There are savers and investors out there who do not religiously open an ISA (or top up an existing ISA) every year in order to use up as much of their annual ISA allowance as they can.
This is nuts.
ISAs are one of the best tax breaks going for the likes of you and me.
Everything you hold in an ISA is shielded from capital gains tax.
There’s no tax to pay on interest or on the dividend income from shares held in an ISA, either.1
Tax might not seem a big deal when you’re starting out with investing. But over the long-term, paying too much tax can dramatically cut your returns.
It’s true that there can be modest fees for holding an ISA on some platforms. But it doesn’t take much for the tax breaks to outweigh these tiny costs – maybe as little as £100 or so in dividend income if you’re a higher rate tax payer.
Even these platform fees can be avoided if you simply open an ISA directly with a fund provider and invest in, for example, one of their cheap tracker funds.
But there’s another good reason to get into the habit of investing in ISAs.
Whatever you buy in an ISA and whatever gains you make from your investment – capital gains or income – is your business. You don’t have to tell HMRC about it and it doesn’t want to know.
Using ISAs for all your investments therefore sidesteps the horrors of paperwork that can build up if you invest outside of their lovely HMRC-shielded protection
Avoiding self-assessment paperwork with an ISA
I can think of plenty of places I’d rather not be at two o’clock in the morning.
Delivering pizzas in Kabul, Afghanistan, for example.
But being in my home office filing through old share trade notes to calculate my CGT situation for the taxman – that’s right up there with the war zones.
You have to declare details of your capital gains and losses from share trading over the past financial year if:
- You made more than your CGT allowance in capital gains in the year
- You made total disposals of 4x that allowance
And you might be surprised to discover how easy it is to stumble into such a situation…
Let me take you back to 2009.
I sold quite a few holdings in the tax year to 5th April 2009, recycling the proceeds into what I guessed judged were safer harbors during the bear market.
As you’d expect back then, this meant I realised capital losses. Even if I wasn’t bound by law to detail them to HMRC, I’d have done so anyway to carry the losses forward to set against CGT in future years.
But as it happened I did have to detail them, because my total disposals were beyond the 4x threshold.
For example, I sold my remaining bank shares in summer 2008, which looking at the prices I got for them seems a lot cleverer/luckier in retrospect than it felt at the time.
Selling Lloyds shares for between £2 and £3 when I got cold feet about the merger with HBOS was hard, given they’d recently been over £6. But considering the share price approached 30p within 6 months, I thank whatever angel was sat on my shoulder that day.
Looking at other trades was equally painful; positions built up over years sold at less than cost, down from twice that level in 2007.
And I had to note it all down for the taxman. Talk about adding insult to injury!
(Note that I typically didn’t take the money raised out of the market. Selling low and missing the upturn is a classic bear market error; instead, the money my sales realised were recycled into other shares, trackers, and trusts. I was a net buyer during the bear market).
In short, share trading outside of an ISA was a lot of hassle and paperwork for a pretty uncertain return that year.
(Remember, it’s better to use a tracker folks!)
There’s hassle, and then there’s Sharebuilder
What made this tax accounting exercise even more tedious was that most of the shares I sold were located in a so-called Sharebuilder account where I had held my high-yield portfolio.
Sharebuilder accounts seem a great idea, because they enable you to buy small bundles of shares at a much lower cost per trade (£1.50 a trade back then, since raised to £2).
You can even set them to automatically re-invest dividends, which at the time I was doing it incurred no commission fees at all.
The trouble comes when you have to calculate a taxable gain or loss on disposal. Then the Sharebuilder is an instrument of torture.
I had some positions built up from half a dozen more purchases or more over the years, including reinvested dividends.
This meant I had to tediously go through and collect all the transactions to calculate my total purchase costs.
With Sharebuilder, I also frequently ended up buying fractions of shares. This seems a lot less cool at two in the morning when you’re staring at something like:
BT.A 23-Jan-04 BUY 269.3072 184.18 5-Mar-04 BUY 274.524021 180.68 20-Aug-04 BUY 136.464485 181.19 7-Sep-04 BUY 15.566294 184.18 14-Nov-04 BUY 249.38911 198.89 29-Nov-04 BUY 253.557919 195.62 8-Feb-05 BUY 22.261045 208.93 27-Oct-05 BUY 219.669073 203.67
Believe it or not, it got even worse.
The ultimate nightmare is when some shares were bought and sold multiple times over say a five-year period.
Back in those days, the rules said you had to work out how a pool of expenditure on the shares changed over time, in order to work out the capital gains or losses due. (Thankfully this element of CGT accounting has since been simplified).
In short, paperwork like this is fiddly and boring, and if you’re lucky you’ll never have to do it. (If you’re unlucky and you’re stuck, check out the UK government page on tax arising from share transactions for more details.)
I spent a weekend digging through old trades and working out my gains and losses on disposal that year.
What idiot said share trading was fun?
ISAs and SIPPs avoid all this hassle
Avoiding tax on gains and dividends is the big benefit of ISAs and SIPPs.
But being free of this paperwork is another great reason for using a tax-exempt trading account to hold your shares.
ISAs and SIPPs (Self-Invested Personal Pensions) enable you to shelter your holdings free from income and capital gains tax – and also from paperwork.
The tax advantages are obviously worth having. But the thing is, many people will take a few years to reach the stage where their investment will be generating serious dividend income. Or else they’ll invest in a tracker or other fund and allow it to grow without selling it.
They therefore wonder why they should bother setting up an ISA, especially if they have to pay a fee for it, since they’re not getting much income or seeing capital gains in the early days.
But eventually through regular saving and reinvesting, dividend income will grow to be meaningful. When it does you’ll curse the unnecessary tax you’ll pay on your hard-earned investments.
Equally, deferring capital gains by not selling is a fine strategy – right up until you do need to sell2, and then you discover you owe the taxman a big slug for two decades worth of growth.
Yet even if these tax benefits take a while to show, avoiding paperwork is a bonus you get straight away when you open an ISA or a SIPP for share trading.
You aren’t expected to tell the taxman what you hold in an ISA. He doesn’t want to know. You can make gains and losses in your own perfect little ISA kingdom, free of the toll of the taxman.
I have about half my portfolio in ISAs and a little more in a SIPP. I started using tax shelters too late, and so will forever be playing catch up by moving my money into them (likely by harvesting capital gains on unsheltered holdings).
I see little chance of me ever sheltering all my money within them, unless I stop earning and saving altogether.
But just maybe you can do things differently.
If you have only recently started investing, you can avoid this sorry fate by thinking about tax shelters from day one.
Or if you’re an old hand who is yet to open an ISA – yes, they exist, I’ve met a few – then bite the bullet and start sheltering your funds from tax today.
Remember the deadline for opening an ISA is April 5th.
Note: This article on reasons to open an ISA was updated in 2015 to reflect the current tax situation.
- I don’t want to hear a peep in the comments about the hoary old 10% dividend credit you used to get a trillion years ago in an ISA but don’t any more. The old situation is irrelevant and anyway in almost all situations the 10% ‘tax’ is not a tax you pay as such. [↩]
- It’s not always your choice – companies get taken over for cash surprisingly often, for instance. [↩]
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Have you tried opening spreadbets on your shares instead of buying them? No paperwork with spreadbets – and no taxes. Have to watch what youre doing with margin calls and funding and easy to go mad and blow up of course.
@OldPro – I have used a spread betting account before, but only as a dabble. I am familiar with the risks and the theory of using it as a conventional portfolio (i.e. use small positions with a lot of cash in an instant access account to fund the portfolio, so you’re not actually leverage). I’ll try and write a post sometime.
The big problem I found was that it was almost impossible to resist trading due to the design of the platform, something I talked about here:
http://monevator.com/2008/08/14/how-a-boring-broker-will-make-you-richer/
Thanks for the suggestion though.
Regarding the original suggestion, I’ve now found another tedious element to slow me down – company re-organisations, which complicate working out the price per share of remaining holdings. *sigh*
Hi,
just a quick note regarding dividend income – for both ISAs and SIPPs the dividend tax credit of 10 per cent is not reclaimable. Therefore, for basic rate tax payers the only additional benefit for wrapping in an ISA is is avoidance of any CGT liability.
However, holding fixed interest investments is worth doing in ISAs as they are taxed as interest and therefore, the income is completely tax free.
Of course, you don’t want to let the “tax tail wag the investment dog” but this is worth bearing in mind if you’ve got investments in ISAs/SIPPs as well as directly held.
If you’ve got any OEICs/UTs opt for the accumulation units version when you can as they are slightly more efficient for CGT (when not held in an ISA). Naturally, if you’re looking for natural income than this won’t be an option.
Thanks for your comment Thomas.
Incidentally, I actually think the 10% tax credit is a bit of a red herring for today’s UK investors, since it’s notional and not reclaimable as such anywhere as I understand it (certainly for anyone with income above the personal allowance?) and hasn’t been for years.
For private investors outside of an ISA, it boils down to:
lower rate income tax bracket – no further tax on cash dividends to pay
higher rate tax bracket – 25% tax to pay on their cash dividends.
(Ignoring the new temporary special rate for the super high earners).
Agree that cash/bond income is tax-advantaged in an ISA, and so for basic rate tax payers who won’t pay tax on dividend income anyway and who have bonds as well as equities, the bonds should therefore go in the ISA first. (Though as I said in my post, I’d argue there are paperwork and tax-invisibility benefits to keeping shares in ISAs beyond the monetary advantages.
My wife has a lot of unwrapped holdings because we’ve had more spare than will fit in ISAs and pensions for the last few years.
Yes, tracking gains and income is a real PITA and it’s even worse if you also hold some ITs that are based offshore and/or REITs that pay both dividends and PIDs with the latter taxed as interest.
Things are even worse if you use DRIPs or accumulation funds as you never see the income so can overlook it.
I keep meticulous records in spreadsheets but it still takes us a few hours to complete her self assessment and she doesn’t even work!
Just a little “heads-up” on some recent changes that might affect those with decent pension funds (SIPP or otherwise)! I’m finding, this year, that an increasing number of client’s are either unaware of or are being affected by changes to pensions. Indeed, some are taking “24-hour” retirement to avoid high tax charges.
In sum, in 2011/12, the pension “Lifetime Allowance” was reduced from £1.8m to £1.5m. The pension “Annual Allowance” was reduced from £225,000 to £50,000.
In the 2012 Autumn Statement, it was announced the maximum tax-free amount people can take from their pension over their lifetime will be reduced from £1.5m to £1.25m in 2014/15.
The tax-free annual contribution allowance was also reduced from £50,000 to £40,000.
When the lifetime allowance was reduced to £1.5m savers likely to breach this amount were able to apply for fixed protection. This safeguarded them against tax charges as long as they stopped contributing to a pension scheme. Protection details under the new regime are yet to be finalised.
Breaching the LTA can mean a 55% tax charge on any lump sum above the LTA or a 25% charge if no lump sum is taken. Anyone who exceeds the AA limit plus any unused annual allowance carried forward from the three previous tax years will also be taxed.
These changes are affecting more and more people, often to their complete astonishment.
It’s not just senoir people but middle management who tend to be long-serving members of the pension scheme and have salaries of about £80,000. Individuals earning a rapid promotion could quickly find themselves in danger, too.
Don’t forget that while you may consider your own conttibutions to a pension scheme (whether company or private), remember that employer’s contributions are counted in as well!
Speaking with certain client’s and several local accountants, rather surprising things are happening; for example, doctors and other NHS senior employees are often affected, at much younger ages than you might think, those with successful private pensions, and, particularly, those lucky ones in decent final salary schemes.
At present, the Treasury says that some 360,000 will be hit by the latest LTA reduction and 140,000 by the AA change; if my clients ar representative, these are clear underestimates!
Please do be aware of these significant changes as you might be surprised, rather unpleasantly, by them.
I hate the constant fiddling with private pensions.
I got hit by the Special Annual Allowance a few years ago, and had just about got everything working smoothly with the new allowance (after *lots* of research regards PIPs and creating some very complex contribution and carry forward spreadsheets to let me play “what if”) and then along come the new rules.
I have a plan, but I’ve had to quote lots of pension legislation to our GPP provider and their tame IFA to 1) get them to understand that what I want to do is within the rules, 2) agree I can do it. I have no won this battle and just need to explain it to my accountant such that he can sanity check it; I’m drawing pictures!
Pensions should *not* be this complicated and HMG’s war against private pensions is doing nothing for their argument that we should all be saving for retirement.
> I also frequently ended up buying fractions of shares
I didn’t realise you could buy fractions of shares (as opposed to units in funds). Certainly in my employee share saving which I took the payments as dividends they would roll over the fractional amount and indeed paid me the 30p residual when I left.
The calulation does look truly nasty though. I hope you were also buying BT.A when the SP dropped to 70p 😉
Hmmm.. the “Special Annual Allowance Charge” from 2009/10 & 2010/11 was very sneaky and, unfortunately, I have a client who has been “caught” by this – not nice.
I think, most of the time, few individuals have set in place what might be called a “decumulation strategy”. Although such a strategy can clearly be affected by legislative changes, it can be possible, assuming a fair wind and a bit of decent planning, to end up with an effective tax rate of something like 3.2% in the first year of retirement, compared with something like 29.9% if all annuity/drawdown income is taken.
It’s all about your choice of “tax wrappers”. Can we ignore, just for the moment, matters such as the EMH, charges, and other murky details?
Let’s imagine that a “decumulation strategy” has been agreed (my thanks, by the way, to Jeremy Pearson of Canada Life, for the figures used here) and that you want, say, £100,000 income a year from age 60. Clearly, you have been a very successful and productive individual in your working life and can only be described as “wealthy”!
So you have the following assets, after constructing a decumulation strategy with an appropriately qualified adviser (or, at a stretch, much of this could be done “solo”):-
£800,000 in a SIPP
£120,000 in an ISA
£150,000 in ETFs/OEICs
£600,000 in an offshore bond.
We know you want an income of £100,000 a year. Currently, only a gross income of £3,000 is being taken on the ETF/OEIC money, with ISA income being reinvested.
You stop working and have 5 years to wait for the state pension. If you simply crystallised your SIPP, the tax-free cash would fund the first two years’ tax-free income, but thereafter the more income you take the more tax you pay. For example:-
Annuity income £20,000, effective rate of income tax 11.9%
Annuity income £50,000, effective rate of income tax 19.8%
Annuity income £100,000, effective rate of income tax 29.9%
Although “phased crystallisation” would help, I think that, in this scenario, that I might suggest that the SIPP is left untouched – no crystallisation at all!
I might suggest that “income” is taken as follows:-
SIPP income of £0
ISA income and encashments of £8,000
Full encashments of individual ETFs/OEICs of £17,000 (with a capital gain of £10,000)
Offshore bond encashments of £72,000 (with a chargeable gain of £24,000 – see below).
Let us look at the tax implications of these suggestions in turn.
SIPP
Although there is the temptation of taking the tax-free cash and nil income, through drwadown, that would make the residual fund subject to the 55% recovery charge on any lump sum death benefit.
In addition, the fund is tax-free – although it suffers withholding tax. It could also be paid IHT free on death.
ISA
Another tax-free fund, except for any withholding tax, unless you are an estate planner who knows differently, IHT being the only personal tax that the ISA is not automatically free from. At present, you are reinvesting your ISA income but could choose to have it paid out instead. Coupled with a withdrawal of funds, you could take £8,000 with 0% tax.
OECIs dividends.
Your OEIC produces £2,700 in net dividends from a portfolio of equity funds, which currently arises in accumulation units. You could switch to income units and bank the income distributions.
OEICs encashments
You are entitled to an annual exempt amount of realised capital gains, before you pay tax at 18% or 28%.
This is a “use it or lose it” exemption, so it makes sense to take some profits on the OEICs without tax.
These gains have to be within the limit of £10,600 for 2012-13. This will probably reduce your OEICs yearly income as well.
Offshore bond encashments
I have often contemplated to question of investment bonds or collective investments for clients.
In truth, the answer is a bit of both in most cases, but the crucial factor with recommending investment bonds – where taxation can be deferred for many years – is to have an exit strategy. This is even more vital for offshore bonds, where chargeable gains are taxed at the policyholder’s full marginal rate.
In you case, the cessation of your earned income is an excellent exit point. This is because so far, my suggestions have only generated £3,000 of taxable income – and that income is taxed after offshore bond gains, which saves more tax. It it far better for you to offest taxable gains against your personal allowance rather than dividends with unrecoverable 10% withholding tax.
The UK tax system
To explain that last point, I have to take a diversion from this scenario into the wonderful world of income tax.
When HMRC is working out someone’s income tax bill, it cumulates that person’s income in a certain order:-
1. Non-savings income, for example, income from employment or self-employement, or property income.
2. Savings income (includes bank and building society interest, and gains made on life insurance policies (without a “notional” tax credit – offshore bonds)).
3. Dividends and tax credits.
4. Taxable lump sum payments.
5. Gains on life insurance policies with a “notional” tax credit – onshore bonds.
So, for eaxmple, the earned income may be taxed at basic rate but the dividends taxed at higher rate because the total at the point exceeds the higher rate tax threshold.
The interesting fact from the point of view of the suggestion made to you is that the offshore bond chargeable gains are before dividends, allowing you to offest them against your full personal allowance.
Offshore bond tax calculation
It was stated above that you have offshore bonds worth £600,000 and it has been suggested that you encash £72,000 of these. The bond investment was £400,000 and it has 100 policy segments. The chargeable gain calculation is as follows:-
1. Current value = £600,000
2. 12 segments encashed = £72,000
3. Segment value = £6,000
4. Less original investment = £4,000
5. Segment chargeable gain = £2,000
6. 12 segments, so total gain = £24,000
So, what is the cargeable gain, what is the actual income tax bill?
Firstly, your income is all savings income, so you will benefit from the 10% starting rate for savings income.
This means that the first £8,105 of the offshore bond chargeable gain is not taxed as it is covered by your personal allowance.
The next £2,710 of gains is taxed at the 10% savings rate – so £271 of tax to pay. The remaining £13,185 of gains is taxed at basic rate – tax of £2,637. This means your overall tax on income – or on receipts would be a more accurate term to use – is £3,208 when £300 of withholding tax on the OEICs is added in. That is an effective tax rate of just 3.2%. Compared to an effective tax rate of 29.9% id it had all been annuity income.
Your strategy also has estate planning benefits. Because you are cashing in and spending investments that are subject to inheritance tax, rather than raiding your pension fund – which is free from estate taxes until age 75.
From a pure estate planning point of view, the advice to clients could be “don’t touch your pension fund until age 75 and live off your other investments until that time.”
You could then crystallise, make a gift of the tax-free cash and transfer surplus net retirement income into trust using the normal expenditure out of income exemption! Fanciful perhaps, and it would be good to find a client in such a position, but the theory is sound.
Some people do not have a choice in how they fund their retirement income; they may be members of a final salary scheme perhaps. But for those people who have private or personal arrangements, they could benefit from a decumulation strategy.
Please note that the above is provided for “information only” and no-one should act upon it unless they have sought and obtained independent financial and taxation advice.
Rather interesting though!
The next time I intend to consult an IFA is in around five years to finalise my “decumulation strategy”. They really do need tuning to every individual’s (and couple’s) investment and tax position and there are (as you observe) some deeply non-obvious tax and IHT wrinkles.
> and that you want, say, £100,000 income a year from age 60
Blimey, it it just me that suddenly feels poor round these parts or all Monevator readers that well heeled? I’ve never earned that much, never mind twice that (given the usual presumption of dropping back 50% on pension income w.r.t. working income). And I’ve just been on holiday and bought a shedload of wine, so it’s not like I am boracic lint 😉
Great as Monevator is, I’d suggest an individual on £200k would probably be best served by picking up the phone to someone and going “fix this for me” rather than reading up on here how to wrangle with his S&S ISA 😉 In the same sort of vein as he probably doesn’t clean his own dishes or fix his own car, you DIY less as your time becomes more valuable due to the opportunity cost of DIY…
@Mark Meldon
I’m reading all this tax avoidance you are writing down to allow people who have accumulated great wealth, much of it in tax sheltered investments, and describing how they can pay no income tax and pay no inheritance tax when they pass it on to their children
All it means to me is that the bulk of the average middle wage 40% tax payer on PAYE just has to pay more because of various weases employed by the fabled 1% to avoid paying their fair share
With your off-shore bonds and associated how far away are you from Jimmy Carr/Starbucks and their guernsey/netherlands tax avoidance scams?
Really all this makes me want to see is the Inland Revenue hire even more inspectors, implement proper anti-avoidance legislation and come down on this behaviour like a ton of bricks
As what’s being described is entirely legal and prudent, and much of it is covered on various HMRC web sites, then they can inspect as much as they like and will simply find that it’s sensible mainstream tax planning.
I also pay tax at 40+ but this will drop once I retire, but is this really a bad thing or even unusual?
@Ermine
I know what you mean – the line that got me was the one where ‘middle managers’ were earning £80k!
Our IT director gets £100k and we’re not a tiny company.
Also note that this hypothetical individual isn’t earning £100k but instead spending £100k per year that is mostly coming from savings that have already been taxed with just some coming from a pension where tax has been deferred.
Do we really think people should be taxed on their earnings and then taxed again on anything they decide to save in an ISA?
The offshore bond is perhaps unusual, but not much different to a normal investment bond in that most of the income is draw down your own capital, hence the low tax, and everything else is just deferring tax.
Well, I can only tell it as it is! I have always thought that people should pay the right amount of tax, not too little, not too much; paying tax is, ahem, “participation in democracy”.
My points are, clearly, hypothetical, but you might be surprised as to how many people are caught by some of the 400+ tax changes we have had in recent years. I have no ethical issues with making use of above the board tax planning. I will not, however, get involved with anything dodgy or blatantly illegal – no-one (IFA or not) should.
I deal with a few very wealthy individuals, but the overwhelming majority of my clients are ordinary, hard-working, individuals who will never be in a position to make use of many of the tax breaks I set out. They need impartial advice just as much as anyone else, whether working out a way in becoming debt-free as soon as possible, using the open market option for annuity purchase when their money purchase pension scheme “matures”, understanding “sufficiency”, and, generally, delagating the “money stuff” and getting on with all of the other more enjoyable things in life!
@gadgetmind, hey, no offence meant! Most people target a retirement income of about 3/4 to 1/2 their income while working, on the assumption that expenses like mortgages are paid down and the kids hopefully should be off their hands, so from this fellow’s target assume he’s earning £200k while at work. And good luck to him, it’s way over twice the max I’ve ever earned, but so what. I don’t want to take that away from him 😉
However, if he does earn £200k p.a. he doesn’t need Monevator. He needs to get on the phone and get somebody on the case. Just like it’s only ordinary grunts that fix their cars or hang their own wallpaper – he’s probably better off sticking to earning the wedge or taking a break from it rather than putzing about trying to get the lowest TER on his ISA.
And no, there’s no reason for anybody to pay more tax than they are legally required to. That applies to the hypothetical customer and to Starbucks too. It is up to governments to set the rules to meet their electorate’s requirements, and where necessary outlaw the sort of false accounting that Starbucks et al use. Much has changed with the increase in mobility of capital and to a lower extent labour over the last decade, and the rules do have to change in a changing world.
@Mark Meldon I’d have to respectfully disagree. For
their best route forward is to roll up their sleeves, understand what the problem is before them, how they got here, develop a coherent plan to get out, and use resources like Monevator and moneysavingexpert to action that plan. They do not need to pay for financial advice, they need to reach for the on-switch on the grey matter. Otherwise without understanding they will dig themselves back into the hole they came from. In extreme cases there is a place for free advice from the CAB or from free debt consultancy, but let’s hope there’s nobody reading here who is in that sort of mess, because this site is about investing and if you’re up to your eyeballs in debt investing isn’t a priority in your life.
Ermine, I quite agree with what you say, perhaps surprisingly enough, but, despite your best efforts on “Simple Living in Suffolk”, the level of financial ignorance in this country is astonishing. Perhaps it’s general apathy, “being too busy”, or whatever, I don’t know.
I do come across frankly amazing things from time to time, even down here in Somerset. Take, for instance, the thirtysometing with £48,000 worth of credit card debt at something like 20%APR I met a few years ago. Nothing much to show for the debt. The thing was, he had £62,000 in a bank deposit account earning 1.50% or so at the time. I made him get out the chequebook pronto!
Or the “well-heeled” bloke in the village here who popped his head around my door 4-5 years ago. He was rather streessed. Turned out that he had managed to borrow 18 times his earnings of £60,000 (much of which was a “self-cert” mortgage). After I said something along the likes of “you are crazy”, never saw him again (surprise, surprise) – later heard about his bankruptcy, repossession, divorce, etc.
Or the pleasant couple with a modest mortgage who had only ever dealt with insurance salesmen/women in the past. Mortgage had 15 years to run. I explained that the various endowments and whole-of-life policies they had been flogged were not very effective for life insurance (which they needed for a few years whilst their girls were still at home) or mortgage repayment purposes. I arranged some inexpensive term life insurance, written in trust, of course, and recommended that the policies with the likes of Cornhill, Pearl, General Portfolio, etc were cashed-in. They did this, applied the proceeds to their interest-only mortgage, switched the rump to a capital & interest repayment basis and paid the mortgage off in 2 years and 4 months! That, I’m sure you will agree, saved them thousands and thousands of pounds, and now they are no longer serfs to the the mortgage company.
Whilst I quite agree that people should sort these things out for themselves, I do find many incapable of doing so/or “can’t be bothered” – that’s probably why I have a job.
@ermine – absolutely no offence taken.
I think the problem here might be the phrase “middle manager” for someone who’s clearly earning a decent wodge.
Dunno about “darn sarf” but in the grim North, getting to £70k to £80k as a manager running a team of 50-100 people, steering existing products and creating new ones, generating a stream of valuable patents, and generally doing good stuff isn’t that hard for those with the skills and drive.
Getting beyond that, and picking up that elusive extra digit, is much harder and you’d be expected to discover new product areas that no-one had ever thought of before, create new divisions from scratch, and much more.
However, I’m sure that varies from sector to sector and I only really know engineering.
But what I do know is that we need more of the high fliers I’ve described above rather than fewer, and we need to keep their skills at work for longer rather than scaring them into retirement by threatening to tax their “excess” pensions.
Hear, hear, gadgetmind!
I’m currently aware that GP’s, for one, are taking 24-hour retirement to avoid/reduce heavy taxation on their pensions. Okay, the pensions are “gold-plated”, but this change has upset many, and not just those in the world of medicine. I’m sure this is going on rather a lot at the moment.
Constant tinkering around with pensions probably costs more to administer than the taxes raised.
@Gadgetmind @ Mark Meldon
We have a perverse situation in this country whereby benefits for the poor are very high and wealth is largely untaxed
Since corporations and the self-employed seem allowed to pay the tax level they choose prudent through tax planning, the tax burden for the country simply falls on employees making above alittle above or a lot below average wages as eye-wateringly high marginal tax rates
Its truly insane and the current government seems to mainly be pre-occupied with the half the issue around benefits
Perhaps the only good thing they have done is cut the lifetime allowance for pensions
In 2010-2011 an estimated £33bn of income tax went uncollected because of the tax relief on pension contributions
– £10-12bn of that went to basic rate tax payers
– c.£21-23bn went to higher rate tax payers
The incoming lower LTA of £1.25m will allow you a pension of over £50k a year on a final salary scheme (admittedly a bit less on money purchase), which is approximately twice the average weekly earnings in the UK
My question is why someone should be allowed tax free to build up a pension worth twice the national average wage, undoubtedly saving tax mainly at the higher rate while paying it in decades time at the standard rate? The only people who are going to pay for this tax relief for the very well off are other lower earning tax payers
I just think that people ought to be able to save for their old age without the tax man being on their case while they’re doing it. Even those not directly affected by all the new attacks will be indirectly affected because of the negative effects on the country in general, and it also conveys the impression that HMG really have it in for private pensions.
As I have nothing but my own pension and ISA savings (no DB, FS or anything else like that) I probably won’t be personally affected by the new LTA but it could well be the case that I withdraw my skills from the labour market earlier than I otherwise would; do we really expect this third major cut to be the last?
However, I know a lot of skilled surgeons etc. who will be affected and they are retiring pretty much immediately. Call me odd, but if someone is going perform a difficult operation on me, then I’d like them to be highly-experienced and really don’t begrudge them a prosperous retirement.
We all have to accept that everyone – rich or poor – have to work within the tax rules that exist right now. We elected those who make up the rules and regulations, after all. When considering investments, and ignoring one or two esoteric options, it all boils down to an ISA or a SIPP. The tax concessions are, undeniably, attractive, probably more so for ISAs than SIPPs for those of modest means.
Broadly speaking, and ignoring any existing arrangements, someone anticipating an investment portfolio of £100,000 or so should usually focus on building up their savings in an ISA (as long as the rules don’t change). Anyone planning a larger portfolio should begin with an ISA, but expect to place a significant fraction into a SIPP. The tax concessions on these forms of investment mean that savers in Britain need pay little or no tax on an investment portfolio until it exceeds several hundred thousand pounds.
On top of the basic ISA/SIPP portfolio, those esoteric investments like, for example, offshore bonds might then be considered.
The fact that some have more, some have less is inescapable.
In sum, as the late Alan Kelly, a noted financial planner who died in 1991, said when trying to define financial planning:-
“finding the best ways of utilising the financial facilities that exist in order to maximise personal wealth and minimise personal taxation.”
I can only concur, despite what others here have intimated.
@ Gadgetmind
Translating:
“will be indirectly affected because of the negative effects on the country in general” – is that like the mythical “trickle down economics”?
“I know a lot of skilled surgeons etc. who will be affected and they are retiring pretty much immediately” – you know a lot of over-paid people whose gravy train has now ended and they have been so over-paid they can now afford to retire with a pension several other workers will pay for
Actually I would personally be just as willing to strip a NHS surgeon of some of his (and it will almost invariably be his) six figure government guaranteed index linked pension as I would to turf a chav out of their £1m london council house so it can be sold to build six flats somewhere else. I’m just a really antagonistic trouble maker
I do dislike the current government with quite a bit of venom, but I can only applaud it when they make their occasional move to remove tax advantages from the wealthy, e.g. higher university fees, removing child benefit from higher earners, lowering public sector pension accrual rates and lowering the LTA
@Neverland – You clearly have a jumbo-sized chip on your shoulder, and this is Monevator not The Sun, so perhaps we can just leave the matter with everyone having stated their views and agreeing to differ?
@Gadgetmind
Interesting that a desire for fairness = “large chip on shoulder”
I am interested as in the reasons why? To a first approximation it would take you tens years to load an ISA to that level, but this is probably shorter as the whole point of investment is to accumulate capital. I personally expect to be over halfway there this year, and that’s only after three and a half years, so I have already observed some of the runaway effect once you have a couple of years’ worth of money in it. I can see there’s a case for splitting ISA providers due to the FSA protection limits, but is there some other element that makes an ISA capital of > 100,000 unadvisable? We’re talking S&S ISAs here, well I think that’s what TI means. You’d be borderline crazy to build up a Cash ISA to 100k over 15-20 years 😉
Yes, S&S ISAs do build up far faster than expected, and have done even during the “lost decade”.
Of course, just as with a SIPP, having a large ISA to live off in retirement does mean that you’re exploiting the workers, or something like that!
@Nevermind
Can you imagine the reaction of certain sections of the press if a Labour government had introduced some of the measures removing tax advantages from the wealthy which you mentioned ?
More to the point of this excellent blog, I’d suggest that those who can afford it take full advantage of ISAs while they can; the facility to make contributions may not last forever! Remember what happened to index-linked National Savings certificates.
@Grumpy Paul — Excellent point regarding NS&I certificates. Use it or lose it, as the Australians say.
This talk of maxing out ISAs is generally sensible, but how about for those 40% taxpayers who have yet to build up a big enough personal pension/SIPP pot to even face much income tax on the eventual income?
Say you pay 40% tax + NI on that portion of your income that is used to amass a significant ISA pot but end up with a tiny pension. You really want to be drawing at least 10k in income from a SIPP in retirement to gain the maximum tax efficiency of saving 40%+ on the way in, paying nothing on the way out. This means until you look like building up a pot of at least 270-340k then concentrating on just ISAs may be a bad idea.
It is with this in mind that I am going to hold off making anymore ISA contributions until both my SIPP is a lot closer to that projection, and mortgage reduced to a less significant level.
I do however agree that you should have any non-pension or property wealth wrapped in ISAs. This is your most accessible wealth.
@SemiPassive — Yes, if you’re a higher rate taxpayer and are happy with the (admittedly now much diminished) restrictions on pensions, then contributing to a SIPP and taking the tax relief is likely a good idea. Almost infinitely so if you’re getting any kind of matching company contributions.
Keep in mind that pension rules (and indeed ISA rules) are subject to Government meddling, though. Might be worth a person doing a little bit in the ISA as well just in case. As the rules currently stand one could transfer at least some of your ISA money to a SIPP in the years approaching retirement and collect more tax relief then, though the recent annual contribution cut to £30K for pension relief does limit the utility of this approach.
The main point is not to invest outside of tax wrappers, unless you have to because you’ve filled them. Especially not to save a couple of tenners on platform fees. Investing outside of an ISA or SIPP for no good reason will seem crazy to most Monevator readers, but I hear from people who do it all the time — and even hear fund managers promote such a strategy (partly, I suspect in certain cases, because they’re not on the ISA platforms).
Ive just opened a non isa trading account for my child as i want to maintain control, the plan is just to drip feed to vanguard life strat 100 for 20 years. obviosuly tax and cap gains then could be an issue over 20 years!?
Charles Stanley shows you the overall capital gain so i assume when this comes near the yearly cap gains threshold i should sell the whole holding and rebuy it or lifestrat 80%. who knows when this maybe thou!!? 5, 10 15 years from now?
After having years of having to declare foreign income I all too well know what a pain it is filling out the tax forms, so not having to do this was one of the bonus’ of having the stocks and shares ISA, as well as keeping the tax man from my dividends and gains.
Of course the one down side using an ISA is that you just have to take CG losses, unlike with an normal share dealing account where you can declare them, so for my more speculative investments then I still use the normal share dealing account.
@Phil: Isn’t the tax situation on this a bit complicated? See TA’s article here:
http://monevator.com/how-to-invest-for-children/
And I’m not sure that accumulation funds help either:
http://monevator.com/income-tax-on-accumulation-unit/
Depends on how big the “drips” are I guess.
@Phil
I’m sure one of the political parties has a promise to reduce the Capital Gains Tax allowance to a few hundred pounds. That would mess up your plan!
I don’t really understand why you’re avoiding the wrapper. It sounds like there’s going to be 12 monthly payments and and maybe some reinvested dividends to account for if you ever have to do the paperwork. The maths sounds moderately difficult already.
If the gain on the fund is more than the annual CGT allowance then I don’t know what happens if you sell part of the holding and repurchase in the same fund. With my maths ability, I’d have to buy a second choice fund just to avoid the complex CGT calculations!
And your child might end up with a nice lump sum… but if it was in an ISA they could choose to take a bit of tax free income each year. Or they could withdraw it all at once. As it is unwrapped then they’ll be paying income tax on whatever they get, or maybe have to withdraw over several years to avoid paying CGT.
I’m sure I read recently that the average pension pot in the UK is thirty grand. (That’s the total of the pot and not the annual income!) There are going to be so many people totally reliant on the state pension that you really begin to fear what’s going to happen to those who have put away for their own pension and personal savings. You can’t help but feel that (any) government is going to do all they can to get their hands on this cash in the name of “fairness” as the gulf divides into the pensioner haves and have-nots. OAP’s will have to be divided and ruled because, as a block vote, pensioners are feared and it will just be easier to target the minority element who have saved for their future.
I have a similar question to @semipassive
If you are fortunate to have the choice, should you allocate your money to an ISA, a SIPP, or paying off your mortgage. Assuming you’re not so fortunate that you can do all 3 at the same time.
(some one had to raise the paying off the mortgage alternative, so it might as well be me)
From your original posting
>>I have about half my portfolio in ISAs and a little more in a SIPP. I started using tax shelters too late, and so will forever be playing catch up by moving my money into them (likely by harvesting capital gains on unsheltered holdings).
I see little chance of me ever sheltering all my money within them, unless I stop earning and saving altogether.
If you have unsheltered holdings or spare cash, these can be channelled into your ISA each year as you say, using your £15k allowance.
What’s stopping you sheltering even more in a SIPP up to your £40k annual allowance?
Even if you’re a 55 year old non tax payer like me. In this case you may only get limited tax relief (£720), but you have gained from sheltering significantly more of your assets from future taxes and HMRC paperwork as your posting points out.
With the new pension freedoms coming next month, putting more of your assets into a SIPP is more attractive, and access to your SIPP will be more flexible.
Future income can all be tax free too, coming from
1) taking a lump sum from the SIPP (up to around £13.3k using your 10k personal tax allowance boosted by the 25% allowed tax free)
2) and some tax free income from the ISA
@Neverland
For those who think taxing people excessively on higher incomes is a good idea, there needs to be a realisation that when you get what you want, there are consequences.
Previously self employed, I was forced into turning a partnership into a limited company and ran a small business , generating a substantial six figure sum in taxes from the business plus personal taxes from my family, I eventually got fed up with the burdens on a small business and disposed of a precision engineering business at 49.
Skilled jobs were lost and I retired thank you. I have an older brother who did something similar at 52, some people create wealth and I would suggest everyone benefits as a whole and thus a little encouragement is sensible.
I am perfectly happy but higher taxes and regulatory burden made running a business no longer worthwhile for me and the country as a whole loses jobs, skills , economic activity and tax revenue. I won’t be missed as an individual but the more people who act like me then we have a more significant loss.
“and now they are no longer serfs to the the mortgage company.; good-oh. But you’d like them to be serfs to the taxman apparently.
It’s much worse than just monitoring buy/sell for a pooled cost in a taxable account…
When I look at my taxable account which has only five holdings I see: equalisation payments, excess reportable income on foreign domiciled funds, conversions to “clean” share classes, mergers within Vanguard funds, return of capital on fund reorganisation…. All of which have to be tracked and accounted for on sale to HMRC even if in many cases they are a matter of a few tens of pounds…
While I am able to do this myself the worst of it is that I still feel it necessary to have an accountant rubber stamp my tax return … there’s a further few hundred quid costs down the drain…
@Devonman — Thanks for your thoughts, which I quite agree with in principle.
This is an old post that I updated for ISA season, and the improved pension flexibility (plus the inevitable marching of time taking me closer to retirement day! 🙂 ) has indeed made the idea of loading up a SIPP much more attractive than when it was first written (in 2011).
However I have particular circumstances that mean I’m quite timid with the non-income money I put into my SIPP. (I run my own company, incidentally, so the SIPP is funded directly from that).
One big one is I want/need to keep the option of buying a property open at some point (I am short one London house!) before I’m 55, though I won’t without either a price correction or a windfall. (I could, but I likely won’t! I’m a sky high price-to-earnings ratio refusenik!)
The other reason is, without being indiscreet, it’s a sizeable sum that has pretty much tripled in the past six years. Which is a high class problem to have, as Charlie Munger would say.
Still, yes, it’d probably be shelterable eventually if I wasn’t earning/saving new money too, and I was prepared to fully load the SIPP, and if the market/my nefarious active investing returns hit the buffers.
I think/agree for most people the whole bother is best avoided by diligently using ISAs and SIPPs. If I’d started that way (at least by fully loading ISAs from day one instead of from about 2004) I’d be in a far better place, although I’d possibly find it spiritually impossible to liquidate the ISAs to buy a house… 😉
The obvious solution for the first world problem of having unwrapped paper assets too big to transfer to wrappers would be to sell them and buy a house with the proceeds, and either live in it (saving on rent) or rent it out.
I still don’t believe we will have a property crash of 20% or more without taking down the stockmarket by a significant level, so shares would be no place to hide.
PC’s question on ISA vs SIPP vs mortgage, I go through this review annually and there really is no one-size-fits all. I think everyone needs at least a chunky emergency fund in Cash ISAs.
I think you’d be mad to turn down free money from employer pension contributions.
And even if you don’t get any, say if you run your own ltd co and are into the 40-45% income tax bands then its still really tax efficient to make company contributions, and doing this over a long time you take advantage of compounding, and pound cost averaging, so you won’t be forced to buy all your shares at a historic market high.
But still a big fan of making big mortgage overpayments in parallel, which is also tax efficient to a lesser degree, but also – more importantly – has a guaranteed outcome.
And at the moment the best 2 year Cash ISA you can get is 2%, coincidentally the same as 10 year Gilts.
If your mortgage rate is higher than this then overpayments are effectively a completely risk free, tax free return.
How you split the pie though is a dilemma, I typically pay 2 or 3 times as much off my mortgage than contribute to my pension, and not adding anything to ISAs at the moment.
Some may do the opposite and put way more in their pension, in doing so perhaps avoiding 40% tax altogether, but I’m not happy running a big mortgage balance and want to get it under 6 figures ASAP.
If the reds get in this May and ruin pension tax relief then that might change things and I will start adding to a Stock and Shares ISA again.
@SemiPassive — Yes, a house would have been a lot easier all around. 🙂 It’s all very well calling it a First World Problem, and I take your point, but there is an ‘unfairness’ (for want of a better word) here as to how assets are taxed.
I have a substantial portfolio which is still plenty unsheltered, and I do not own a home. That exposes me to the full corrosive wind of CGT and other investment taxes, while I try to keep up with those who buy (leveraged, using a mortgage) a property that then runs CGT-free!
So yes, I agree that the solution is to accept that is how things are, and to get into property (and preferably to have access to a Tardis 😉 ).
But the fact is you probably don’t often get to this First World Problem on an un-sensational London income without being the sort of investor who finds it almost physically impossible to buy crazy-expensive assets! 😉
On a related note, it’s interesting to me how people mentally account for housing. I made the mistake of revealing the size of my portfolio as an illustration of a related tax point to a friend a few month’s ago, and she has never since stopped calling me a fat cat, and sending me Guardian links to rile me up.
Her house is worth more than my portfolio, even accounting for the mortgage!
But because like many delusional folk she doesn’t see her house is an asset, it doesn’t count as real money in her mind. Hence she’s scraping by, and I’m a high-rolling 1%-er, in her eyes.
“she has never since stopped calling me a fat cat, and sending me Guardian links to rile me up.” I infuriated a Guardian-reading friend by pointing out that he and his wife were both millionaires: adding their house value to twenty times their index-linked final salary pensions is rather an easy sum. And conservative: the “twenty” perhaps ought to be thirty, and I didn’t add on their state pensions. Nor did I guess at their savings or any inheritances they might have had. Of course, once you start adding on their right to use the NHS and so on, there’s no end to how wealthy they are. Like many of us first-worlders. We’re many of us in the 1% globally, I assume. The 10% certainly.
@dearieme
For no special reason I did that sort of maths myself not so long ago and I was pleasantly surprised. I doubt you’d look twice at me in the street and I live in the rural West Country not in London but with nothing more than my hard-earned albeit 100k investment portfolio and my nothing fancy property, and with my no more than modest final salary and my state pensions capitalised as the lump sum I’d need to purchase an equivalent annuity, I got to £1.1m.
Agreed, there are millions of millionaires in the UK now, especially in the South East, and plenty of them read The Guardian.
As for the global perspective, I recall some articles around the time of the 1%/Oxfam furor pointing out that on a global basis many middle-class people in the South East are in the 1%, including a good few Guardian readers no doubt*. Here’s one:
http://www.forbes.com/sites/timworstall/2015/01/22/theres-probably-more-one-percenters-working-for-oxfam-than-there-are-billionaires/
*I read The Guardian (and link to it on Saturdays) amongst many other media sources, admire much of its output work but always making due adjustments for its spin, and most of my friends are Guardian readers. But boy can they be blind and/or hypocritical at times! 🙂
I have an offset mortgage with an interest rate of 3.49%. I’m also a higher rate tax payer. Surely this is a better place to place my cash at the moment as it delivers an almost 6% interest growth.
Love to know others’ views.
@Tim — I presume you’re comparing paying off your mortgage with a cash ISA? As the article discusses there’s plenty else you can put in an ISA, not least shares which have done rather well over the past few years…
That’s not to saying paying off a mortgage isn’t an excellent use of spare capital. It is, especially on a risk/reward basis (very little risk, very clear known reward). Depends on personal temperament at the end of the day.
I’d probably run a mortgage to keep taking out and using up my ISA allowances nowadays, but I’m definitely a rather extreme outlier (and I wouldn’t do it at all market levels / even in all circumstances for me, let alone recommend it to most/many! :))
We’ve discussed/debated this at length elsewhere on the blog, so probably better to take the conversation there if you’re interested in discussing more. 🙂
p.s. I don’t quite understand/agree with your maths, or at least the way you’ve stated it, unless I’m having a moment of brain failure. 😉
It doesn’t deliver almost “6% interest growth” does it?
It is the *equivalent* of earning interest on cash savings at 6%, and then paying higher rate tax on it to bring you down to 3.49%.
i.e. You’re still only ‘earning’ at 3.49%, not near-6%?
Yes you’re right, sorry I should have been clearer, 6% is in comparison to a non-isa saving product.
Related question; would we not be better off putting that money in a pension (assuming we don’t need access to it) before we consider filling up our Isa -£50k Max per annum. There I’d immediately get a 40%+ benefit. So even if the market crashes say 30% I’m still better off than putting it in a stocks and shares ISA where the tax man takes his cut first.
@Tim — See these articles. (The search bar top right is your friend! 🙂 )
http://monevator.com/pensions-versus-isas/
http://monevator.com/sipps-vs-isas-best-pension-vehicle/
I appreciate the horrors of a CGT return and avoiding one probably trumps any benefits I’m about to query. But from 2016 with a dividend tax allowance of £5000 and an interest allowance of £500 (for higher rate payers) it seems, relatively speaking, to increase the attractiveness of putting the £15k ISA share of that money into a Cash ISA rather than a Shares ISA? (and acquiring similar amount of a fund outside an ISA, rather than the other way around?)