Why you must draw up a financial plan

by Ed Bowsher on 16 April 2013  |  3 comments
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Get the most from your money with a financial plan.

Everyone above the age of 21 should draw up a financial plan. A plan can help you get the most from your money and help you achieve your goals in life. If you don’t draw up a plan, you’re more likely to end up in a financial mess.

Drawing up a plan sounds tough, but it’s easier than you might expect. I outline the first steps in Five steps to reduce your financial fear.

Here are five financial perils that could inflict serious damage if you don’t have a plan:

You’ll spend more than you earn

Spending more than you earn is the first step on the road to financial disaster. If you keep on spending more than you should, your debt will grow every month and your interest bill could spiral out of control. As your debt balloons, your stress levels will soar and life will be no fun at all. Trust me, I’ve been there.

You can only get away with spending more than you earn if you have significant savings or you expect your income to rise in the near future.

The best way to keep your spending under control is to draw up a budget. Monitor all your spending for a month and you’ll probably see areas where you could cut back. You can then draw up a more prudent budget for the future.

If you stick to the budget, you’ll be well on the way to financial security. Sticking to a budget is a crucial component of successful financial planning.

You’ll pay too much tax

We all want to pay less tax – in theory. But, in practice, lots of people are paying more tax than they need to. Financial planning can help you cut your tax bill.

One example is by using your partner’s personal allowance.

Let’s say you’re earning £45,000 a year while your spouse isn’t earning anything. You also have £40,000 in savings on which you earn £1,000 a year in interest.

As a higher-rate taxpayer, you’ll have to pay £400 of that interest to the tax man. But if you transfer the £40,000 to your spouse, the two of you could keep the whole £1000. That’s because the interest income now comes within your spouse’s tax-free personal allowance of £9,440.

You’ll have a rotten retirement

Life expectancy is getting longer all the time. A man who turned 65 this year can now expect to live until he’s 82. A 65 year old woman can expect to live to 85. These figures are going to carry on rising.

Yet with the birth rate falling, there’s going to be fewer and fewer taxpayers around to support pensioners. Sure, there will probably still be a State Pension, but no one knows how generous it will be in twenty, thirty or forty years’ time.

The only safe solution is to look after yourself and save for your retirement while you’re working.

If you don’t make a plan, chances are, you won’t save enough.

Your children could suffer

If you have no financial plan, you’ll probably have less money to spend on your children. Not just when they’re young but also when they may need help to buy a home or cope with university costs.

What’s more, financial planning can boost the amount your kids inherit when you die. Inheritance tax kicks in if an estate is bigger than £325,000 - or £650,000 for a couple – but sensible planning could help you to avoid paying this tax.

You won’t be able to cope if you’re ill or you lose your job

At Lovemoney we believe it’s essential to try and build up a financial cushion. In other words, you need to save money that could tide you over if disaster struck. Ideally this cushion should be as large as six months’ salary although we accept that’s not a realistic target for many people. Still, it’s something to aim at and you’d be mighty relieved to have that much cash if you lost your job.

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The other big potential calamity is illness or death. Would you be able to cope if you had to give up your job due to illness? If you have a family, could they cope if you died? So you need to consider taking out life insurance as well as critical illness cover or income protection insurance.

I could write about several more plan-free perils but I reckon I’ve made my point. Drawing up a financial plan makes loads of sense. A good Independent Financial Adviser should be able to help you with this, but if you want to do it on your own, start here.

If you need help with a specific issue, why not see if you fellow lovemoney.com users can help by asking a question in our Q & A section?

This is a classic Lovemoney article that has been updated.

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