Reader Case Study - How to prepare for decreasing income (UK)

[Elh]

Life Situation: 24yo, UK (London) resident, not married, no dependents

Gross Salary/Wages: I'm currently a contractor so I get paid £280 for each day I work. Obviously this is usually 5 days a week but bank holidays/sick days/time off etc isn't paid therefore making the income slightly variable although generally it is £1400 a week (£5600 a month)

Pre-tax deductions: I pay 1% (0.8% from wages, 0.2% from gov tax break) into my pension. This is currently the max that can be contributed a year although next financial year, this cap will be removed. My employers matches this 1%. My contribution is therefore approx £20 per month. I also pay Employers NI contribution (£595.04 pm) and umbrella company fee (£90 pm).

Other Ordinary Income: Starting from July I will receive £500 a month from my boyfriend to cover his half of the bills. (I therefore won't include this in the calculation figures below although I will of course factor it into budget plans)

Adjusted Gross Income: £4894.96 pm

Taxes: PAYE £1123.68 pm
   NI £354.12 pm

Net Income: £3417.16 pm

Current expenses: All figures are monthly
Broadband    £43.99 (Both my boyfriend and I work from home one day a week so super fast broadband is very necessary. This figure also includes landline rental and a tv package that was a request from my bf for moving in)

Council Tax   £68.02 (This will increase to £100 from June when my boyfriend moves in and I no longer receive single person discount)

Tolls   £5.00 (this should reduce to £0 once my boyfriend moves in as we will no longer be going back and forth to his place)

Electricity   £61.00

Lunch   £83.82 (working on reducing this to £0 this month by increasing the grocery allowance and packing lunches)

Groceries   £74.13

Life Ins   £19.29 (This is necessary for my mortgage as it's a joint mortgage. I will get rid of it the second the mortgage is paid off)

Mobile   £10.00

Mortgage   £705.00

Mortgage Overpayment   £1,639.27 (this is obviously variable each month depending on how much extra I have to throw at it. Some months it is as high as £2000)

Maint. Charge £45

Spotify   £9.99

Take Away   £95.65 (eek! This is ridiculous and is definitely being cut in half this month if for no other reason than it's bad for my waistline!)

Tube/Train   £202.00 (£180 travelcard to commute to work and £22 for other rail journeys)

Water   £24.86

Total: £1632.75


Assets:
ISA 1.4% £16,000 (I'm quite risk averse and I wouldn't want to move this out of an easily accessible cash fund as it functions as an emergency fund for my not very secure job)
Regular Saver 5% £2000 (This can only be increased by £500pm and I always max it out)
Vanguard 60% Lifestrategy £200 (I'm currently paying £100 a month into this. I'm not sure I really feel comfortable increasing this any further)

Liabilities:
Mortgage 3%: £134,000 outstanding on a 21 year term (3% is fixed for the next 3 years). I can only overpay £15K per year without penalty. I have approx. £90K equity in the house. Any cash left over at the end of the month goes towards overpaying this.

Specific Question(s): As I'm currently working as a contractor I'm on a fixed term contract until the end of the year at which point I'll be going back into regular employment. My wages are currently artificially high as a result of being a contractor and therefore will decrease once I'm an employee again. I don't know how much they will decrease to as this will be dependent on which job I get but I'm estimating approx £35K per year as a conservative estimate and I was on a little less than this before taking the contractor role. My question is a) how to I make the most of 6 months of these high wages and b) how do I prepare/ future proof for going back to lower income?
My current strategy is to overpay the mortgage as much as possible and get this gone within 5 years to try and free up some extra money a month but I'm concerned that this perhaps isn't the best route towards FIRE?

[Playing with Fire UK]

Welcome Elh,

You're doing incredibly well for 24.

As you are paying 40% tax , you could consider putting the money that you are paying the higher rate of tax on into a personal pension. The upside of this is that you will delay paying tax on it, and will probably pay less tax in retirement, and you will get to take advantage of the larger tax break before it is taken away (which may or may not happen). The downside is that you wouldn't have access to it for at least 30 years and likely more.
Are you thinking about retiring early?

You will still be covering your expenses when your income decreases, so I'm assuming that you are trying to save as much as you can now for FIRE, rather than save now to consume more when your income drops.

In terms of expenses:
Have you checked that a travel card is still cheaper than PAYG as you WFH one day a week? What about shorter weeks? Have you looked into getting a Santander 123 credit card to get some cashback from this? Could you cycle to reduce travel expenses? Are you under SDC (Supervision, Direction or Control) meaning that you can't claim tax back on travel expenses?

Have you looked into claiming your £4 tax per week for using your home office? (Assuming you are required to WFH).

Any annual costs you need to add a monthly contribution for (TV licence?, phone upgrade, home appliances?)

Lunches and takeaways you've identified as an area to save.

In terms of what to do with surplus cash:
Efund is high - you're not going to reduce this [or invest it?] => fine. Consider moving it to a higher interest current account (outside of an ISA) as you still won't pay tax on the first £500 interest, and can move nearly all of it all back into a cash ISA at the end of the tax year if you want.

As soon as you can contribute more to the workplace pension I'd do it - you'll save on tax, NI and get a match from the company.

I personally would put all the extra cash into Vanguard (in an S&S ISA) rather than the mortgage, because I'd expect it to grow more than 3% per year on average. This is a personal risk tolerance thing, and it seems like it might feel too risky for you at the moment. At 24, without dependants, without a major purchase on the horizon (that you've mentioned); many people would say you can afford to take risk and invest at higher volatility (more stocks) for the long term. If you don't feel this is right for you then it probably isn't - maybe read Tim Hale's Smarter Investing for some more information, and check out the risk profiling company he recommends, (but google it to do it for free).

If you don't want to invest more, maybe look at opening regular savers at other banks, HSBC and First Direct both have 6%; and there are more 4% and 5% ones. Even after tax, getting 6% is better than saving 3% on a mortgage.

Plenty of people here have paid off their mortgages first, and there are pages of debate as to whether it is 'better' or not; but it is a mathematical certainty that if you borrow money somewhere at a lower interest and earn a higher interest/growth (after tax and expenses) you will make money.

How does your mortgage work in terms of borrowing back the overpayments? If you can't borrow them back whenever you like (as you could for an offset mortgage), then overpaying the mortgage may give you less security than you think (until it is fully paid off). Your choice and not going to force my opinion on you.

For your boyfriend moving in:
Have you discussed all the joint expenses and how you will split groceries etc?
Have you discussed whether you think he should have an interest in the house if you separated and compared this to the law?
Have you told your mortgage provider? (they may require him to sign a form saying he doesn't have an interest in your property), and not telling them may be against the T&Cs of the mortgage.

In Summary:
Good work so far.
Consider a personal pension to pay less tax this year
Look for high interest accounts as an alternative to your E-fund ISA and/or mortgage overpayments
Look to invest more (by learning more) as soon as you are comfortable with it.
Maybe change the title of the case study to include 'in London' or 'in UK' to get more local comments?

[Elh]

Hi Playing with Fire UK! Thank you so much for the detailed response!

As you are paying 40% tax , you could consider putting the money that you are paying the higher rate of tax on into a personal pension. The upside of this is that you will delay paying tax on it, and will probably pay less tax in retirement, and you will get to take advantage of the larger tax break before it is taken away (which may or may not happen). The downside is that you wouldn't have access to it for at least 30 years and likely more.
Are you thinking about retiring early?

This is a great idea that I hadn't thought of! I am indeed looking to retire early. As I don't expect to be paying the 40% tax rate after the end of this year, would contributing to this in favour of other things eg. S&S ISA lose the advantage once I drop back to the basic tax rate?

You will still be covering your expenses when your income decreases, so I'm assuming that you are trying to save as much as you can now for FIRE, rather than save now to consume more when your income drops.

Absolutely. I have no particular need to increase my consumption any time soon (no plans for kids etc.) so all the money is being saved for FIRE.

In terms of expenses:
Have you checked that a travel card is still cheaper than PAYG as you WFH one day a week? What about shorter weeks? Have you looked into getting a Santander 123 credit card to get some cashback from this? Could you cycle to reduce travel expenses? Are you under SDC (Supervision, Direction or Control) meaning that you can't claim tax back on travel expenses? Have you looked into claiming your £4 tax per week for using your home office? (Assuming you are required to WFH)

This is a good point. I just checked and I can save £4 a month (assuming a normal 4 day week) on the travel card if I payg instead. I obviously travel places other than work on public transport though so it will depend if the cost of this would be over £4 (plus savings from other days where I may not work). I might not buy my travelcard for the next month and tally up the expenses to see which one works out more expensive. My current commute is approx. 20 miles straight across central London so I can't cycle it unless I was to drastically increase my fitness levels! I'm not required to wfh and fall within SDC so can't claim expenses for either unfortunately.

Any annual costs you need to add a monthly contribution for (TV licence?, phone upgrade, home appliances?)

The only annual cost is for TV license which works our about £12 a month so doesn't change the budget much.

In terms of what to do with surplus cash:
Efund is high - you're not going to reduce this [or invest it?] => fine. Consider moving it to a higher interest current account (outside of an ISA) as you still won't pay tax on the first £500 interest, and can move nearly all of it all back into a cash ISA at the end of the tax year if you want.

Efund is definitely high and as soon as I get myself back into permanent employment I'll definitely look at reducing this. Moving it out of the ISA and into a higher interest account is a good thing to consider though now given the newly increased personal savings allowance.

I personally would put all the extra cash into Vanguard (in an S&S ISA) rather than the mortgage, because I'd expect it to grow more than 3% per year on average. This is a personal risk tolerance thing, and it seems like it might feel too risky for you at the moment.

I'm quite weary of this (I'm a particularly risk averse person) but I've recently opened a Vanguard 60% Lifestrategy in a S&S ISA and I'm putting small amount into that each month. Depending on how that goes, if I feel more comfortable with it after a few months of trying it out I might increase the contribution/move some of the Efund into it.

How does your mortgage work in terms of borrowing back the overpayments? If you can't borrow them back whenever you like (as you could for an offset mortgage), then overpaying the mortgage may give you less security than you think (until it is fully paid off). Your choice and not going to force my opinion on you.

I can't borrow back the overpayments and I certainly understand the arguments for investing the money for greater return than the mortgage interest instead. As above, I think I'll probably see how my experiment with the Vanguard Lifestrategy fund goes and then reevaluate whether to redirect future mortgage overpayments to this instead.

For your boyfriend moving in:
Have you discussed all the joint expenses and how you will split groceries etc?
Have you discussed whether you think he should have an interest in the house if you separated and compared this to the law?
Have you told your mortgage provider? (they may require him to sign a form saying he doesn't have an interest in your property), and not telling them may be against the T&Cs of the mortgage.

All fixed household expenses (ie. mortgage overpayments not included) are being split in half and he'll pay me that amount each month. Groceries we'll just take turns each week paying for as the amounts should be roughly even. We take a turn based approach to pretty much all other expenses (takeout, dates etc) as we figure out this pretty much levels out to equal over time.
I just checked with my bank and they say I do need to let them know so thank you so much for this!! I did not know you needed to do that at all!


Thank you so much for all your suggestions and advice! I really appreciate it and I've got some great starting points to try and optimise things a bit now.

[Playing with Fire UK]

Pensions vs S&S ISA:

You would retain the benefit of contributing to your pension this year.

With a pension, you gain the 40% tax that you would have paid this year (ie, if you earn £5600/mo between April and December = £50k; you would have paid 40% tax on 350k - £43k = £7k (plus your earnings from January - March at a lower day rate, up to a total of £40k per tax year).

As a 40% tax payer, you can put  (£7k * 0.8 = ) £5.6k into a personal pension, the government will top it up to £7k (inside the pension), and then give you an extra £1.4k (0.2 * 7k) outside the pension, either via a tax code change, a cheque, or Self Assessment. This is yours to keep when you go back to 20% tax next year.

The £7k stays inside the pension (and grows tax free) no matter what tax you pay next year. You can only claim the second £1.4k outside the pension in the tax year that you pay 40% tax and contribute it to a pension. If I was you I'd save like crazy to benefit as much as possible from this in this tax year.

There are two benefits to an S&S ISA:
1. No tax on dividends or Capital Gains (sale price - purchase price) on anything inside the ISA. The allowances for dividends are £5k per year and for Capital Gains 11k per year; so you will probably need to save for a while to actually benefit from this.
2. You don't need to fill in paperwork to confirm that you are below the levels above for an ISA.

The main benefit of wrapping your savings/investments into an ISA now, is that there is no way of putting more than the current annual limit (£15k this year and £20k next tax year) into an ISA. So you need to do it as you go along, even though you probably won't reach the taxable limits for a few years. I don't think it will make much difference to you if you do it next tax year instead. If you are worried about this then decide what you are going to do before you take the money out of the Cash ISA.

Re risk aversion: it takes some time to feel comfortable with it - don't rush yourself. But definitely don't watch the business news and don't sell your Lifestrategy60!!! It is a good choice for your age and risk tolerance.

Re the mortgage and partner moving in: I didn't know either until I was chatting to the bank (and mortgage co) about some transactions they'd flagged and mentioned my SO in conversation and they told me off! I'm guessing that when we fill in the application form there is a question about if anyone is living with us that says we need to tell them but who remembers that?!?