The start of the year is a great time to think about your financial goals and how best to use your resources. If you have surplus cash, either in the form of a lump sum or a regular income, you should consider how you can use this to help achieve your goals.
Clearing Debt
Clearing expensive debt should be the first step, as every penny you pay in excess interest is money that could be used elsewhere.
Credit cards and loans should be cleared as soon as possible. If it’s not possible to pay off the full balance, consider monthly overpayments. Not only will the debt be cleared more quickly, but you will pay less interest overall.
Clearing or overpaying your mortgage requires a bit more consideration. Interest rates are low at the moment and it could be more effective to keep the debt and invest (tax-efficiently) for potential growth. Of course, there are no guarantees and there is always a chance that the investment will under-perform, leaving you more financially vulnerable.
Making modest overpayments while investing some of your cash is one way of balancing priorities.
Cash Reserves
You should aim to build up an emergency fund of at least 6 months’ expenditure. This means that you will be well-prepared if you face an unexpected bill, repair, or short period out of work.
It’s also worth keeping aside cash for any planned expenditure in the next year or two. It’s not a good idea to invest money you need in the short term, as the value can fluctuate.
Interest rates are low at the moment, but it’s still worth shopping around for the best deal on your savings account. We favour instant access, monthly interest paying cash savings accounts, over ones that lock you in or ones that pau interest annually or include an annual bonus.
NS&I Premium Bonds are another option you can consider, as you will have full access to the money, they are backed by The Treasury and you have the possibility of winning a prize every month (possibly £1 million albeit the odds are low).
Avoid tying up excess cash in lengthy fixed term contracts. Interest rates and inflation are on the rise, which could mean that your money won’t keep up with the cost of living.
Top Up Your Pension
Pensions are one of the most tax-efficient investments available. Personal contributions benefit from 20% tax relief at source. Higher and additional rate taxpayers can claim further relief via their tax returns. Non-tax payers can still pay up to £2,880 per annum net and receive 20% tax relief (£720) which is equates to £3,600 gross in total.
The annual allowance for pension contributions is £40,000 gross. If you have not used your full annual allowance, you can carry this forward by mopping up unused allowances for the previous three tax years, providing you have been a member of a pension scheme throughout and you satisfy the criteria.
Personal contributions are further capped by your earnings (salary or trading income) in a given tax year. Higher earners, or those who have already taken money out of a pension, may face additional restrictions on their contributions. Limited company owners can pay into their pensions directly from their business via an employer gross pension payment, but advice should be sought in this regard.
It’s worth seeking advice if you plan to make larger-than-normal pension contributions.
Use Your ISA Allowance
You can invest up to £20,000 into an ISA in the current tax year. The returns are tax free, and you can withdraw your money without penalty.
If you are trying to get on the property ladder, it could be worth adding up to £4,000 of your ISA allowance to a Lifetime ISA (LISA). You will receive government bonuses of £1,000 on your contributions providing all conditions are met.
You might also want to consider Junior ISAs for your children. You can pay in up to £9,000 per year and gain the same benefits as an ISA. Your child can either withdraw the money at age 18 or roll it over into an adult ISA.
For long-term investing, a Stocks and Shares ISA is usually the best option. You should aim to invest in a wide range of different assets, taking an appropriate amount of risk based on your situation and goals.
More Tax-Efficient Investment Options
Once you have used your ISA and pension allowances, you may be looking for other investment options.
An investment bond allows you to invest a lump sum for tax-efficient growth. These can be based in the UK or offshore and can help you achieve objectives such as capital growth, regular income, gifting, and estate planning.
A General Investment Account (GIA) allows you to access most of the same investments as your ISA, although without the tax advantages. Selling the investments can realise gains, which become taxable if they exceed £12,300 per year per person. You must be 18 for a GIA and 18 for a Stocks and Shares ISA.
You can use up this allowance by switching funds, phasing your GIA into your ISA or moving monies between spouses and intentionally selling down (disposing) sufficient assets to realise the CGT annual allowance. This avoids large gains building up, potentially incurring large amounts of tax when you eventually need to withdraw the money.
If you decide to use your ISA or GIA to invest in direct shares (as opposed to collective funds), you may wish to consult a stockbroker, as this is not usually something an IFA can advise you you on, but you can give instruction to do this.
For even more tax-efficiency, you could consider investing in Enterprise Investment Schemes (EIS), Venture Capital Trusts (VCTs) or Alternative Investment Market (AIM) shares. These allow you to invest in smaller or early-stage companies. As such, they are classed as very high risk.
Buying cryptocurrency, unregulated investments or unlisted shares is more like gambling than investing. If you are considering these options, make sure that you are prepared, financially and emotionally, to lose the money. Never invest more than 5% of your wealth in these schemes.
You should always seek advice before investing in complex or high-risk investments.
Buy an Asset
Maybe you have already used your allowances and your investments are on track to meet your financial goals. What’s next?
Perhaps you could improve your home, increasing the value if (or when) you eventually decide to sell.
Or you could invest in a buy-to-let, either in the residential or commercial market.
Remember, property is a long-term investment, and it may not be easy to get your money back if you need to sell quickly. Landlords face additional taxes compared with homeowners and other types of business. It’s worth seeking tax advice if you are considering a property business.
Invest in Your Business
You could also use your surplus cash to give your own business a boost. Perhaps you need to invest in new equipment or premises.
If you loan money to your company, you can claim it back over time without paying income tax. You should speak to your accountant if you would like to find out more.
Give the Money Away
If you are already in a financially secure position, perhaps giving the money away would offer the most satisfaction. Gifting can also reduce the value of your estate for Inheritance Tax purposes.
Gifts of up to £3,000 per year (in total) are immediately outside your estate. This is called the ‘annual exemption’ and can be carried forward by up to one year.
Other exemptions are available for smaller gifts, special occasions, or regular gifts from income. Charitable donations are also exempt.
Larger gifts remain in your estate for seven years.
You can make gifts into trust if you would prefer to keep some control over the money.
Just Spend It
If you have achieved your goals and your family is financially in a good place, why not just spend the money? A special purchase or holiday of a lifetime could be the best use of your surplus cash. After all, creating good memories is often why we make financial plans in the first place.
Everyone’s situation is different. The best use of your surplus cash will depend on what you want to achieve and where you are in your financial journey. Tandem Financial can help you clarify your goals and establish what you need to do to achieve them. Ultimately it is all about balance and developing a personal strategy that meets your needs.
Please don’t hesitate to contact a member of the team to find out more this subject matter.
