A guide to starting saving and some of the products available.
Saving is a lot like exercise, we could all probably do with a bit more but sometimes it can be difficult to motivate yourself to actually do it. A common reason many people give for not saving enough, or at all, is that they don’t have a sensible savings strategy. Another common reason is that there can appear to be such a vast range of options available that people don’t know which is best for them.
Your savings strategy
A savings strategy is built upon the answers to the following questions:
- Why are you saving?
- Are your saving goals long-term or short-term?
- Are you prepared to risk your savings in investments for potentially higher returns or do you want low risk and lower interest rates?
- How will your tax position affect your savings?
- Will you need to access your savings quickly?
Once these questions have been answered then it will be easier to work out a sensible strategy with achievable goals.
Creating a plan
First, create a document detailing all monthly income and expenditure. This should include one-off large payments which can be divided across 12 months. This document should indicate what money remains after all of your regular payments and whether there is any money that can be saved on monthly outgoings. Next, bearing in mind the amount of money available to save, set goals such as saving a minimum of £100 per month.
Risk and interest
Investing in the stock market is a potential strategy to try and secure a higher return on the money invested. However, investing carries increased risk and there is no guarantee that your investment will increase and may go down in value over time. Putting your money in a deposit based savings account or cash ISA is lower risk but the long term returns are likely to be lower.
The effect of inflation on savings
Inflation has a marked effect on savings. If the rate of inflation is high and an individual’s savings are in a low interest account then the net result could be that the buying power of their savings reduces over time. A simple rule of thumb with reference to inflation and savings is that your money will still grow if it earns interest, but its buying power/relative value will only grow as well if the interest rate (net of any taxes) is higher than inflation.
Personal savings allowance
Anyone starting to save should also be aware of their personal savings allowance. At present anyone paying the basic rate of tax (20%) can earn up to £1,000 per year tax-free from interest on savings. Savers paying the higher tax rate (40%) can earn up to £500 per year from interest on savings. There is no savings allowance for savers paying the highest tax rate of 45%. Interest earned on tax free accounts such as ISAs or Premium Bond wins does not count towards the personal savings allowance.
An ISA is a tax-free account for individuals to use for their savings or investments. There are a range of ISAs available to savers and this is where some confusion can arise. You can save up to £15,240 into an ISA in the 2016/17 tax year. The annual saving limit is due to increase to £20,000 a year in the 2017/18 tax year.
ISAs can take the form of cash ISAs and stocks and shares ISAs which are higher risk depending upon the type of investments you hold in them. Cash ISAs can be fixed rate or easy access, it should be noted that fixed rate ISAs will have a better interest rate than an easy access ISA.
There is also a Help to Buy ISA aimed at first home buyers and an innovative Finance ISA which offers up to 6% interest but is more complex than an ordinary ISA. The innovative finance ISA is based on peer to peer lending, whereby individual investors lend out their money to other individuals or businesses. Innovative finance ISAs are higher risk in that if a borrower cannot return the lender's money, the money is lost. Additionally the lender’s money is not protected by the Financial Services Compensation Scheme.
The new Lifetime ISA (LISA), which will be available from April 2017, is designed to help people save for the purchase of their first home of for their retirement.
The LISA works in the following way:
- you must be aged between 18-40 years old to apply for a LISA
- individuals can save up to £4,000 per year in the LISA (as part of the overall £20,000 annual ISA contribution limit ) and the government will add a 25% bonus to this sum
- people can contribute and receive the bonus until they are 50
Early withdrawals will lose the bonus, and interest or growth on the bonus. There will also be a 5% charge.
Other savings options
Another straightforward option for saving is a saving account with a bank or building society. However, it should be noted that some current accounts have ‘in credit’ interest rates which are higher than savings account interest rates. It might take a little research to find these accounts but it would be beneficial to anyone looking to save using a bank account.
Easy access savings accounts have a lower interest rate but the money can be accessed instantly. These interest rates do fluctuate so it is advisable to monitor them and switch account if need be.
Savings accounts include fixed rate accounts which also require the saver to leave the money in the account for a set time period. Although they do frequently offer a higher interest rate to savers compared to easy access accounts.
Premium Bonds are a secure way of saving; they do not pay any interest but offer the bond holder the opportunity to win prizes of between £25 and £1,000,000 in a monthly prize draw. The prizes represent an annual interest rate, but only for the winners and the prizes themselves are tax-free.
The way in which tax charges (or tax relief, as appropriate) are applied depends upon individual circumstances and may be subject to change in the future. The LISA information in this document is based upon our understanding of the Government’s ‘high level design’ document for the LISA, the details of which may change when the final requirements are published later this year.
This document is solely for information purposes and nothing in this document is intended to constitute advice or a recommendation. You should not make any investment decisions based upon its content. ISA eligibility depend on personal circumstances. The value of investments can fall as well as rise and you may not get back the full amount you originally invested.
Whilst considerable care has been taken to ensure that the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information.