4. Dealing with income shocks

Each year, many households experience events that can lead to an income shock – a sudden unexpected fall in income – for example, illness, job loss, changing caring responsibilities or relationship breakdown. This analysis uses the Wealth and Assets Survey (WAS) to evaluate the extent to which households are protected from such an income shock by their financial assets (such as current accounts, savings and investments, trusts and bonds).

In practice, there are many other ways in which households might be protected, including support from government benefits, employers, and friends and family. Nonetheless, savings buffers form an integral part of households' overall financial resilience.

Looking at households where the head is an employee or self-employed (Figure 1), the proportion with financial assets to cover a three-month income shock reduces when the employment income drop gets larger. For example, for households where the head is an employee, 73% could cover a three-month drop in household employment income of 25%, and 54% could cover a 75% income drop.

On average, households where the head was self-employed were more resilient by this measure meaning they are, on average, more prepared than employees for income shocks, with 76% being able to cover a household employment income reduction of 25%, and 61% able to cover a 75% reduction. This is potentially a behavioural aspect of self-employment, where income streams are more volatile throughout the year and those in self-employment potentially have a greater need to maintain a savings buffer in order to maintain living standards during periods of lower income.

There is evidence that self-employed households do, on average, have higher formal financial wealth than employee households; the median value of household formal financial assets for self-employed-led households is £12,000, compared with £8,200 for employee-led households (WAS, April 2016 to March 2018).

Figure 1: Self-employed-led households more able to cover household employment income drops (with financial assets) than employee-led households Proportion of households with sufficient formal financial assets to cover a three-month reduction in household employment income of 25%, 50% and 75%, by employment type of household head, Great Britain, April 2016 to March 2018 Source: Office for National Statistics – Wealth and Assets Survey Notes: Only where formal financial assets are greater than the loss of employment income are households deemed to have sufficient assets to cover reduction in employment income. Where formal financial assets are less than or equal to loss in employment income households are not deemed to have sufficient assets to cover reduction in employment income. Formal financial assets are detailed within the Glossary. Household head (HRP) is defined within the Glossary. Employment income includes any income from all adults (not adults aged 16 to 18 years and in full time education) within the household from employee and self-employed work from main or other jobs. Households where (prior to any employment income reductions) net regular household income (before housing costs) are less than or equal to zero have been excluded from this analysis. The derivation of net income changed from July 2016 onwards. Before July 2016 'Total net regular household annual income' was used, from July 2016 onwards "Total net regular household annual income (before housing costs)" was used. Download this chart Figure 1: Self-employed-led households more able to cover household employment income drops (with financial assets) than employee-led households Image .csv .xls

The regular net equivalised household income for households was split into five equal groups (quintiles) and ranked from lowest (quintile 1) to highest (quintile 5). For all three levels of household employment income reduction (25%, 50% and 75%), the proportion of employee and self-employed-led households with sufficient financial assets to cover the loss increases with income level (Figure 2).

For the lowest-income households (quintile 1), the proportion that had financial assets to cover fell as the amount of employment income lost was increased. For employees, 60% could cover a 25% drop, 49% a 50% drop and only 43% of households could cover a 75% drop in household employment income for three months using their financial assets.

Higher-income employee households (those in quintile 5) are more resilient according to this measure, being 1.5 times more likely to be able to cover a 25% drop and 1.7 times as likely to be able to cover a 75% drop than those in the lowest quintile. This reflects the capacity of higher-income households to build more financial assets than those in lower-income households.

Self-employed households with lower income are more resilient than their employee counterparts according to this measure. Following a 75% drop in household employment income, the self-employed in the lowest quintile are on average 1.3 times more likely to have financial assets to cover the drop in household employment income than their employee counterparts.

At the lowest household employment income drop level considered (25%) the resilience level of employees and the self-employed is similar from quintile 4 upwards, showing that both employee and self-employed households on middle to high income have sufficient financial assets to cover this relatively small percentage drop in household employment income.

However, once the household employment income is theoretically dropped by 75%, for all except the highest-income households (quintile 5), the self-employed are more likely to have financial assets to cover the drop than their employee counterparts. Despite this, many self-employed (and employee) households do not have sufficient savings buffers to cover a large employment income drop (75%) for three months, even those on relatively high incomes.

Considering income quintile 3, where median net equivalised household income would be around £29,000 a year, half of employee households and three-fifths of self-employed households would have sufficient financial means to cover the household employment income drop. This has serious implications as, for various reasons, households may likely find themselves in a situation where their household employment income does drop by this amount or more, or for time periods of longer than three months (for example, through ill-health or job loss).

Figure 2: Once household employment income falls by 50%, self-employed households (for all but the highest income households) are more likely than employee households to have financial assets to cover drop

Proportion of households with sufficient formal financial assets to cover a three-month reduction in household employment income of 25%, 50% and 75%, by employment type of household head and total household net equivalised income quintile, Great Britain

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Notes:

Only where formal financial assets are greater than the loss of employment income are households deemed to have sufficient assets to cover reduction in employment income. Where formal financial assets are less than or equal to loss in employment income households are not deemed to have sufficient assets to cover reduction in employment income. Formal financial assets are detailed within the Glossary. Household head (HRP) is defined within the Glossary. Employment income includes any income from all adults (not adults aged 16 to 18 years and in full time education) within the household from employee and self-employed work from main or other jobs. Households where (prior to any employment income reductions) net regular household income (before housing costs) are less than or equal to zero have been excluded from this analysis. The derivation of net income changed from July 2016 onwards. Before July 2016 'Total net regular household annual income' was used, from July 2016 onwards 'Total net regular household annual income (before housing costs)' was used. Net equivalised income quintiles have been created by employment type of the household head.

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We now extend the analysis to look at the effect of age (of the household head) on the ability for households to lose differing proportions of their household employment income and replace it with their financial assets.

Figure 3 shows that both employee and self-employed-led households where the head is younger are less resilient by this measure than those with older household heads. This correlates with the fact that both household income and wealth generally increase with increasing age of the household head (until retirement, where levels drop again). Additionally, younger-aged household heads may have increased responsibilities (potentially related to childcare), that may have reduced or even prevented saving, compared with older-aged household heads where pressures of this kind are less or non-existent.

Looking at the most extreme income shock, a 75% drop in household employment income for three months, only 40% of employee-led households in the youngest age band (16 to 34 years), and 37% of self-employed, had sufficient funds to cover the employment income drop. Employee households where the head is aged 35 to 44 years were less likely than their self-employed counterparts to have funds to cover the drop (48% compared with 54% for self-employed households).

Older households (aged 55 years to State Pension age) were most likely (of working age groups) to be able to cover a large percentage (75%) employment income drop with their financial assets, with 70% of employee and 76% of self-employed households having sufficient funds.

Households where the head is over State Pension age were the least affected by a drop in household employment income (as expected as at least one member in the household is likely to be retired). In this age bracket, 85% of employees and 89% of self-employed households have sufficient assets to cover a 75% drop in household employment income.

Figure 3: Households headed by the youngest age band (16 to 34 years) were less likely to have sufficient financial funds to cover a drop in household employment income

Proportion of households with sufficient formal financial assets to cover a three-month drop in household employment income of 25%, 50%, 75%, by employment type and age of household head, Great Britain, April 2016 to March 2018

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Notes:

Only where formal financial assets are greater than the loss of employment income are households deemed to have sufficient assets to cover reduction in employment income. Where formal financial assets are less than or equal to loss in employment income households are not deemed to have sufficient assets to cover reduction in employment income. Formal financial assets are detailed within the Glossary. Household head (HRP) is defined within the Glossary. Employment income includes any income from all adults (not adults aged 16 to 18 years and in full time education) within the household from employee and self-employed work from main or other jobs. Households where (prior to any employment income reductions) net regular household income (before housing costs) are less than or equal to zero have been excluded from this analysis. The derivation of net income changed from July 2016 onwards. Before July 2016 'Total net regular household annual income' was used, from July 2016 onwards 'Total net regular household annual income (before housing costs)' was used. SPA – State Pension Age at the time of interview.

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