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Are you ready for the big squeeze?

We highlight seven things set to squeeze your finances, and what you can do to help protect yourself.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

The big squeeze is crushing the life out of our finances. Inflation is running at a thirty-year high, outstripping rises in pensions and wages, and leaving us worse off with every passing month. And that pressure is set to intensify over the next few months.

But we don’t need to take this lying down. There are things we can do to break free from the worst of the squeeze, and where there’s no easy solution, there are still steps we can take to limit the impact.

This article isn't personal advice. If you're not sure what’s best for you, ask for financial advice.

1. Rising energy prices

Right now, energy prices are taking centre stage. Plenty of us have already seen prices rise dramatically, as fixed deals have come to an end, and providers have gone under. But things are set to get much worse. Without the government stepping in, the energy price cap is set to rise dramatically in April, by as much as 50% – or £600.

What can you do about it?

The horrible fact is there’s not a great deal we can do. You can’t find anything meaningfully cheaper than the energy price cap by shopping around, so currently it’s unlikely you’ll be able to switch to a better deal.

Instead, you need to think carefully about how much you’re using. For some people this will include everything from insulation to energy efficiency appliances and bulbs to energy-saving habits. For others, the scale of the rises will mean some incredibly difficult decisions. If you’re facing real hardship, it’s worth looking into whether you qualify for any help from your energy provider, such as the warm homes discount or other grants.

2. Higher inflation

Inflation hit 5.4% in December, and there’s every sign we haven’t reached the top yet. To make matters worse, lots of the items seeing dramatic price increases are the things we can’t live without, like petrol or home repairs.

What can you do about it?

The most powerful thing you can do is to be aware of price rises, so you don’t get sucked into paying more for everything without thinking about it. One straightforward option is to keep the receipt from the big shop. You can then check the prices when you’re next at the supermarket to see if they’ve risen. You could also make a note of the petrol prices next time you fill up.

Once a price has risen, if there’s the option to trade down, you can take it – to own brands, budget brands, or a budget supermarket. For things like petrol, there are more difficult compromises to make. You need to think carefully about whether you can find a more cost-effective option for each journey – and whether every trip is strictly necessary.

3. Negative wage inflation

Regular pay (without bonuses) fell 1% after inflation in November compared to a year ago. There’s a chance this figure will stay negative in the coming months, meaning wages will actually be falling in real terms.

The marginally better news is that wages are likely to recover in the second half of the year, and crawl 0.1% higher (even after inflation is taken into consideration) over the year as a whole.

What can you do about it?

Now is the time to consider whether you’re being paid a fair wage for the work you do. Recruitment has been hard for businesses recently, and 15% of businesses were reporting a shortage of workers at the end of 2021. It means that elsewhere in your industry, someone else could be offering more for your role in order to attract people like you. Remember though, that might not be the case for everyone.

You don’t necessarily have to move to improve your pay – you could start with a conversation with your manager about if the going rate for the role has changed and go from there.

4. Higher interest rates

Rates have already had their first bump, from 0.1% to 0.25% in December, and the next one could come as early as February. This tends to feed into borrowing rates fairly quickly.

This month, the average tracker rate mortgage is up 0.15% to 3.53%. The average standard variable rate is up to 4.41%. And the average new two-and five-year fixed rate mortgages have risen for the third month in a row.

What can you do about it?

If you’re on a variable rate mortgage, and it makes sense for your circumstances, you could seriously consider re-mortgaging to fix your rate. While fixed rate mortgages have risen, you can still fix for five years for as little as 1.46% and two years for 1.11%, which are still very low rates. Although whether you can get a rate this low will depend on your circumstances.

If you’re borrowing money on a credit card, you can expect your rate to rise. If you’re not already paying this debt down as fast as possible, it’s worth prioritising this. That’s because over time you’ll end up paying more in interest, which will make repaying the debt even more difficult.

If you’re concerned about debt, you should speak to a debt charity like Stepchange.

5. National Insurance rise

The 1.25 percentage point hike in April is going to be painful for workers.

Someone earning the average basic rate salary of £24,100 will pay £180 more, and someone earning the average higher rate salary of £67,100 will pay £715 more. It looks like it’s going to come at the worst possible time, so our take-home pay drops just as our outgoings soar.

What can you do about it?

If you’re employed, check to see if your employer offers a salary sacrifice scheme. These involve you and your employer agreeing to cut your salary and pay the equivalent into benefits with tax and National Insurance (NI) breaks. This includes pensions, pension advice and cycle to work schemes.

It means you get the full value of your pay – without any tax or NI taken off – paid directly into your benefits. This won’t leave you better off today, because you’ll get less in your pay packet. However, it does mean you’ll be boosting your overall reward package instead of handing over more to the taxman, and you could be putting more aside for your retirement. Remember tax rules change and any benefits depend on individual circumstances.

6. Dividend tax rise

Dividend tax will rise 1.25 percentage points in April to 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for additional-rate taxpayers. This will affect those who make more than the dividend allowance of £2,000 a year in investments outside an ISA, or own their own company and pay themselves in dividends.

What can you do about it?

For investments, your best bet is to shelter as much as possible in an ISA, where you won’t pay any UK income or capital gains tax. Assets can also be passed between spouses without triggering a tax bill. So between the both of you, you can shelter £40,000 a year in ISAs.

For business owners, while it’s a blow, you’re still taxed less on dividends than on income, so you can’t save money by shifting to take a salary instead. The fact is, there’s very little that can be done to avoid it. That’s a tough pill to swallow considering those who pay themselves in dividends largely fell outside the remit of the furlough scheme and self-employed grant.

7. Frozen tax allowances

The freezing of tax thresholds announced in March last year won’t have had an immediate impact. But over the years, as wages rise, it will drag more and more people into paying higher rates of tax. By 2026, it’s likely to mean 1.5 million more people paying tax and 1.2 million more paying higher rate tax.

What can you do about it?

Again, your best bet is salary sacrifice and payments into tax-free benefits instead – although this won’t leave you with more money in your pocket, it will just cut your tax bill.

Will the big squeeze end?

Even if you do everything possible to limit the impact of these seven factors, they’ll still likely have a significant impact on your finances.

However, inflation doesn’t last forever. Things will eventually settle down again. By taking these steps, it improves our chances of getting through the big squeeze in one piece. And when things do start to improve and look a little more normal, you’ll likely be in a much better position.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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