Five in 5: Financial planning tips on recent rate cuts
Welcome to the latest edition of Five in 5, our snapshot of the hottest topics within financial planning. Designed to give you the top headlines to keep in mind when talking to clients in just five minutes. This edition discusses recent rate cuts.
With the recent Bank of England rate cut, now is the time to reassess your financial strategy. Savers should consider locking in favourable rates, while gilts offer a tax-efficient, low-risk opportunity for growth.
Mortgage rates are also dropping, and potential changes to pension tax relief make this the ideal moment to review your options and maximise contributions.
Get the full insights below.
1. Cash management
On 1 August 2024, the Bank of England announced it had cut interest rates from 5.25% to 5.0%. While this is welcome news for borrowers, savers are now seeing the interest they can earn on cash falling, with further base rate cuts expected into 2025. You might want to ask yourself if now is an opportune time to lock in favourable rates before further reductions.
Cash funds should remain a key component of an investor’s portfolio. The first priority is identifying the best available rates. In today’s competitive market, diversifying your cash across multiple banking institutions not only helps secure top rates but also reduces the risk of exposure to any one bank. The Financial Services Compensation Scheme (FSCS) supports this approach by protecting deposits up to £85,000 per individual, or £170,000 per couple per institution, adding an extra layer of security.
To simplify this process, we encourage our clients to utilise a cash management platform. This service provides a single login that grants access to a variety of accounts across different banks, making it easier to protect your money and secure the most competitive rates.
At the time of writing, the highest available rates are:
- Instant access: 4.70%
- 1-month fixed: 4.59%
- 3-month fixed: 4.70%
- 6-month fixed: 4.80%
- 12-month fixed: 4.75%
Anticipating further reductions, consider if securing a mix of fixed-term accounts now might allow you to take advantage of the highest available interest rates while they’re still available.
2. Gilt investments
Gilts, being loans to and backed by the UK government, are amongst one of the safest investments that can be made. But why consider a gilt investment over cash? By investing in a gilt, you’re almost guaranteeing what you’ll get back if you hold to redemption, similar to a fixed-rate savings account. The main draw to gilt investments, however, is that part of the return, being the capital growth element, is completely tax free, making this an incredibly powerful savings vehicle for higher- and additional-rate taxpayers.
For example, if an individual buys 1,000 units of a gilt at 91.5p each, it would cost £915. In two years, when the gilt matures, the government will repay £1,000 for those 1,000 units. This provides a tax-free gain of £85, equivalent to an annual return of approximately 4.64%. To achieve the same net return, a higher-rate taxpayer would need to earn approximately 7.73%, and an additional-rate taxpayer 8.44%.
Incorporating gilts into a broader investment strategy can offer peace of mind by securing tax-efficient short-term growth via a low-risk asset. However, it’s crucial to correctly structure your gilt portfolio. Not all gilts offer the same tax advantages, so selecting the right ones to match your financial goals is essential.
3. Protection – living vs death cover
Protection or life cover is a term used to describe life insurance designed to provide either a replacement income or a lump sum payment in the event of death or long-term illness.
Life cover should form the bedrock of an individual’s financial plan, providing security for you and your family to achieve your financial goals, even in the face of unexpected health issues. Without adequate life cover, your financial goals become vulnerable to your own health, potentially making you the weakest link in yours and your family’s own financial security.
Imagine this: you’ve consistently invested over the years with a clear path to purchasing a forever home, planning for retirement or supporting your children through education. However, an unexpected illness or injury interrupts these goals. Without proper protection, both your and your family’s financial stability quickly unravels, leaving your plans on hold. In the worst case, if you pass away, you expose your loved ones to financial strain at the worst time.
So, what can you do to safeguard against these risks? Consider the following options you could incorporate into your suite of cover:
- Mortgage protection: ensure that your mortgage can be repaid in the event of critical illness or death, alleviating this major expense during challenging times.
- Income replacement: replace your income if you are unable to work until retirement, helping you manage daily expenses, maintain your standard of life and continue saving for the future, irrespective of health.
- Protecting your family: provide a replacement income or lump sum payment for your family in the event of your death. This ensures they receive ongoing financial support for living expenses, akin to how you would have supported them.
Having protection incorporated into your financial plan provides peace of mind. Knowing that if you suffer an illness or injury, you will receive funds to help manage financial obligations such as the mortgage, bills and childcare, or simply maintain your standard of living. In the event of your death, your loved ones receive the funds.
4. Mortgages
Following the Bank of England’s recent 0.25% reduction, the first decrease in over four years, mortgage rates have started to decline. This has been further accelerated by increased competition among lenders, resulting in noticeable reductions in fixed-rate deals, with five-year fixed mortgages now available at rates below 4%.
Ideally about six months before your current mortgage deal expires, shop around and lock in a new rate well in advance. This proactive approach allows you to secure the best terms while protecting yourself against potential rate increases, say from a poorly received autumn budget. Should interest rates fall further before your new mortgage takes effect, your broker can update your offer to reflect the lower rate. Conversely, if rates rise, you will be protected from your existing offer.
For those looking to purchase a new home, the recent drop in interest rates means lower monthly payments and potentially increased borrowing capacity, giving you a broader range of options compared with this time last year.
Beyond interest rates, we have outlined three common themes that could impact your mortgage:
- Explore the entire market: Ensure your broker is ‘whole of market’, meaning they have access to all available lenders and products, rather than being limited to a closed panel or just your own bank. This broad access allows for better tailored mortgage options and more competitive terms and rates.
- Assess your financial situation: Small adjustments in your financial profile could lead to more favourable terms. For example, do you know how your bank statement expenditure will impact your mortgage application?
- Review your credit history: Lenders evaluate the depth of your credit history, including existing debts, credit card usage and any new financial obligations. Being aware of these factors can help you address any issues before applying for a mortgage.
Consider if speaking with an independent mortgage broker before the next bank rate announcement on 19 September 2024 may help you explore how the recent changes impact your mortgage options.
5. Pension annual allowance and carry-forward
Pensions are a highly effective but often underutilised tool for financial planning, with contributions offering significant tax relief. Depending on your income tax bracket, the relief you receive can be substantial:
- Basic-rate taxpayers (20%): For every £1 you contribute, it effectively becomes £1.25, as £1 taxed at 20% equals £1.25.
- Higher-rate taxpayers (40%): Your contributions enjoy a 66% boost, turning every £1 into £1.66.
- Additional-rate taxpayers (45%): Contributions receive a remarkable 80% boost, turning every £1 into approximately £1.82.
How much can you contribute?
From the 2023/24 tax year, the maximum annual pension contribution eligible for tax relief is the lower of £60,000 or 100% of your earnings. This is your annual allowance.
For example, if you earn £30,000, your contributions are capped at £30,000. However, because tax relief is included in this figure, you can contribute up to £24,000 and receive £6,000 in tax relief, totalling £30,000.
How can you backdate unused contributions?
If you haven’t maximised your pension contributions in previous years, you may be able to use the carry-forward rule. This allows you to carry forward any unused annual allowance from the last three tax years (2021-22, 2022-23 and 2023-24).
To qualify, you must first fully utilise your current annual allowance (for 2024-25). Then you can carry-forward the unused portions from prior years, potentially enabling you to backdate unused contributions up to £140,000 if no pension payments were made in those years.
Potential changes to tax relief
There is speculation that the new Labour government will introduce changes to pension tax relief, potentially shifting to a flat rate, such as 25%. This would benefit basic-rate taxpayers by about £500 but could significantly reduce the benefits for higher earners.
It is worth considering whether now is the right time to maximise your pension contributions while the current tax benefits remain in place.
