Most people don’t put the effort into managing their money, at great cost in interest payments, higher than necessary tax payments and potential lost income. And with inflation far outstripping both interest rates and wages – making untouched money lose value every day – there has never been a better time to take control of your finances.
Make 2016 the year you put your money to work.
Use your ISA allowance
ISAs are like a gift from the government. Every tax year you can pay up to £11,520 into ISAs, split evenly between cash and stocks & shares, and receive the interest and/or profits tax-free.
Seeing as the allowance increases each year with inflation, and ISAs can be topped up every year by the full allowance, you can build up a significant cash pile through ISAs alone. They may be limited in number, but ISA millionaires do exist.
So far government has resisted tinkering with ISA rules (like they do constantly with pensions), but it could happen. There has been talk of a £100,000 cap, although nothing has come of it yet. But for now at least, ISAs are easily the best way to save money.
Invest in a mutual fund
If you’ve got more money to put away than ISAs allow, or if you’re really set on beating inflation (which even the best fixed-rate ISAs and savings bonds won’t do at the moment) then it might be time to get a bit bolder with your money and start investing.
Obviously there is more risk involved in investing than saving – stocks go down as well as up – but effectively risk managed, investing doesn’t have to be the rollercoaster ride it can be, and you can still beat high street interest rates.
Putting your money into a mutual fund means you’ll be part of a larger pot of money which will be well diversified – invested into lots of different companies – sheltering you in part from the fortunes of one or two particular corporations, the downturn of which could ruin you as an individual investor.
If you go with an index fund, tracked to the top companies in a given market index – such as the S&P 500 – the fund aims to reflect moves in the market as a whole rather than picking particular stocks at all. And other than being relatively secure thanks to wide diversification, index funds actually outperform riskier, actively managed funds most of the time, particularly in the long-term.
Build a pension fund
You need to save for retirement. People are living longer, stretching annuities further and requiring more care; and pensioners are an increasing demographic, meaning the government has to spread its pensions budget thinner.
All in, the income you get from your state pension won’t add up to much. To even maintain a modest living in retirement – say around £15,000 per annum – you would need to save £475,000 in addition to drawing your state pension.
Some sort of private provision is clearly necessary. The younger you are, the truer that is. And the younger you are, the more you can make your money work for you thanks to the magic of compound earnings.
The good news is that investing in a pension – whether into a personal fund or through a SIPP – is one of the most tax-efficient things you can do with your money. Contributions are automatically afforded basic rate tax relief (higher rates can be obtained as appropriate by contacting HMRC directly) and once you reach 55, up to 25% of the fund can be withdrawn as a tax-free lump sum.
Annuity income is subject to the usual rates of income tax, but taking into account the personal allowance and how much less you’ll be earning than when you were working, you should end up paying much less tax on the money you contributed than had you simply kept it and spent it. And you won’t be so poor in retirement.
Claim every penny of tax relief you can
When we think about how much tax we pay, we tend to think about the headline rates – income tax, Capital Gains Tax, inheritance tax – without considering how much we pay in National Insurance and indirect taxation like VAT. You can’t do anything about inflation chipping away at your income, but you can reduce how much tax you pay.
If you’re self-employed you can take advantage of tax relief on expenses and capital expenditure. If you’re employed but sometimes work from home or have to pay for your own equipment you can do the same.
Avoiding ‘sin taxes’ can drastically reduce the amount you’re paying in tax. Trade in your new Range Rover for a Toyota Yaris and you’ll see your road tax plummet from around £490 per annum to nothing. Not to mention the amount you’ll save on petrol. You might not want to quit smoking, but 85% of a packet of cigarettes is money spent on tax which could be better used elsewhere.
Managing your money like this may take a bit of effort, but that effort can translate into tangible savings – retaining more value in your cash – and you could even earn more without too much effort.