Rebecca O’Connor helps a freelance copywriter to plan for the future despite his irregular income
THE benefit of being self-employed is that you have more freedom. The downside, as Paul Machin has discovered, is that financial planning becomes a lot harder.
Paul, 31, lives in Dorset with his wife, Natalie, 33, and their one-year old daughter, Iris. He has not paid into a pension since he left full-time employment in the autumn of 2005 and has no savings because his irregular income as a freelance copywriter makes monthly deposits tricky.
For the past two years Paul has been making about £30,000 a year writing brochures and website copy for companies such as KPMG and Vodafone, as well as public sector clients. “I love the autonomy and the variety of work that comes with being self-employed. Both outweigh the inevitable lack of security,” he says.
Natalie is currently a full-time mother but runs a vintage interiors and accessories website called www. eravintage.com. This earns some extra cash, but she is hoping to boost earnings from the website when Iris is older.
The Machins live in a three-bedroom terraced loft conversion, worth £210,000, on which they have a £174,000 mortgage.
Paul admits that he is probably not as prudent as he ought to be and says that their biggest expense is organic food, closely followed by visiting friends and squeezing in the occasional summer music festival.
However, Paul’s priorities are changing and he now wants to start saving into deposit accounts and a pension. The problem is knowing where to start. “My income varies from a few hundred pounds one month to a few thousand the next, so paying into an account regularly is difficult,” he says.
“I am also confused about whether I need to save in an Isa or in a regular savings account. It would be useful to be able to access some savings for unexpected emergencies, such as car repairs, so would it be a good idea to open two accounts, one that requires notice and one with instant access?”
Paul currently has a retirement pot worth £11,500 from three former occupational pensions. He wants to know what he should do with these and asks: “Would it be possible to combine them, and if so, will there be a fee to pay?” He also wants to know the best place to start saving in a personal pension and how much he needs to invest.
Natalie also has a few thousand stashed away in suspended occupational pension schemes, but she is not currently paying into a personal pension.
One thing that they have sorted is a Child Trust Fund account for Iris, which she will receive when she reaches 18. They have invested £460 in the Insight Investment European Ethical Fund, managed by the Children’s Mutual, and are paying in £30 a month.
Paul also wants to plan ahead with the mortgage but is unsure what to do when their two-year deal with Northern Rock, fixed at 5.89 per cent, comes to an end next January. “I really like the certainty of fixed rates, so should I consider one of the really long-term deals that are now available?” he asks.
The Machins have no other debts on credit cards or on personal loans.
Financial CV Earnings: £31,000 a year.
Pension: Paul has £11,500 from occupational schemes and Natalie has “a few thousand”, also from old employment schemes.
Objectives: To establish a regular savings plan, start contributions to a pension scheme and to remortgage when their current fixed-rate deal ends next January.
The Machins: what the experts say
Adrian Lowcock, Bestinvest
“Because Paul would like to save some instant-access funds, I suggest splitting his investments between a cash mini-Isa, contributing up to £3,000 a year (£3,600 from April 6), and a direct-access savings account for emergencies. Loughborough Building Society has a 90-day notice Isa at 6.1 per cent, with a £1 minimum deposit. West Bromwich Building Society’s instant-access savings account pays 6.55 per cent, also with a £1 minimum deposit.
“As Paul’s income is variable it would be prudent to place a small monthly sum, say £50, in the two accounts and top this up as his income allows. Once these have sufficient funds to cover emergencies, he could then consider a stocks and shares mini-Isa to provide access to investments, starting with a a multi-asset fund, such as CF Midas Balanced Growth.”
Open a cash mini-Isa with Loughborough Building Society and pay in £50 a month.
Open an instant-access savings account with West Bromwich Building Society and pay in £50 a month.
Top up in higher-income months.
Consider taking out a stocks and shares mini-Isa later on.
Jason Witcombe, Evolve Financial Planning
“There is a general misconception that retirement planning means paying money into a pension. A pension is simply a tax-advantaged investment and it is often best to hold a mixture of pensions, investments, such as Isas, cash and other assets.
“Paul should consider delaying pension contributions until his income lifts him into the higher-rate tax bracket, which starts at £39,825. He can then claim 40 per cent tax relief, against 22 per cent (20 per cent from April 6) for basic-rate taxpayers.
“To draw 5 per cent a year from his pension at retirement, he would need a fund of £200,000 for every £10,000 a year of income. With higher-rate relief, this would cost £120,000, rather than £156,000 with basic-rate relief at 22 per cent.
“In Paul’s shoes, I would concentrate on paying down the mortgage to a manageable level and building up a cash buffer for when income is low.
“If he really wants to start a pension, I suggest a stakeholder with either Legal & General or Norwich Union. Charges are capped at 1.5 per cent on stakeholders, and the charges on these two decrease over time. As Paul is quite young, he should probably go for a ‘lifestyled’ investment option, which will switch the fund into less-risky investments the older he gets.”
Delay contributions until earnings rise above higher-rate tax threshold.
Pay down mortgage and build up a cash buffer.
Open a stakeholder pension with Legal & General or Norwich Union, with a “lifestyled” investment option.
Rob Clifford, Mortgageforce
“Paul should not switch mortgage deals until the end of his fix in January because of the early repayment charges. These should not apply once the deal comes to an end, but he should check the terms and conditions. If he took out a Northern Rock “help with costs” option, which provides a cashback on completion of the mortgage, he may have to repay up to £1,000, as this is repayable if the mortgage is cleared within the first 36 to 42 months.
“Paul should speak to a mortgage broker three to four months before the end of his current fixed rate, as it is too early to consider mortgage rates for next January.
“Deals that are fixed for ten years are relatively unpopular because of recent rate falls, as is the concept of locking in to one lender for such a long spell. He should consider the competitiveness of the rate and how he would feel if interest rates continued to fall and left him at a noticeable disadvantage.
“Long-term fixed rates do, however, have the advantage of allowing Paul to budget and plan for years ahead. Abbey offers a 5.59 per cent deal until 2018, with a £999 set-up fee, while Dunfermline Building Society has an excellent 5.89 per cent deal fixed until 2018, with a £599 fee.
“Given his erratic monthly income, Paul should consider flexible and offset mortgages. The amount of mortgage interest saved by offsetting could be significantly better than returns in a deposit account. A flexible mortgage would accommodate peaks in his income and may permit payment holidays if times get tough.”
Look for a new deal a few months before the current fix ends.
Weigh up the costs and benefits of a ten-year fixed rate.
Consider a flexible or offset deal to save on mortgage interest.