neglected in favour of the expected lump sum from downsizing.
According to Webb’s report, however, many such households will not fare as well as they expect, and may suffer as a result of not utilising retirement savings opportunities. In a lot of cases, Webb says, couples who planned on downsizing will find their plans interfered with because they are still paying off their mortgage when they retire, or still have children living at home.
Even those who do effectively pull off their planned move may find that the financial benefit is far less adequate than they hoped. On average, those who do downsize still see their income cut in half upon retirement, which can mean a significant reduction in living standards.
“In most of Britain,” Webb said, “the amount of money you could free up by trading down at retirement to a smaller property would generate a very modest income.” For example, he imagined a hypothetical person who sold a £310,000 detached property and moved into a £197,000 semi-detached home – the average prices for such properties. The annuity purchased by the £113,000 price difference, he said, would pay out an annual income of only £5,700, and this figure would not increase in line with inflation. In combination with the state pension, this would only generate a retirement income equivalent to about half the national average wage.
Better protections have been unveiled for those who save for retirement. The Queen’s Speech announced plans to make pension savings safer for millions of people, particularly in the event that an occupational pension scheme should collapse.
Fears have recently been expressed over the safety of some pension schemes paid into under auto-enrolment. In particular, concerns have centred around “master trusts,” a kind of workplace pension scheme which arose as a solution to the needs of auto-enrolment, and offers a centralised workplace pension fund which serves as a solution for multiple companies at the same time. A number of groups and organisations have expressed concern about the security of savings held with some master trusts, including MPs from the Work and Pensions Committee who called for government action to mitigate the threat of “potentially unstable master trusts.”
In February, the BBC investigated providers of auto-enrolment occupational pension solutions known as master trusts, and reported that many such companies were “too small to survive.” This could put thousands of individuals who have paid into such schemes – perhaps up to a quarter of a million – at risk, the BBC said. They could face losing the money they have paid in should the scheme in question collapse. In its report, the BBC also claimed to have found evidence that some providers of auto-enrolment pensions were deliberately misleading both employers and employees.
In response to these kinds of concerns, the Pensions Bill has been unveiled in order to better protect people who pay into master trusts under auto-enrolment. This bill, announced in the Queen’s Speech, would give additional powers to the Pensions Regulator (TPR). This includes greater powers when it comes to regulating and authorising such schemes, as well as expanded capabilities if TPR should deem it necessary to intervene. At present, there is no responsibility placed with TPR to check the accuracy of claims made by master trust schemes and, of the 72 in existence, only nine are named on the TPR’s website as carrying their Master Trust Assurance mark
The Pensions Bill will also place additional responsibilities on the companies providing master trusts. Stringent criteria will be created for master trusts, and providers of these schemes will be required to demonstrate that their funds meet these standards.
The announcement of the new bill was welcomed by TPR. Chief executive of the regulator, Lesley Titcomb, said that the organisation had “voiced concerns for some time about the need for stronger legislative standards for master trusts,” and was “pleased that today’s announcement proposes to give us the power to implement these safeguards.”
The new tax year begins early next month, and 2016/2017 will see a number of changes made to the way that ISAs work. These will give savers new flexibility in how they use their ISAs and the kind of savings they put into them. Some of the key changes due to be rolled out this year are:
No Longer the Only Tax-Free Savings
This is not so much a change to ISAs as to savings tax rules, but it stands to massively transform the role that ISAs play in most people’s savings strategies. From April, your first £1,000 of interest earned on savings (or £500 for higher-rate taxpayers) will be tax-free regardless of whether it is held in an ISA or not. For a basic rate taxpayer with a top-paying easy-access savings account, this means being able to save almost £75,000 before paying any tax on interest. For many people, this means that tax on savings interest will no longer be an issue, and a non-ISA account with a higher interest rate could become more profitable than an ISA.
Innovative Finance ISA
For a long time, only cash and stocks and shares have been eligible for tax-free ISA status. However, for some time there have been plans to introduce the ability to place investments through peer-to-peer lending into an ISA. These plans will now finally be put in place through the Innovative Finance ISA, for which peer-to-peer investments will be eligible.
A number of restrictions are being removed from ISAs in the new tax year. For example, it has always previously been the case that if you put money into an ISA and then withdrew it again, it would still be subtracted from your ISA allowance for the tax year. Now, this is no longer going to be the case. Furthermore, the new tax year will see a lot more flexibility introduced to the rules for making transfers between ISAs, for example moving the contents of a stocks and shares ISA over to a cash ISA to readjust your balance between cash and investments.
This new kind of ISA could provide a significant boost to young savers who are hoping to build up a deposit on a home purchase. For every £100 placed into a Help-to-Buy ISA, the government will give an additional £25 towards your deposit up to a maximum of £3,000. The additional money from the government is paid out at the point of purchasing the home, and savers will be able to save up to £1,200 in the account in the first month and up to £200 in following months. You will not be able to pay into a cash and Help-to-Buy ISA in the same year except under certain split schemes.
ISA Benefits Following Death
When an ISA-holder dies, it will now be possible for ISA benefits to be passed onto their spouses. During the administration of the estate, ISA status will be maintained on savings, with relevant tax reliefs granted to the representatives of the deceased.
Consumer organisation Which? Has said that UK savers are losing billions of pounds every year through their choice of savings accounts. Savers who stick with accounts offering poor or mediocre rates when they could get more elsewhere are collectively losing out on £3 billion annually, according to Which?‘s estimates, which equates to £65 per person per year.
The gap between the best and worst accounts is significant, the consumer organisation said, yet the lowest paying accounts remain popular. Which? used the example of a saver who wants to invest £10,000 into an easy-access savings account. Highly popular yet low-paying accounts such as the Everyday Saver from Barclays or Lloyds Easy Saver pay in the region of £50-60 over the course of two years. In contrast, the current leading instant access account in terms of interest rates – the Freedom Account from RCI Bank with its AER of 1.65% – would earn that hypothetical saver well over £200 more, paying £333 in interest over the same period.
The organisation points to a couple of key reasons why savers lose out and stay with underpaying accounts. One of these is a simple unwillingness to switch and a lack of appreciation over the difference it could make, especially when “teaser rates” are involved. People may have previously switched to an account that offered a highly attractive introductory rate which dropped abruptly over the course of the first year. Many such savers will continue to stick with that account, and often not realise just how much less competitive the deal has become. This is especially true when it is considered that banks are not always clear about changes in their rate, to the point where they have recently been ordered by the FCA to make it easier for their customers to find out just how much interest they are earning.
Another key factor the consumer body pointed to was the rise of “challenger banks” offering superior rates. The current best-paying easy access account, offering 1.65%, comes from lesser-known alternative banking provider RCI Bank. Most of the runners-up are also smaller challenger banks such as Shawbrook and Paragon Banks, each offering an AER of 1.45%, and Charter Savings Bank or Aldermore Bank, both of which are offering 1.25%. These kind of rates leave many of the bigger banks far behind. However, many consumers have simply not heard of the challenger banks, or are unnecessarily reluctant to entrust their savings to a smaller and less well-known name. They therefore stick with significantly lower-paying savings accounts from high street banks and lose out on interest.
When looking for a savings account, many people quite naturally look straight at the big high street banks and building societies such as HSBC, Lloyds, or Nationwide. However, this might be a mistake if your goal is simply to secure the best interest rate possible.
The best deals on the market may come from other providers. These are providers of a sort that could be loosely termed “alternative,” though really this represents several distinct groups. Good examples are foreign banks with limited operations in the UK, companies and organisations which aren’t readily associated with savings but do offer some banking operations, or companies that are simply smaller and lesser-known. Respectively, good examples include the Punjab National Bank, Harrods Bank, and Charter Savings Bank, though there are many more such names to choose from with market-leading interest rates on offer.
Despite their comparative obscurity, these alternative savings providers are certainly not to be dismissed out of hand. Look at just about any “best buy” league table for savings accounts, and you’ll probably find these kind of providers dominating the upper echelons.
Despite the competitive rates on offer, however, many people are reluctant to go with such “alternative” providers, and instead skim over them when perusing league tables and go for the best rates on offer among the bigger names. However, in truth there is little reason to avoid lesser-known names in banking, and it can be well worth looking outside the high street chains if you want to get more interest from your money.
A lot of people are worried about whether it would be inconvenient to save with a bank that does not have branches on the high street. However, it is usually very easy to set up, manage and access accounts online. This allows you to quite easily create your account, stick money in, and get it out again (subject to access terms of course). This along with the nature of savings, as opposed to regularly-used current accounts, means that most people are unlikely to miss physical branches. Those institutions that do offer current account services often have other arrangements in place, such as the ability to carry out activities such as paying in through any branch of a nominated high street bank.
Others are simply reluctant to entrust their savings to smaller banks they have never heard of, but again these fears tend to be unfounded. As long as you are dealing with a legitimate institution (and any bank appearing on a respected league table will be), your savings should not be used in unscrupulous ways and will be fully protected under the Financial Services Compensation Scheme (FSCS). The only major exception to this last point is Triodos, a Dutch bank, which instead offers similar levels of protection from its home country’s equivalent of the scheme.
All cash savings accounts, including ISAs have somewhat disappointing rates of interest at present. Even if the rates on paper or lower, their tax-free status has meant that ISAs fairly consistently tend to be the best bets. To get the very best rates, savers usually have to forfeit access to their cash for a time by placing it into an account with a fixed term of at least a year.
However, if you are looking to sign up for a year’s fixed term in order to boost your interest, the market has now reached a slightly unusual position where an alternative, non-ISA account could be more profitable. This is due to changes to the way savings are taxed, which will come into force in less than a year and already have implications for some fixed-term accounts due to mature after they take effect.
As a result of these changes, one year bonds could now prove more profitable than cash ISAs with the same fixed term. Under the new system, which begins next April, up to £1,000 worth of interest paid on savings will be tax-free, regardless of whether the savings in question have been sheltered from tax in an ISA or not. As fixed-rate one-year bonds generally pay interest when they mature rather than progressively throughout the term, interest on bonds taken out now will be paid in a year’s time and will therefore be subject to the new rules instead of the current ones.
For quite a large chunk of savings, this eliminates the tax-free advantage that ISAs have previously enjoyed and instead brings it down to a matter of simply comparing interest rates. As it happens, the ability to take advantage of the new rules coincides with the highest rates for one-year fixed-rate bonds in two years. The best deal on offer at the moment comes from Charter Savings Bank, which pays 2%. By contrast, the best cash ISA offering the same one year term is a tie between Nationwide Building Society and Shawbrook Bank, both of which are offering 1.65%.
As both are tax-free unless your savings amount to more than £50,000, this quite simply means that the best bond pays more interest than the best cash ISA over the same term. As an illustration, if you were to save £15,000 – almost all of your ISA limit – in the best one-year cash ISA today, you would receive £247.50 in interest when the term is up. The best one-year bond, on the other hand, would pay £300 in interest at the end of the year. This is 21% more than the ISA, and would leave you £52.50 better off.
Stocks and shares have received a boost in popularity in recent years. Savers are dissatisfied with savings accounts that pay very little, and with shares eligible for the same tax-free status in an ISA they seem like a natural alternative. However, compared to a bank account, stocks and shares are more volatile, more complex, and more difficult to get right. This has put many savers off, and inspired many others to look for easier ways to work out where and how to invest.
As it happens, there are indeed simpler ways to invest in stocks and shares than picking all your own investments and working out which companies to put your money into. These can significantly simplify the process of investing and potentially improve the returns you get on your savings.
A Note on Risk
Easy investment is not the same thing as easy profit. The stock market is undeniably more volatile than a bank account, and there is always a danger you will lose money. These routes make it easier to physically invest and to place your money in places that will have a fair chance of success, but they do not guarantee profit and the value of your investments could fall overall. Indeed, it is certain that the value of your investments will fall for at least some of the time, as stocks and shares constantly fluctuate in value.
Instead of investing directly in companies, you could invest in a fund. These are managed by professional investors, and all investor money is pooled together and invested as this fund manager believes best. A percentage – usually small – of any returns are taken by the fund manager as payment, and the rest is yours. This significantly simplifies the investment process, as you only put your funds in one place and the fund manager then sorts out which companies it goes in. Unless you have a very large amount to invest, the fact that your funds are pooled with those of other investors allows for wider distribution which means, assuming your fund manager has chosen well, a better buffer against something going wrong. Some of the easiest funds to invest in are Exchange Traded Funds (ETFs), which are listed on the stock exchange like a company and can therefore be bought as if buying a single stock.
Some providers offer “ready-made” stocks and shares ISAs, which are similar to funds in many ways but simplified and made to more closely resemble traditional bank accounts in functionality. You place your money into the ISA in much the same way as you would with any other bank account, and the provider pools your funds with those of other investors and places them into investments chosen by an expert manager or team of managers. As with funds, a small fee is normally taken from your returns. Sometimes, these are made to fit a pre-defined level of risk, allowing you to choose the level you are happy with. For example, the Share Centre offers three ready-made ISAs, pursuing higher target income levels at the expense of progressively increased risk levels. Look through different accounts and providers to see which best suits your needs.
Much has been said on the importance of regularly switching suppliers when it comes to things like energy and insurance. The best deals in these industries are almost invariably used as hooks for new customers, while existing, loyal customers languish on comparatively sub-standard rates. However, a lot of people, if asked, would say that the same is not true for savings accounts.
On the face of it, savings accounts work very differently from insurance or utilities when it comes to the deals offered to new and existing customers. Where adverts in other industries tout the fantastic tariffs and discounts that are open to new customers, banks offer exclusive deals to keep their existing customers onside. Often, the highest-interest savings accounts and ISAs are open exclusively to those who already have other products such as a current account. Accounts with names such as “loyalty,” “premier,” “bonus,” “prestige” and “exclusive” promise that customers who stay with their bank or building society – and choose them for their full portfolio of both current and savings accounts – will be rewarded with the best rates.
This is, of course, an approach which will come as a welcome change to many consumers. Where so many other industries are interested in increasing customer numbers at the expense of the customers they have, it is certainly nice to see that loyalty is rewarded. The matter is compounded by the fact that new customer deals are not nearly such big news in the banking world as in those other industries. There is the occasional cash bonus for switching, but on the whole there is much less focus on hooking new business. With or without a specialist loyalty account it can seem like there is little reason to change.
Why Disloyalty Pays
So if all this is true, then why is switching provider still an approach that pays off? Surely the situation in the banking industry is the exact opposite of that which makes it advisable to switch regularly in other areas?
However, the truth is that these loyalty deals are rarely if ever market-leading. They usually represent the best rate offered by that particular bank, but are often far from the best rate around. Rather than accepting loyalty deals, you should still shop around as you may well find you can still get an even better deal by being disloyal. Often, loyalty accounts with “exclusive” deals seem designed more to keep existing customers from looking at the better rate elsewhere, rather than to reward their loyalty with unbeatable interest.
It is also a good idea to look around for better deals fairly regularly, though this is arguably less important than with utilities, insurance and the like. The savings market changes constantly with new accounts, rates and offers being introduced so after a year or two with a given bank you may well find that a better deal has turned up elsewhere.
For some time now, it has been difficult to talk about savings without mentioning the longstanding low interest rates that continue to plague the market. This is one of the key challenges facing savers right now, and many are turning to alternative investments in order to earn worthwhile levels of interest.
Bonds are a fairly popular way to pursue better interest rates than savings accounts can offer. But are they really a good choice? This depends on a number of factors, not least the type of bond you choose.
What are Bonds
In one sense, bonds can be similar to fixed-term savings accounts. You purchase one or more bonds, and hold them for a given amount of time. During that term you will receive interest at a fixed rate, usually paid yearly, and if all goes well you will then receive the bond’s purchase price back at the end of the term. In practice, many investors sell the bonds on before they reach maturity rather than holding it for the full term.
Types of Bond
There are several types of bond in which you can invest:
Government gilts are popular because of their reputation for being a relatively low-risk investment. They are bonds issued (and therefore essentially backed) by the government. While there is some risk if the government encounters financial difficulties, a relatively stable government such as the UK’s is generally a safe place to put money. The British government has never yet reneged on a debt. The main disadvantage is that government bonds do not carry interest rates too far above the best savings accounts. However, they can offer those interest rates over shorter terms and offer greater flexibility for certain investment goals.
Corporate bonds are similar to government ones in many ways. However, they are issued by businesses and this leads to several key differences. They tend to be higher-risk, as companies are more vulnerable to financial difficulty than governments and you will be relying on a single firm to pay you back. Investment credit ratings can help you assess the exact level of risk. If that firm encounters serious problems, it may be unable to repay. However, the trade-off is that returns tend to be much more attractive than on government gilts.
Retail bonds are bonds issued by private companies specifically for the retail market. They are generally traded through the London Stock Exchange’s Order Book for Retail Bonds (Orb). Compared to other corporate bonds, they can be bought and sold more easily providing greater liquidity. Many qualify for tax-free investment in a stocks and shares ISA or SIPP. Unlisted bonds from smaller companies are also available, but these are higher-risk and are generally recommended only for experienced investors. Everyday savers looking for a boost should look at safer options.
If you only have a little to put aside every month, it can seem like there’s little point in making any sort of saving plan. It can seem best to either chuck what little you can into the savings account you were probably given along with your current account, or even not bother saving at all.
However, there are a number of tactics you can use to try and get more out of a small but regular amount. Even if you don’t have much left each month, it is worth trying to use it in the most effective way you can.
Pay Towards Your Mortgage
Your mortgage probably has a higher interest rate than any savings account, so the debt you will build up on it will probably far exceed the returns you will get from putting your money aside. While it’s important to build up some savings in case of an emergency, if you don’t think your money is performing well enough you could try putting what you have left each month towards your mortgage. By lowering your debt, and therefore the interest that builds up, you could ultimately save yourself thousands.
Premium bonds can be a good, fun place to put your money. Tax-free prizes are awarded regularly, and can be up to a million pounds. The minimum investment at one time is usually £100, and you can set up a standing order if you choose to invest in a premium bond every month. If using a standing order, the minimum is just £50. Unlike gambling, your money is not at risk. You can withdraw the same amount that you put in whenever you like. However, your money will not build up any interest and there is no guarantee you will win prizes. However, if the interest you would earn seems negligible anyway then premium bonds can be an attractive option.
If your money isn’t doing you much good now, it could potentially do a lot more for you in the future when you retire. Putting a little extra each month into a pension plan can really build up by the time you retire. This is helped by the fact that pension contributions are eligible for tax relief. Basic rate tax payers get 20p in tax relief for every pound the pay in and higher rate tax payers receive tax relief of 40p for every pound. For additional rate tax payers, the rate is 45p to the pound.