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Valuing Your Future
Ian McKeever & Co Consulting Actuaries
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Why should the government have to rescue banks?
The banking Crisis
The banking Crisis
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The Economic Outlook
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Issued by Ian McKeever & Co. Authorised and regulated by the Financial Services Authority in the conduct of investment business
What Government Borrowing means for you
What it means
What it means
Older Families and Pre Retirement 2
Where to Invest
The thing to remember is that you are not really saving for a specific capital sum at retirement. What you are saving for is an income for the rest of you life after you retire, so that you can meet the cost of continuing to live in the manner you expect.
Almost all the money you spend is in pounds sterling and so it seems obvious that you should invest in sterling investments to protect against currency risk.
However, maybe I should tell you what I did yesterday. This morning I dressed in clothes made in Thailand and Malaysia, I drove to work in a Japanese car powered with Arab oil. When I got to work, I turned on a computer made in China. At work I spoke to an insurance company's call centre in India. After work I went to ASDA and bought meat bred in Ireland, some sugarsnap peas grown in Kenya and some bread made with wheat grown in the USA. I then went home and watched a television made in Korea.
The point is that ultimately a large proportion of your cost of living will be determined by the cost of producing the goods you consume and many, if not most of these costs, will be determined by cost one overseas economy or another.
Taking an international view of investment does not add to the risk, it actually reduces it because ultimately many of your costs are in foreign currencies. It is just that you pay in pounds sterling because that is the currency you have in your wallet.
In the situation envisaged you should be thinking in terms of equity type investments but overall much depends on how old you are and the level of risk you feel comfortable with.
When considering how to invest the money it is well worth trying to see how things will look when you actually do retire as that has implication for exactly how you invest the money beforehand. See retirement.
For a more general discussion of risk and risk reduction strategies see the pages on risk
How to Invest
From a tax point of view investment in a personal pension arrangement has many attractions. Contributions or premiums are deductible at your highest rate of tax. Roll-up is technically tax free although in effect equity dividends suffer basic rate tax because any tax credit is not reclaimable. A quarter of the proceeds can be taken tax-free although the rest will be taken as some kind of taxable pension. However, for a high rate taxpayer with a good, as opposed to a very high salary, contributions will attract relief at 40%, whereas the pension may suffer only basic rate tax.
On the other hand the money is not really easily available until you retire and you probably have some other financial commitments before retirement such as wedding anniversaries or weddings, helping the kids get onto the housing ladder etc. There are other investments with tax benefits almost as good as pensions and they are much more flexible.
It is therefore worth considering other investment options as part of savings strategy.
1 Pay off Your Mortgage
This may be surprise but it is probably one of the best investments you can make. Mortgage interest is no longer tax deductible. If the interest rate on a mortgage and your deposit account are both 6% then £100 pounds in your deposit account will earn £6% interest and suffer 20% tax and so you will get £4.80 (£3.60 for a high rate taxpayer), but you will pay £6 of interest on £100 of your mortgage the net cost to you is £6.00. Clearly if you are a basic rate taxpayer and use the money to reduce your mortgage you will lose the net interest on the deposit account of £4.80 but save £6 in mortgage interest and therefore be £1.20 better off. For a higher rate taxpayer the saving is twice as great. Paying of the mortgage is therefore equivalent to investing in a tax-free deposit account but you lose easy access to the money. (See Mortgages)
The money you would have spent paying off the mortgage should be invested, in a pension arrangement. It has the additional advantage that this means that money is drip fed into the stock market at a steady rate and any price volatility actually helps you because it reduces the average price you pay for your investments. However you may need to use some of it to bring back your cash float to a reasonable level.
2 Cash ISAs
You still need easily available cash to cover emergencies. Cash ISAs are tax-free. Use them. Do however have some money outside of an ISA so that you are not always dipping into your ISA account or accounts. You have an allowance each year and if you take money out you cannot put it back without using up this year's allowance.
3 Index Linked Savings Certificates
For a high rate taxpayer they are likely to beat most if not all non ISA savings accounts and the inflation protection built in makes them a must have investment for high-rate taxpayers. A high-rate taxpayer should think about conventional saving certificates too. Basic rate taxpayers should not necessarily ignore Index Linked certificates because of the inflation protect particularly in current economic conditions.
4 Equity ISAs
More flexible than pensions contracts. A must have investment for someone earning enough to be constrained by Inland Revenue limits on pension arrangements. Otherwise investing the money in a pension arrangement is probably better.
The above is very much an overview. In most cases a more in depth analysis should be carried out to look at your own individual circumstances.
The thing to remember is that you are not really saving for a specific capital sum at retirement. What you are saving for is an income for the rest of you life after you retire, so that you can meet the cost of continuing to live in the manner you expect.
Almost all the money you spend is in pounds sterling and so it seems obvious that you should invest in sterling investments to protect against currency risk.
However, maybe I should tell you what I did yesterday. This morning I dressed in clothes made in Thailand and Malaysia, I drove to work in a Japanese car powered with Arab oil. When I got to work, I turned on a computer made in China. At work I spoke to an insurance company's call centre in India. After work I went to ASDA and bought meat bred in Ireland, some sugarsnap peas grown in Kenya and some bread made with wheat grown in the USA. I then went home and watched a television made in Korea.
The point is that ultimately a large proportion of your cost of living will be determined by the cost of producing the goods you consume and many, if not most of these costs, will be determined by cost one overseas economy or another.
Taking an international view of investment does not add to the risk, it actually reduces it because ultimately many of your costs are in foreign currencies. It is just that you pay in pounds sterling because that is the currency you have in your wallet.
In the situation envisaged you should be thinking in terms of equity type investments but overall much depends on how old you are and the level of risk you feel comfortable with.
When considering how to invest the money it is well worth trying to see how things will look when you actually do retire as that has implication for exactly how you invest the money beforehand. See retirement.
For a more general discussion of risk and risk reduction strategies see the pages on risk
How to Invest
From a tax point of view investment in a personal pension arrangement has many attractions. Contributions or premiums are deductible at your highest rate of tax. Roll-up is technically tax free although in effect equity dividends suffer basic rate tax because any tax credit is not reclaimable. A quarter of the proceeds can be taken tax-free although the rest will be taken as some kind of taxable pension. However, for a high rate taxpayer with a good, as opposed to a very high salary, contributions will attract relief at 40%, whereas the pension may suffer only basic rate tax.
On the other hand the money is not really easily available until you retire and you probably have some other financial commitments before retirement such as wedding anniversaries or weddings, helping the kids get onto the housing ladder etc. There are other investments with tax benefits almost as good as pensions and they are much more flexible.
It is therefore worth considering other investment options as part of savings strategy.
1 Pay off Your Mortgage
This may be surprise but it is probably one of the best investments you can make. Mortgage interest is no longer tax deductible. If the interest rate on a mortgage and your deposit account are both 6% then £100 pounds in your deposit account will earn £6% interest and suffer 20% tax and so you will get £4.80 (£3.60 for a high rate taxpayer), but you will pay £6 of interest on £100 of your mortgage the net cost to you is £6.00. Clearly if you are a basic rate taxpayer and use the money to reduce your mortgage you will lose the net interest on the deposit account of £4.80 but save £6 in mortgage interest and therefore be £1.20 better off. For a higher rate taxpayer the saving is twice as great. Paying of the mortgage is therefore equivalent to investing in a tax-free deposit account but you lose easy access to the money. (See Mortgages)
The money you would have spent paying off the mortgage should be invested, in a pension arrangement. It has the additional advantage that this means that money is drip fed into the stock market at a steady rate and any price volatility actually helps you because it reduces the average price you pay for your investments. However you may need to use some of it to bring back your cash float to a reasonable level.
2 Cash ISAs
You still need easily available cash to cover emergencies. Cash ISAs are tax-free. Use them. Do however have some money outside of an ISA so that you are not always dipping into your ISA account or accounts. You have an allowance each year and if you take money out you cannot put it back without using up this year's allowance.
3 Index Linked Savings Certificates
For a high rate taxpayer they are likely to beat most if not all non ISA savings accounts and the inflation protection built in makes them a must have investment for high-rate taxpayers. A high-rate taxpayer should think about conventional saving certificates too. Basic rate taxpayers should not necessarily ignore Index Linked certificates because of the inflation protect particularly in current economic conditions.
4 Equity ISAs
More flexible than pensions contracts. A must have investment for someone earning enough to be constrained by Inland Revenue limits on pension arrangements. Otherwise investing the money in a pension arrangement is probably better.
The above is very much an overview. In most cases a more in depth analysis should be carried out to look at your own individual circumstances.
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