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Case Study: Money management lessons
By Hannah Ricci
Des and Claire Arnold live in Didcot in Oxfordshire with their six-month-old son, Finn. They are both teachers - Claire, 31, at a primary school earning a salary of £31,098 and Des, 32, at a private language school where he earns £20,372.
The Arnolds were faced with the tricky question of who should look after Finn when Claire's maternity leave ends. As Claire is the higher earner, has longer holidays, and is a member of the Teacher's Pension Scheme they decided that Des would give up work to look after Finn.
Des and Claire have a mortgage of £120,000 on their £190,000 house, which is a 'key-workers' property with the South Oxfordshire Housing Association (SOHA). They have a repayment mortgage with Abbey on a fixed rate of 4.85% until October 2007, and pay back £774.49 a month.
They have a number of savings and investments; including mini cash ISAs totalling approximately £4,240, equity ISAs worth £3,670, and some Premium Bonds. They have £300 in a National Savings Children's Bonus Bond as well as £250 in a Child Trust Fund for Finn.
"We'd like an all round financial health check due to our change in circumstances," explains Des. "We'd like to achieve long-term security for the family and reduce our mortgage as quickly as possible."
Financial guidance
Tony Byrne, an independent financial adviser from Wealth and Tax Management in Milton Keynes, says Des and Claire are pretty organised financially. "They have paid £6,000 off of their mortgage this year, which is highly commendable, and aim to pay off their mortgage as soon as possible," explains Byrne. "I fully support this approach - a mortgage doesn't have to be held for 25 years."
The Arnold's were lent £25,000 from South Oxfordshire Housing Association (SOHA) to buy their house. They do not have to repay this until they sell up, when they will have to repay £25,000 plus the percentage growth on the property's value.
Des's job is being left open for him until June 2007 - at the moment he plans stay at home and care for Finn until then, but possibly until Finn starts nursery. The Arnold's are planning to have another baby in about two years' time.
Financial protection
Byrne first turns his attention to the Arnold's financial protection. They both have pension term assurance with Legal & General - £160,000 for Des and £200,000 for Claire. Des has critical illness cover with Liverpool Victoria for a sum of £20,000 - with children's cover of £10,000 - whereas Claire's cover with Unum Provident is for £50,000 including children's cover of 25%. In addition, Claire has death-in-service cover as a teacher, equal to two times her final salary.
They do not have private medical insurance (PMI). "PMI is a bit of a luxury when finances are tight, as you can always fall back on the NHS," says Byrne. "Income protection is well worth considering though, because it pays you an income after a deferred period, typically six months, for temporary or permanent disability. It includes conditions not covered by critical illness and vice versa. "Their student loan repayments of £104.05 a month end in March, so this could be an opportune time to consider such a policy," adds Byrne.
Critical illness cover
Byrne is concerned that their level of critical illness cover is inadequate, because at the very least they should have enough to repay their mortgage. "I recommend they increase their cover to £120,000 each," he says. Byrne says they should also both seriously consider changing their policies to ones with guaranteed premiums rather than reviewable ones.
Estate planning
Next, Byrne turns his attention to the Arnolds' estate planning. They both have cost-effective pension term assurance that expires when Finn turns 21. "Currently neither of them has their policies written into trust nor have they nominated a beneficiary," says Byrne. "This means that the proceeds of each other's life insurance policies on a claim will simply go into the deceased's estate on death."
Byrne says at the very least, they should make a death benefit nomination by completing the relevant form and submitting it to Legal & General. Or take the better option, which is to put each policy into trust. "There are several advantages of doing this, including the fact that benefits are paid out very quickly on receipt of the death certificate as there is no need to wait for probate; the proceeds fall outside the deceased's estate for inheritance tax (IHT) purposes and the policyholder has full control over deciding to whom the benefits should be distributed," explains Byrne.
Making a will
Like 70% of the population, Des and Claire don't have wills. "They should arrange wills as soon as possible," says Byrne. "They should also consider changing the ownership of their property from joint tenants to tenants in common, which means owning a distinct share, rather than jointly owning the property.
"Their wills also should contain a discretionary will trust - the effect of all this is to ensure that on the first death, half of the value of the house is placed into trust for the benefit of Finn," adds Byrne. He explains that the surviving spouse can continue to live in the property and has full security of tenure. "This means that the deceased partner will have used up some of their nil-rate band of £285,000 for IHT purposes.
Byrne points out that although IHT isn't an immediate issue for Des and Claire, they should take advantage of this opportunity to put arrangements in place.
"Each person in the UK has an IHT tax-free allowance of £285,000 - but simple planning and transferral of assets can legitimately save a married couple up to £114,000 in IHT," adds Byrne. He also suggests Des and Claire each arrange Enduring Power of Attorney (EPA). "This means if that either of them becomes physically or mentally disabled, the person selected as EPA is able to make decisions and sign documents on their behalf," says Bryne.
Pension and investment review
Finally, Bryne says the Arnolds should review their pensions and investments. "Des is a keen self-investor and regular saver, which is great. However, their portfolio is mainly invested in unit trusts and OEICs, including the Invesco Perpetual High Income fund and Jupiter European Special Situations fund - and is not very diversified," explains Bryne. "I recommend they spread the risk by investing more into property funds and possibly some fixed-interest funds."
He says Des should apply the same strategy to his stakeholder pension, while Claire is lucky to be part of the Teacher's Pension Scheme, which can be left alone.
"In summary, Des and Claire have made some prudent financial planning. Once they implement a few more changes they can look forward to a comfortable and secure future," adds Byrne.
Tony Byrne is managing director of Wealth and Tax Management in Milton Keynes (01908 260418)
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