Managing Finances during Covid-19.
An unfortunate context
We find ourselves in a time of political, social, and economic unrest. Both Brexit and the global COVID-19 pandemic has had an impact on everyone, with the stress put on individuals and businesses comparable to those from the 2008 financial crisis. The office of national statistics (2020) has reported that 50% of businesses in the UK have seen a decreased level of turnover for this time of the year, with only 8% seeing an increase in revenue. Not only have businesses had to adapt with a decreased customer base and retail closures, but also the increased administration costs from the 1st of January 2021. The impact of COVID-19 has seen unemployment levels reach 7.5%, meaning people cannot work and are put under increased amounts of financial stress. According to UCL (2021), 1 in 3 people are worried about their finances in the UK. I would argue that a year ago financial planning was necessary, now it is essential.
How much has COVID-19 cost?
According to the National Audit Office (2021), COVID19 has cost the UK £271 billion in measures that the central government departments are responsible for. So far, the government has only spent £116 billion on these measures meaning that the UK has only spent 42% of what this pandemic will cost, and we thought we were near the end.
So how do the government pay for all this?
The most obvious solution is to raise taxes. However, this is not that simple and it’s a controversial strategy. So far, the government has borrowed over £200 billion to help fight the pandemic, suggesting that the government may have to look at other viable options (Inman, 2020).
Is raising taxes as bad as it seems? If done correctly, raising taxes may be an effective way to pay some of the debt that the UK finds itself in. Income tax, VAT and NIC contribute half of the Governments income, but what about the other taxes? The institute for Fiscal studies (2017) states corporation tax only makes up 8% of the total tax income for the government, the protection over our big tax paying corporations could be reviewed. Increasing corporation tax could relieve the financial strain on the public. On the other hand, it is important to provide an environment for businesses to grow in our country.
Why is raising taxes so controversial? The most obvious reason is that no one wants to pay more in taxes, but we must understand the context of the economy. In such an uncertain financial climate where job security is huge worry, the government taking away disposable income may prove very problematic from a social standpoint. There are also strong political incentives not to raise taxes, the conservative party were elected under the promise that the three main taxes (NIC, Income tax and VAT) would not be increased so this may have an impact on the parties future success.
What other options do the government have?
One alternative strategy is the increased auctioning of government bonds. The debt management office revealed in April that they would be able to raise an extra £45 Billion from Gilt auctions across the UK, however this is only a short – midterm strategy (Lambert, 2020). The Government has also borrowed from the bank of England, however borrowing money creates debt. The independent (2020) reports the UK’s national debt is the highest in 60 years, suggesting the government should find a way to generate more income rather than borrow.
Why has financial planning become so important? Financial planning carries the purpose of looking towards the future and assuring that a person can meet their financial goals and equally as important their non-financial goals. This includes becoming as tax efficient as possible, planning for retirement, death and probably the most relevant issue of protection against loss of income. Due to the rise of unemployment and the uncertain economic environment, financial planning for individuals has become very important. One element of financial planning that will become more essential is protection. This is because of the rise of unemployment in the last year, according to the Guardian (2020) unemployment is now at 5% (1.7 million people) compared to 4% in February 2020. Families and individuals need to know what measures exist to protect their finances.
What steps can you take to ensure you're fully protected?
When considering protection, it really depends on the individual’s circumstance. For example, if Client X is a 30-year-old married with children and a mortgage then planning for a loss of income is essential. If Client X loses their income, then this will directly impact the beneficiaries (Spouse and children). This is especially the case if Client X is the bread winner in the family. Mortgage insurance in this case is sensible, this monthly payment will still have to be paid if unemployed, and the security of having a roof over your head is not to be undervalued. Client X should also consider income protection, this will pay out an income upon unemployment which is usually capped at 50 – 70% of their salary. This is a fixed rate with a deferral period of 4 – 104 weeks once taken out. It is advised that the deferral periods be extended for the length of time deemed necessary as longer deferrals usually mean lower premiums. If considering income protection, then be aware that it is usually expensive and at risk to inflation. There is the option of purchasing an index-linked policy that will protect income against inflation, however this comes with additional cost.
The global pandemic has severely raised concerns over health, Gov.uk (2021) states that the UK just passed the 120,000-death toll and it has shown how it can affect anyone healthy or unhealthy. Let us take Client A for example, he/she is a basic rate taxpayer along with their spouse, Client A is 45 years old and works with heavy machinery. It is advisable that they need to consider critical illness cover as their job carries an element of risk. Critical illness cover will help pay any additional medical costs, helps with provision of long-term care and mortgage/debt repayment, all these costs on one partner’s BR salary will to put a strain on the family’s finances and wellbeing, making it harder to maintain their previous standard of living.
Critical illness cover can be expensive and there is risk an individual cannot claim on the insurance unless the diagnosis meets the requirements set out by the insurer. However, it is likely to get a higher pay on a successful claim than on income insurance (Leeks, 2020)
With unemployment rising job security is not guaranteed. Redundancy insurance can protect clients usually for a 12-month period by paying out a proportion of their salary. This is a short-term strategy for individuals that are concerned over job security in the short to midterm.
Does everyone need protection?
Everyone should consider it, but in truth there are better alternatives for some individuals. Income protection is expensive. For example, very wealthy people do not necessarily need protection, they are better off using private savings. Apart from that most people need some form of protection; it is just a case of picking the correct product.
There are other methods of preparing for loss of income. For example, it is sensible to build up a savings account to be used as an emergency fund and investing your income in a money generating asset to provide income upon unemployment.
How to protect yourself against a raise in taxes
If the government does increase personal taxes, then it is essential to be tax effective. The first step to becoming more tax efficient is to make use of the personal allowance, Personal savings allowance, and dividend allowance. The government has gifted a tax-free amount for any income, make sure it’s used! For example, if Client C is married and owns shares in ABC ltd which provides £2,000 pa, and their spouse is not using their full dividend allowance of £2000 but Client C is, then it would be tax efficient to transfer those money generating shares to the spouse. That way the client will maximize the £2000 tax free amount, and once better, the transaction isn’t vulnerable to Capital Gains tax or Inheritance tax as it is a spousal transfer. The same goes for any money generating asset, for example rental properties, this income is considered non-savings income which provides a £12,500 tax free sum. Moreover, if the main bread winner in the couple pays tax at a higher rate whereas the partner pays tax at a basic rate, use up the partners BR tax band, this saves any non-savings income being taxed at 40% rather than 20%.
Tax-exempt methods of generating income are very popular in the UK. For example, ISA’s are tax exempt and are a great way to keep money safe in the long term for children or grandchildren, though bear in mind some ISA’s allow the children to obtain control at 18, if that is a concern maybe look at investing money in a trust which allows you to obtain full control of the account until necessary. National savings are also exempt, like ISA’s the returns are often very poor, however it can be argued that with the financial uncertainty of COVID-19, financial security is more important than higher returns.
If an individual’s income is low, it is good practice to check whether they are claiming all the benefits they qualify for. For example, council tax benefits, which will cover part of all the council tax bill and housing benefit to aid in rent payments (Jonquil, 2013).
What if I have more money due to COVID?
The Office for National statistics reported an increase of 49% in home working between May and June 2020. Meaning millions of individuals are not paying costs associated with going to work. Moreover, lockdowns have cut down any ‘going out’ expenditure which has led to a higher disposable income. The extra disposable income should be invested properly in hope of future gains. If an individual has a surplus income, then going to a financial planner is a good way of getting advice on diversifying an investment portfolio. Because it’s extra cash an individual would have otherwise spent, it might be worth considering a higher risk approach and looking at investment products such as government bond which offer around 3% return pa. Individuals with more money and an appetite for higher risk could look towards a potential >5% return in equity unit trusts.
To summarise
Financial planning is all about personal circumstance. How an individual manages their income is dependent on multiple factors. COVID-19 has meant a change in most people’s financial affairs. For many this has meant an increase in financial vulnerability. Because of this acquiring the proper and suitable protection is ever more important.