Building your financial independence (20s-30s)
For many people – such as students or those with lower disposable incomes – big ticket payments such as rent can mean that saving and investing is a lower priority. But it remains the case that the sooner you can start to put money aside, the greater chance you have to turn that cash into a more meaningful sum over time, again benefiting from compound interest.
As you have now taken charge of your professional and financial life, it is good time to start to plan for your future, perhaps by starting to build an emergency fund to ensure you are financially able to meet unknown or increasing living costs. A savings account allows you to get hold of your cash quickly, but at the moment will only provide very low returns.
Investing in shares can offer the prospect of far better returns – but there is a risk that over some periods you may lose money, so this is more suitable for longer-term saving, typically over at least five years. This could be worth considering if you are thinking about putting money aside to use as a deposit on a home, or if you simply wish to build up savings for later in life that you can access earlier than a pension.
Whether you opt for a cash savings account or stock-market investments, you should save tax-efficiently if possible. This means doing so through an Individual Savings Account (ISA). Up to £20,000 can be put into an ISA in the 2019-20 financial year, and any returns on your ISA – in the form of savings interest or investment growth – are permanently sheltered from tax.
The tax system
The job you get after leaving university may be the first time you have to pay income tax, which from 6 April 2019 to 5 April 2020 applies on annual earnings in excess of £12,500, as well as National Insurance contributions.
Your employer may offer staff what is known as a salary-sacrifice scheme, which is a tax-efficient way of buying items such as travel passes, bicycles and computer equipment. The costs are taken out of your salary before it is taxed, which means you avoid income tax and National Insurance on those particular expenses. Some companies also run their pensions as salary-sacrifice schemes (see next section).
Your company pension
Recent changes in the law mean that the vast majority of employers must now automatically enrol staff into a company pension scheme and make payments at a certain minimum rate into it on their behalf. This is called auto enrolment. It applies to workers aged 22 and over provided they earn at least £10,000 a year. The way this works is that employees contribute up to 3% of their “qualifying earnings” or salary to these schemes, while employers will pay up to 4%. A further 1% comes from government in the form of income tax relief. At the moment, qualifying earnings are between £6,136 and £50,000 – these minimum and maximum amounts rise annually in line with inflation.
It may be, however, that your particular employer offers its own pension plan on a more generous basis. If you are automatically enrolled into a pension, you can opt out if you wish.
For many younger workers, especially those who have a substantial amount of debt or who are not earning large salaries, it can be tempting to opt out of saving into a pension. But there are benefits of starting a pension at an early age, even if you can afford only the minimum level of contributions, can be very significant indeed. Any money you save into a pension in your early twenties, will have much longer to grow and will benefit from many extra years of compound growth. The impact on the eventual size of your fund could be dramatic.
The money you put into a pension will not under normal circumstances be available until you are 55 at the earliest, so you may also wish to consider how you can use any spare income – once you’ve dealt with expensive debt – to meet short or medium-term financial goals.
Important information: Columbia Threadneedle Investments does not give investment advice. If you are in any doubt about the suitability of any investment, you should speak to your financial adviser. Data as at 30 September 2019 unless otherwise specified. Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Your capital is at Risk. The analysis included in this document has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable, but its accuracy or completeness cannot be guaranteed. The mention of any specific shares or bonds should not be taken as a recommendation to deal. Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. columbiathreadneedle.com
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