Wealthcheck: 'I want to live life now but save for the future'

Caroline Smith faces one of the oldest financial planning dilemmas: How can she enjoy her money now and still buy a flat next year? By Harriet Meyer

The patient

Caroline Smith, 25, from Hove, Sussex, is making a New Year's resolution to slot away spare cash each month. "Saving is one of those things I always thought I'd do when I was more financially comfortable," she says. "But even after reducing my overheads since moving in with my boyfriend, I've been using the extra money to have more holidays and meals out instead."

Caroline, who earns £20,000 a year as a marketing executive, has amassed £1,500 in a cash individual savings account (ISA) paying 2.5 per cent with Abbey, but this sum is being eroded.

"I am slowly drawing money out of the ISA. I have to make the most of life, but realise this isn't sensible – particularly as we also want to buy a flat next year," she adds. "So, I've decided to make 2010 all about saving money."

She pays £330 a month to rent a small one-bed flat with her boyfriend. Fortunately this means bills are also low, with rent, council tax and utility bills amounting to a total of £415 a month.

"My boyfriend has enough money saved for a deposit on a house so I feel like a bit of a dead financial weight in the relationship," she says. They plan to start flat-hunting later next year for a one-bed flat in Brighton or Hove.

While she has managed to wipe out student debt since she started working a few years ago, she still makes full use of her overdraft facility. "I often reach the £1,000 mark, but don't go over this," she says. She has a current account with Abbey, which charges 12.9 per cent on any overdrawn sum.

Caroline also has yet to start planning for her long-term future. While her company has a pension scheme that will match employee contributions up to 3 per cent, she has chosen not to join this. "I figure I'll worry about it nearer the time," she says. She has no protection policies in place.

The cure

Many people will identify with Caroline's situation, says Robin Keyte from independent financial adviser (IFA) Towers of Taunton. "She wants to spend now and enjoy life but also feels the need to save and plan for tomorrow," he says.

"The spending and borrowing habits of the past 10 years are definitely behind us, it is no longer acceptable for so many people to live beyond their means. In truth, we have already started the process of where reducing debt and reducing outgoings are becoming the way of doing things. Add to this the fact that taxes are bound to go up after the next general election and we have entered an era of new austerity," Mr Keyte reckons.

With some financial discipline, Caroline can start to make savings and stop dipping into her overdraft.

Savings

As a first step towards making savings Caroline needs to set herself a budget and stick to it, agree the advisers. "At present she is subsidising her lifestyle by dipping into her savings, and coupled with going into her overdraft this is a dangerous strategy," says Dennis Hall from IFA Yellowtail Financial Planning. "And with the recent court ruling declaring unauthorised overdraft charges are not unlawful, any charges are unlikely to be reclaimed. What's more, there's little to stop banks raising charges in the future."

It is a false economy to make savings when you are being charged interest on debt at a much higher rate. "A quick win is for Caroline to use some of the money in her ISA to put herself back in the black," says Duncan Carter from IFA Clearwater Financial Planning.

Caroline should then look to move what is left to a higher paying ISA. Standard Life Bank is currently paying a variable rate at 2.65 per cent. This is an instant access account. If Caroline wants to safeguard herself from the temptation of dipping into her savings she could consider putting her money into an ISA which requires notice to be give before any withdrawals are made or even limits the number of withdrawals that can be made each year.

Whatever choice Caroline makes it's essential that she focuses on building up a savings cushion, equivalent to at least three months' salary. Using sites such as Moneyfacts.co.uk or moneysupermarket.com will ensure she always gets access to the best rates.

After tax and national insurance Caroline's monthly income is about £1,310, and from that she pays £415 in accommodation costs. This leaves her with £895. "A sensible budget might be to limit herself to £10 a day during the week for lunch and treats and slightly more for weekends," says Mr Hall.

One method of budgeting is to allocate money at the start of the month into separate accounts for savings and bigger planned purchases, say the advisers. "By allocating money at the beginning of the month, it forces you to live within your means," says Mr Hall.

Property

Turning to flat-buying, "the bigger the deposit the better", stress the advisers. This will enable the couple to access a competitive mortgage deal. They also advice opting for a repayment mortgage to whittle down the capital debt, rather than an interest-only deal. "I expect interest rates to rise over the next few years so a fixed-rate deal might be sensible," says Mr Keyte. It is also wise to own the property as "tenants-in-common". As tenants in common you each own a share; you can specify how much of it each party owns, for example, 75:25 per cent.

Retirement

Worrying about pensions "nearer the time" is a risky strategy as people leave retirement planning too late and are unlikely to achieve the level of income they would ideally like in later life.

By not joining her employer's pension scheme Caroline is effectively refusing a pay rise. "She is, in theory, doing the same job as someone else, but for 3 per cent less salary," says Mr Hall.

Her employer will pay £600 a year and, after tax relief, her contributions are just £40 a month – so she is getting £1,200 towards retirement for a contribution of just £480," says Mr Carter.

Protection

"Unless Caroline has a contingency plan she may wish to buy some sort of income protection to ensure that her bills are paid during any periods of illness once she gets a mortgage," says Mr Hall.

Do you need a financial makeover?

Write to Julian Knight at the Independent on Sunday, 2 Derry Street, London W8 5HF j.knight@independent.co.uk