One of the benefits of living in a developed, civilised society is the access to things we take for granted; things like medical care, education, roads, etc. Unfortunately, these all have to be paid for somehow and money doesn’t grow on trees you know. Our Governments fund their spending plans out of income and borrowing just like any household. In the case of income, the Government’s main source (it’s salary if you like) is taxation.
In the UK we have been blessed with a fantastically complex tax system. We are taxed as individuals and as businesses. We are taxed on income, earned and from savings and investments. We are taxed again on consumption/spending (VAT, duty on fuel, alcohol, tobacco, etc), ownership (Council Tax), transfer of assets (Stamp Duty) gains on investments (CGT), death (Inheritance Tax). Despite its name, National Insurance is not insurance but another tax. Even the TV licence is a form of taxation. I haven’t checked ALL the tax rates that could apply but here is a quick sample – 0%, 2%, 5%, 10%, 10.4%, 10.6%, 11.8%, 12%, 13.8%, 18%, 20%, 25%, 28%, 32.5%, 35%, 40%, 42.5%, 50%, 55%. There is even an effective rate of income tax of 60% in some cases and many of the consumption based duties on tobacco, alcohol and fuel are in excess of 60%.
If we want to enjoy the benefits of our society we need to pay our fair share of tax but obviously none of us want to pay more tax than necessary.
What has all this talk of tax got to do with possession?
Well, possession is 9/10ths of the law as they say. In tax terms, the ownership of many things such as investments, or the source/ownership of income, determines how much tax we need to pay. Good financial planning can often yield a significant reduction in the amount of tax we pay without the need to resort to any Jimmy Carr or Chris Moyles “aggressive tax planning strategies”.
Often carrying out some simple housekeeping on our financial affairs is enough to make a significant difference.
For couples it is worth considering who actually owns any savings. Interest from bank and building society accounts can be taxed at 0%, 10%, 20%, 40% or 50% depending on your other income. Simply moving a savings account from a higher rate tax payer to a lower rate or non-tax paying spouse could result in a tax saving of up to 50%. To put that in perspective, a 50% tax payer with £100,000 in the bank earning interest at 3% would have £3,000 interest before tax but only £1,500 after tax. Simply transferring the savings to a non-tax paying spouse would result in an improvement in spendable income of £1,500 each year. “Simples”, as those annoying little meerkats would say.
Earlier this year a man came into my office and told me he needed investment advice to make his savings “work harder”. He explained that he had a reasonable level of savings in bank and building society accounts which were all in his name. He also explained that he had already visited two advisers; one Independent Financial Adviser (IFA) and one in-house adviser at his bank. He told them both that he didn’t want to take much risk with his money but needed a little extra return. The bank adviser had him complete a risk profiling questionnaire which placed him as risk group 2 on a scale of 1 – 10; where 1 represents no risk at all and 10 equates to a trip to Las Vegas. Clearly this man did not want to take stock market type risks!
I was shocked to hear that both advisers had recommended a significant portion of his savings (the IFA suggested nearly 100%) should be placed in an Offshore Bond (paying around 7% commission) and should be invested in a range of UK equity funds including some very specialist highly concentrated “recovery funds”.
After discussing his various sources of income, and the fact that his wife had no income in her own name, I told him he didn’t need a Financial Planner. All he needed to do was transfer the savings accounts to his wife. The interest would still fall below her tax free allowance and would therefore provide a 20% increase on the current returns without any additional investment risk.
The same thing applies to gains from investments. Each individual is allowed to make a certain amount of gains each year (for 2012/13 this is £10,600) without paying any tax. Thereafter, gains are subject to Capital Gains Tax (CGT) at either 18% or 28% depending on other income. Simply splitting investments between spouses can double the amount of tax free gains available and can significantly reduce the level of tax paid on any amounts above the threshold.
It is worth noting that the annual Capital Gains Tax allowance is a use it or lose it deal and cannot be carried forward to increase the tax free allowance in future years.
When it comes to earned income, different rates apply to profits from self-employment and salary or dividends from a limited company. Therefore, business owners and entrepreneurs should give careful consideration to how they structure their business interests.
Individuals who are worried about inheritance tax can simply transfer some of their assets to the next generation, either directly or using a trust, and substantially reduce their potential tax liabilities. Obviously this is dependent on their being able to maintain their own desired standard of living.
In addition to the plethora of different tax rates, there are just as many (if not more) tax allowances that can be used to legitimately reduce our tax liabilities.
For many people simple steps such as moving savings and investments to a lower tax-paying spouse will be enough to make a significant difference; they may not even need the help of a financial planner or tax specialist. However, individuals (and businesses) with more complex tax affairs should definitely seek specialist advice from a financial planner, accountant and/or tax adviser.