The Best Thing Young Brits Can Do With Their Savings
(Bloomberg Opinion) -- With the U.K. slowly reopening, it’s a good time to think about what to do with any savings you may have accumulated since last spring.
Among those fortunate enough to have remained employed throughout the pandemic, household savings have soared. According to the Office for National Statistics, the household savings rate rose to a record of 16.3% in 2020, peaking at 25.9% between April and June. Immediately prior to the pandemic, the rate was just 7.7%.
For older workers, what to do with savings is pretty straightforward: repay debt and feather your nest for retirement. Spending some of it would also help to stimulate the economy. But for those in the earlier stages of their careers, the question is more complicated.
The pandemic hit younger workers especially hard. The latest U.K. employment report indicates that the number of people aged 18-24 claiming unemployment-related benefits increased by 114% between March 2020 and April 2021. This likely won’t help wages, which were already growing very slowly before Covid.
So young professionals who managed to keep their jobs and save during lockdown mustn’t waste this opportunity to think about their future financial security. The best way to do this is to create an emergency fund without sacrificing long-term goals such as contributing to retirement and buying property.
So far people seem to be using their savings wisely to pay off expensive debt. With the exception of July and August last year, U.K. credit card balances have fallen every month since December 2019. This is no bad thing as, according to the Bank of England, the average annual percentage rate on UK credit cards is 22.5% — quite high interest compared with other types of borrowing.
But after paying off debt, it’s not always clear how to allocate one’s saved up cash.
The problem with shoving all of it into a retirement account is that your money might be tied up for many decades, offering little help for either buying your first home or covering emergencies such as unemployment. At the same time, having a six-month emergency fund tied up in a deposit account, earning little or no interest, is hardly ideal either. And saving up for a down payment on a home also usually means locking up funds in low-interest cash accounts.
The answer to all three problems might lie in opening a Lifetime Individual Savings Account (LISA). This enjoys all the income tax and capital gains advantages of a regular ISA, with the added benefit of receiving a 25% bonus if your savings are used to either purchase your first home or to contribute to your retirement. LISAs can be left as deposits in a savings account, but you can also invest the money for the long-term by directing it toward stocks and funds. And you still have flexibility to draw upon this in an emergency.
Adults between the ages of 18 and 39 can open a lifetime ISA. Once opened, account holders can continue to contribute until they turn 50. The annual contribution limit is 4,000 pounds ($5,666), which is grossed up to 5,000 pounds by the U.K. government if you contribute the maximum annual amount.
The bonus is clawed back, however, if the money is used for any other purpose, such as an emergency. But unlike a pension, your savings remain accessible should you need them before you retire; and unlike a regular ISA or savings account, a LISA offers a bonus in the first place. The loss of it merely helps to ensure that money isn’t drawn down for trivial reasons.
A LISA can transcend both long-term and emergency saving, but it’s not an entirely costless undertaking. Although you receive the 25% bonus on contributions, your fund is actually reduced by 25% if you make a withdrawal that’s not used for a property purchase or your retirement. An unauthorized withdrawal therefore suffers a net 6.25% penalty, in addition to the loss of the bonus. This penalty was temporarily suspended last year, but was reinstated at the beginning of the current tax year on April 6.
This potential risk has to be considered, but the ability to build wealth over the long-term while still having flexibility to respond to an emergency makes a LISA well worth considering.
If you have already achieved the goal of purchasing your first home, there is another strategy that can help create additional security against an emergency without keeping that money languishing in a low-interest account. Take on an offset mortgage.
Like a conventional mortgage, an offset one allows you to overpay your monthly bills and save interest in the process. But unlike with a conventional set up, your overpayments on an offset remain available to be drawn back down should the need arise. In practice your mortgage account is linked to a deposit account. Before the mortgage interest is calculated, the money in your deposit account is “offset” against your loan. The larger your deposit account, the less interest you pay.
LISAs and offset mortgages offer a financial cushion in case of a crisis, without condemning hard-earned cash to a savings account for an emergency that might never happen. They allow younger workers to put savings toward securing both the short-term and long-term future.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Stuart Trow is a credit strategist at the European Bank for Reconstruction & Development. He is also a pensions blogger, radio show host and member of numerous retirement, finance and audit committees.
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