Once you have your finances under day-to-day control, it’s worth shock-proofing them against anything unexpected. Most people face unpleasant life surprises, from humdrum boiler replacements to something more serious like redundancy.
Stop a shock to the system
Your finances can be severely affected by financial shocks. Personal finance experts tend to distinguish between one-off spending shocks from having to replace something, or income shocks, which affect the amount you have coming in.
At Vanguard, we suggest maintaining emergency savings to give you peace of mind and help you avoid taking out short-term, high-cost debt. For one-off expenses, one rule of thumb is to keep the greater of £2,000 or half a month’s expenses in a bank account.
When it comes to an income shock, however, you want more than just a few weeks savings set aside. We generally suggest keeping back 3-6 months’ expenses in an accessible account. Things to think about when deciding how much cash to hold would be the number of family members or dependents who rely on your income, as well as the regularity of your income. If a large part of your income is from bonuses, for example, it may be worth holding slightly more.
Think about what insurance you need
You may also want to consider insurance to help boost your financial resilience. Insurance can be a cost-effective way of protecting yourself against larger financial shocks, such as a critical illness or being made redundant. Your employer may already provide you with certain types of cover or you may be able to opt-in as part of your overall benefits package. Check what your employer offers before taking out cover yourself.
If you own a house with someone or have children, you may also want to consider life insurance to cover the cost of the mortgage to help your partner should you pass away.
Keeping on top of your paperwork
Regardless of your age – it’s important to make sure your paperwork is up to date. This includes making a will which sets out how everything you own – i.e., your estate – will be divided up once you die. Any major life events, such as the birth of a child or divorce, may mean reviewing your will.
If you have a pension, check whether you need to fill in an Expression of Wish form1. This sets out who receives the pension benefits once you have passed away. You can usually specify the order of the beneficiaries. You might want to leave 100% to your partner, for example, but then split the pension equally between your children once you and your partner are gone.
Finally, you may wish to consider setting up a Lasting Power of Attorney (LPA), of which there are two types. A health and welfare LPA gives someone the power to make decisions relating to medical care, assuming you are unable to make your own decisions. A property and financial affairs LPA gives someone the power to make decisions about your money and property. You may want to set up both so everything is taken care of should you be incapacitated.
While it may seem intimidating to consider situations where you don’t have the physical or mental ability to make decisions, a Lasting Power of Attorney can make life decisions much less stressful when you are recovering from a major upset.
To make sure you’ve passed your financial resilience test, take a look at our proposed checklist below. Once you’re all set, take a look at the next article in our financial wellbeing series on how to make progress towards your long-term goals.
Prepare for the unexpected
1. Build up your emergency savings so that they’re equivalent to the greater of £2,000 or half a month’s salary.
2. Set aside around 3-6 months’ expenses to cover for any disruption to your income.
3. Consider your insurance needs and what your employer may already offer.
4. Keep on top of your paperwork. A will is the most obvious piece of paperwork, but you should also complete an Expression of Wish form and ensure you have a Lasting Power of Attorney in place.
1 For more information on our Expression of Wish form, please see here.
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