Cash interest is at an historic low point, with the Bank of England base rate reducing to 0.10% in March 2020. There have even been discussions of interest rates moving into negative figures, although how this would work in practice is less clear.
You may be wondering how to make the best use of your surplus cash, since accumulating it in the bank is unlikely to achieve your financial goals.
In this guide, we look at some options for you.
Plan for Emergencies
The first step in financial planning is to ensure that you have an emergency fund. Ideally, you should have at least 3-6 months’ essential expenses saved in an accessible deposit account. This has the following benefits:
- You will be able to cover your costs if you have an unexpected bill
- A short period of illness or unemployment will be easier to deal with
- It avoids the reliance on credit
While it would be preferable for your emergency fund to earn interest, this is not the main goal. It is far more important that the money is easily available.
Low interest rates should not discourage you from keeping an emergency fund in place. This fund should be your first priority for any surplus cash.
Shop Around
There is a good chance that your bank doesn’t provide the most competitive interest rate, although it is worth asking what they can offer if you are a loyal customer.
It can be beneficial to hold your savings separate from your main account. That way, it’s less tempting to dip into the money on a regular basis.
The best deals are usually available online. There are various comparison websites available to help you find the most competitive rate.
Here are a few tips:
- Instant access accounts will often have the lowest interest rates. You might be able to improve on this if you choose a fixed term deposit or notice account for some of the money (keeping some cash easily available).
- Don’t overlook National Savings & Investments (NS&I). While many of the rates are on the low side, your savings are backed by the government. Additionally, Premium Bonds offer the chance to win cash prizes, which are free of tax.
- Check Cash ISA rates. While the interest is tax-free, the rate is often lower than that available from taxable deposit accounts. Compare the net interest for a true comparison.
- Remember, basic rate taxpayers can earn interest of up to £1,000 without paying tax. For higher rate taxpayers, the limit is £500. You may also have a savings allowance of up to £5,000 if you earn less than £17,500 per year.
- Avoid holding more than £85,000 with any one banking group (£170,000 for a joint account). This is the maximum compensation available in the event of bank failure.
Clear Debt
Repaying debt is often a sensible use of surplus cash, particularly more expensive liabilities such as credit cards. This has several advantages:
- Reduced debt means you are less financially vulnerable
- It reduces your regular outgoings
- It can improve your credit rating
- You will save interest over the long-term
It is worth seeking advice before clearing your mortgage, as interest rates are generally low. Sometimes investing the money is more efficient, although this will depend on your circumstances and how you feel about risk.
You should certainly consider clearing loans and car finance with surplus cash, but take advice beforehand.
Top Up Your Pension
A pension is one of the most tax-efficient investments available. Some of the benefits of a pension are:
- For every £80 you contribute, you will receive tax relief of £20, resulting in a gross contribution of £100. Higher rate and additional rate taxpayers can claim further relief via their tax return.
- If you are in a workplace scheme and not yet maximising your contributions, it is likely that your employer will add to any deposit you make personally.
- Income and gains within the pension fund are free of tax.
- At retirement (or earlier, providing you are over the minimum pension age) you can withdraw 25% of your fund as a tax-free lump sum.
- The remainder can be drawn flexibly as you wish, subject to your normal rate of tax.
- On death, the fund can be passed to your beneficiaries.
While pensions are subject to investment risk, there are funds available to suit any risk profile. As pensions are a long-term investment, a little volatility is usually smoothed out over time.
High earners, members of defined benefit schemes or anyone who has already taken benefits from their pension should seek advice before making contributions as there are certain allowances and potential tax penalties that may apply if pensions are over-funded.
Opt for Stocks and Shares
With interest rates as low as they are, a Stocks and Shares ISA may be more appealing. This works as follows:
- You can contribute up to £20,000 per year
- ISAs can invest in a wide range of funds, shares and other investments
- All returns and withdrawals are free of tax
- Any money withdrawn can be replaced in the same tax year without using up any of your ISA allowance
- ISAs can be passed to a spouse on death
If you have a Cash ISA, this can be transferred to a Stocks and Shares ISA. ISAs can be transferred between managers to improve on investment choice or reduce charges.
A Stocks and Shares ISA will normally increase in value at a higher rate than a cash ISA, although it will fluctuate in the shorter term. This can make more efficient use of the beneficial tax treatment. You should only consider investing if you do not need access to the money within the next few years.
Everyone’s circumstances are different, and you might benefit from advice regarding the best way to use your surplus cash.
Please do not hesitate to contact a member of the team if you’d like to find out more.
