Independent financial expert Harvey Jones
answers a reader’s query about what to do with regular savings
Well done! Saving money isn’t easy. Now you’re in the habit, you should use that money wisely.
Firstly, before you invest any of your savings, you should use them to pay off your most expensive (non-mortgage) debts, if you have any.
It makes no sense earning, say, 1% or 2% on a savings account if you’re paying a higher rate on your personal loan or credit card debts.
Check the small print carefully before paying off any personal loans, however. They often include hefty charges for people who clear their debt ahead of schedule.
Having tackled your most expensive debts, you should set up a ‘rainy day fund’ for financial emergencies, such as your boiler exploding or losing your job. Ideally you should save the equivalent of between three and six months’ salary.
Keep it in an instant-access savings account, so you can get your hands on it in a hurry.
Look for an account paying a decent rate of interest and make use of your annual tax-free ISA allowance – you can save up to £5,100 a year (£425 a month) in a cash ISA, and your money will grow free of income tax (although you will lose the ISA tax benefits on any cash you withdraw).
Once you have tackled your personal loan and credit card debts and have accumulated a ‘rainy day fund’, you have plenty of options.
You could consider making overpayments on your mortgage.
Although a mortgage is the cheapest way to borrow money, if the interest rate you pay on it is higher than the return you receive on your savings (highly likely, unless you have a tracker mortgage), it makes financial sense to make overpayments.
Some mortgages allow you to make regular overpayments (though do check for penalties) – the most flexible, such as current account mortgages, even allow you to borrow this money back if you need it later.
Whether or not you choose to overpay your mortgage, you should start thinking about saving or investing for the longer term – whether it’s for a deposit to buy a property in the future, your child’s education or your retirement.
If you’re putting money away for at least five years, you might get a higher return by investing in a stocks and shares investment fund, such as a FTSE 100 tracker.
Make sure you understand the risks: shares are likely to generate better returns over the longer term, but this isn’t guaranteed – and the value of your investment can go down as well as up.
You can invest up to £10,200 tax-free every year in a stocks and shares ISA (less the amount you save into a cash ISA, up to your £5,100 allowance). This amount will increase in line with inflation from next April.
As well as shares, you should also consider saving in a personal or stakeholder pension if you don’t already pay into an employer’s pension.
Again, there are tax benefits to pension contributions, because the Government pays tax relief at your current rate (either 20%, 40% or 50%). When you retire, you can also take a 25% tax-free lump sum from your pot (and then use the remainder of your pot to buy an annuity, an income for life).
The drawback to pension contributions is that you can’t touch your pension until age 55 at the earliest, even if you need it in an emergency.
So a combination of these options could be your best option. Exactly how you mix them depends on your future financial plans, and your appetite for risk.
I would recommend that you consider taking independent financial advice, to guide your decision.
- Harvey Jones is a freelance personal finance journalist who writes regularly for the Daily and Sunday Express, Motley Fool and lovemoney.com
- If you have a general financial query or dilemma unrelated to a specific financial services provider, email Harvey at email@example.com
- Harvey regrets that he cannot answer your questions individually. These are his personal views and not those of Virgin Money. Nothing in the article constitutes legal, financial or other professional advice.
- If you have a specific financial concern, you should always seek your own professional financial advice. All details given are correct as of 11 October 2010.
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