Good reads from around the Web.

I couldn’t agree more with an article I read this week on BeyondProxy talking about how the world is chaotic, so you might as well deal with it.

Stability in markets begets instability. Always has and always will.

This is one reason I think financial regulation has its limits, incidentally, and why savers and consumers should sometimes take one on the chin for the common good. That way we’re all encouraged to be more prudent and self-reliant, rather than everyone being cushioned, compensated, and bailed-out to the point of abdication.

The more people believe that something can’t fail, the more of it they will take on, eventually including leveraging up to get more – if not explicitly through debt then through some shadow agent or the dumping of diversification or in some other way getting too much of the good thing.

Nothing can be pushed beyond its limit, not even supposedly risk-free assets.

Consider the negative yields on the average German government bond. One of the safest assets in the world is now guaranteeing a loss to its holders, and stoking the potential for myriad different outcomes (which is what ‘risk’ really means) that are not all pleasant (though some are – because risk doesn’t mean that only bad things can happen).

I’ve no more idea than anyone else how or when this slow death of yield ends.

But I suspect it will be with a bang, not a whimper.

Learning to fear stability

BeyondProxy author Michael McGaughy writes:

Twenty-five years ago as a young analyst I loved analyzing companies that had steadily increasing sales, constant profit margins and growing profits. This made my financial projections easy.

However experience has taught me not to trust steady returns and stability.

The business world is competitive and anything but stable. I now believe that ‘stable’, ‘no risk’, and ‘guaranteed return’ are some of the most frightening words in business and investment.

Consider the following:

• Bernie Madoff’s funds got big by seemingly delivering steady monthly returns in both up and down markets. As we know now, it was all a fraud.

• Before it went bankrupt, Enron was well-liked by sell-side analysts and investors for meeting analyst estimates. It steadily met expectations and was considered a stable and safe company. But it was mostly smoke and mirrors before it became America’s largest bankruptcy.

• The desire for, and fallacy of, steady growth is nothing new. Adam Smith (aka George Goodman) wrote about the illusion of steady growth in his 1972 book SuperMoney. “Everywhere you looked, there was a company with a neat stepladder of growing earnings. Some kept the stepladder right up to the day they filed for bankruptcy”

• In his commentary on Dell being fined by the SEC for fraudulent accounting designed to smooth earnings, author and Darden School of Business professor Edward Hess notes that, “companies that grow for more than four consecutive years without resorting to earnings games are the exception, not the rule”

McGaughy goes on to to sing the praises of instability for giving us all the wonderful change we see in the world – at the price of the occasional wobble.

Remember every investment can fail you. Don’t put all your eggs in one basket – and ideally have a few chickens about the place, too!

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A rare political rant today, which you are of course free to ignore. Alternatively please do have your say (politely, constructively) in the comments. My hope is that by keeping politics restricted to these occasional blood-letting rambles, we can hopefully keep the rest of the site and article comments relatively ideology-free.

Last time we faced a general election, the economy was uppermost in voters’ minds. I even wrote a few posts on Monevator about what I thought needed to be cut, slashed and kyboshed – and also where Government might helpfully spend some money.

Of course, over the five years that followed neither my manifesto nor anyone else’s was achieved.

That’s what you get from a Coalition government that takes office after the money has run out, and yet must minister to the needs of a country that’s grown comfortable on 15 years of economic growth and free-flowing public spending. A queer pitch indeed!

But you know what? I think it turned out okay.

Spending was reigned in a bit, taxes were cut a bit – usefully from the bottom with the personal allowance raise, and from the top, with the end of the mean-spirited 50% rate of tax – and getting the national books in order has at least became accepted lip service among all the parties, if not always the reality on the ground.

Oh, and the NHS has not been destroyed. Millions of people do not languish on the dole queues. At the same time, George Osborne is behind his own targets for tackling the deficit.

Muddling through a crisis like this is one way forward.

If I have one major criticism, it’s that there wasn’t boldness on true infrastructural investment, given the incredibly low cost of long-term borrowing.

I have no appetite for permanently higher state spending as a share of GDP from here, nor for Gordon Brown-style “investment” that walks out the door every evening in the form of higher salaries.

And I understand that some are skeptical of the value for money from any major projects.

Nevertheless, the fact is there are some things a country needs, such as roads, rails, airports, bridges, tidal and nuclear power stations (and in the UK simply more houses) where the state can usefully get involved.

In the earlier years of the crisis, I think such investment would have delivered a lot of bangs for the buck. It might have been a wash overall long-term, in terms of return on investment, but it would have meant more jobs during the downturn and making something good out of a bad situation.

Also, rather like buying shares in a bear market, the odds are surely more in your favour if you spend money as the state when demand from the private sector for the same skills and opportunities has evaporated.

Not doing more visible state spending in the UK is not the glaring failure that I think it is in the US – their roads and bridges are literally falling apart – but it’s still been a missed opportunity.

Six of one and half a dozen of the other

So what about the next five years?

I haven’t written much about the economy recently, and I won’t do so now.

In the eyes of all but the ‘house of paper money, mountain of debt’ fundamentalists, we’re clearly out of the emergency ward. Reasonable people can disagree about how much further and how fast spending should be ‘cut’ (or more likely at best held in real terms) or where the axe should fall. Plenty do elsewhere.

But I don’t think voters are so bothered in this election.

All the main parties have signed up to some sort of fiscal restraint (in the loosest sense of the word) and my gut says the existential doubts that led to everything from the Occupy movement to the rise of UKIP has waned.

Also for everyone who fears, say, a return to profligate spending by a Labour government, there’s another who worries about the rise of inequality and the fact that the super-rich have done so much better over the past five years.

Often, as in my case, those worries reside in the same numbskull!

So I don’t think people believe they are voting to save the nation this time. Rather, they are much more likely to vote based on the outlook for their own wallets.

True, we all know there’s a big economic element to that end.

If a Labour government spooked the money markets, the pound fell and interest rates soared, that could have a much bigger impact than getting a few hundred extra quid in free childcare.

Similarly, if a Conservative/UKIP alliance took us out of Europe and started dismantling public services along the way there could be massive upheaval, too.

But I think there are so many often-contradictory permutations that many floating voters aren’t even bothering to evaluate them, and they will instead resort to self-interest to guide their vote.

And it’s floating voters who swing elections.

It’s housing, stupid

I’m the most floaty voter you’ll ever meet – I have voted for four parties to my recollection, in national and local elections – and I’m finding the current choice amongst the most difficult ever.

I had pretty much resolved to go Conservative again this time. I judge we can do with another five years of half-serious attempts at curbing state spending, and Ed Milliband’s talk of price controls and unilaterally raising the minimum wage really bother me.

(I’m a fan of the minimum wage, incidentally, but only when it’s done through the painstakingly established regulatory process that’s been put in place. Not when it’s lifted on a whim by a party chasing cheap votes).

However in the past few days the Conservatives have come out with two policies that I personally find repellent.

Firstly, the proposed changes to inheritance tax to lift £1 million family homes out of the levy altogether.

I know most people hate inheritance tax, and I’m always accused of being a left-wing commie agitator when I say I want it to be raised.

But the point – which my critics never seem to address – is someone somewhere has to be taxed – unless you’re a true zero-State free market radical, which almost nobody is.

All the major parties are really talking about is 2-5% difference in State spending around the 40% share of GDP mark. So however you do it, that’s a lot of tax that needs to be collected from somewhere.

On principle, I think it’s better to more heavily tax dead people and their heirs who did nothing to earn their windfall gains, because you can then reduce the taxes levied on earnings and on the wealth created by entrepreneurs.

As I say, I know most of you don’t agree with me. Even my left-wing friends go red when they think about paying tax on their parent’s semi-detached pile with easy access to good grammar schools.

Oh well, I’ve never written articles for this website to win fans.

But even if you don’t like inheritance tax, you must surely at least question the logic of this particular Conservative move.

Because if you were going to reduce inheritance tax on any particular asset you could choose, the stupidest one to favour in the UK has to be residential housing.

Save now, pay later

It was one thing to turn pensions into inheritance tax planning vehicles for the mass-affluent, which is what has effectively happened in the past 12 months.

I didn’t agree with it, but there you go.

However to take an asset – UK housing – that is in structurally short supply, where high prices cause daily misery for millions, and to make it even more attractive to sit in it, unproductively squatting for future gains – that is downright irresponsible.

What moderately wealthy empty-nesters living in a capacious four-bedroom house are going to downsize now, knowing that all it will do is expose the money they release to inheritance tax?

On the contrary, they will be advised to consider buying even bigger and more expensive homes to try to shield their (children’s) assets.

Mass downsizing alone won’t solve the housing crisis, but it would be a start.

I want capital gains on residential property (deferred until the point of death), so you can see that this policy is the opposite of where I think we should be going.

The only other option is even more building – something in the order of 300-400,000 homes a year for at least the next decade.

We’re barely doing a quarter of that.

Many of those new homes will have to be built in green belts and pretty market towns across the South East.

I wonder how that will go down?

We need to build at least 250,000 more homes annually anyway, even if we put the housing stock we’ve already got to more efficient use.

But this policy just makes things worse.

No way to compete

One thing you need to know about me to understand my perspective is I was not born into a comfortable middle-class home in the South East. The world was not my oyster.

I came to London from the provinces with a suitcase, and my instinct is always going to be to think of other smart young people who want to do the same.

Already the wealthy middle and upper classes are re-capturing the arts and media scene wholesale – a change that has happened in my lifetime – as their children are about the only ones who can afford to do the unpaid entry-level work demanded, or who can think about a lifetime of sub-par earnings in a city where house prices are approaching 10-times the average wage, knowing they’ve an inheritance to look forward to and plenty of help in-between.

Their parents are there to assist them with tuition fees, deposits for flats, and all the rest of it.

The resultant crushing of the meritocracy that emerged in the 1950s and 1960s is bad enough when applied to the arts, but I can now foresee it impacting the sciences, engineering, and even entrepreneurship itself. (I don’t think it’s a coincidence that every new Silicon Roundabout founder I hear has a plummy Home Counties accent).

You might say you don’t give two hoots, because you’re in the haves and the have-nots can look after themselves.

Fair enough, from a personal perspective. Ugly but honest.

However what is the impact going to be nationally if we move to a society whereby wealth and opportunity is channeled down a narrowing funnel of families, and real social mobility is curbed?

I’ll tell you. It means more mediocre but well-educated offspring of parents who’ve made it (or, eventually, whose own parents made it) doing mediocre work in positions they are occupying because some smarter kid from anywhere 50 miles from London never showed up to compete.

A nation increasingly run and ruled by the Nice But Dim types who currently thrive as upscale estate agents in London.

At least until China and India come along to eat our uncompetitive lunch.

I shudder.

Flog it!

Now I’ve got my left-wing ire up, I will turn to the subsidized right-to-buy social housing association policy that’s been revealed this week by the Tories.

Yet ironically my complaint here comes more from the free-marketeer who sits on my other shoulder.

Don’t get me wrong – given my comments above, I clearly think it’s idiotic for the Conservative Party to encourage the sale at a discount of what little social housing we have left.

However I think it’s even worse when you consider low-earners who’ve scrimped and saved to buy one-bedroom flats or starter homes in the private market – or who are perhaps still renting and saving to do so.

They will be left to watch glumly as those who happened to be in housing association property are granted a one-off windfall gain by the State.

It’s another lottery. Not the genetic lottery of inheritances and the Bank of Mum and Dad, but a lottery of happening to be sitting in the right state assets when the ruling party of the day decides to give them away on the cheap.

How fair.

Nothing really fits me

At this point I’m naturally thinking I might have to cast my vote elsewhere, despite the Conservatives being the party I think is best having their hands on the tiller for the another five years – and despite the fact that they would undoubtedly be the best for my own wallet.

Sadly Labour has veered to the Left, while the Liberal Democrats have some silly anti-capitalist policies in their manifesto, particularly regarding capital gains tax.

(Before somebody pipes in and claims I’m inconsistent in being against reduced capital gains tax allowances but all for inheritance tax, here’s a clue – me and Richard Branson took risks when we allocated our money and we’ve made losses and gains along the way. Your child simply happens to be related to you – they did nothing to get the money, and the only risk they took for their inheritance was their sense of personal achievement being smothered by your generosity).

What about the fringe parties?

I think UKIP has jumped the shark – it did a useful job in making immigration something the chattering classes can cautiously discuss without being socially ostracized, but the party itself is clearly populated by rank-and-file nutters.

Indeed I’d summarize the fringe party offerings as:

• Green party – Climate change is coming! Therefore we need a bloated State-run economy that slams GDP into reverse and reduces carbon emissions by making it so that nobody can afford petrol.

• Plaid Cymru – Wales! Wales! Aren’t we good at the rugby?

• SNP – Wants another once in a generation vote on leaving the Union, six months after the last one.

• UKIP – A sword has been embedded in a stone in an English market square. Whomsoever can draw it forth will be the next king of Albion!

So those aside, I’ve collated below the three main party’s manifesto pledges that I think are most relevant to Monevator readers, from a personal finance and investment perspective.

In other words, I’ve focused on pledges that impact earned income, wealth, and spending on things like rail fares and childcare.

To that end I have not covered benefits, as I’ve assumed few Monevator readers are living in social housing on welfare. (My apologies if that’s you – and I admire your aspiration.)

If you think I’ve missed out anything important from a personal finance perspective, please do let me know below, and if I agree I’ll add it to the list.

Conservatives

• Raise the personal allowance for income tax to £12,500

• Raise the higher-rate / 40p tax rate threshold to £50,000

• Raise the inheritance tax threshold on family homes to £1m by 2017

• Pensions relief hit for high earners. Manifesto says the £1m inheritance tax lift for family homes will be paid for by: “Reducing the tax relief on pension contributions for people earning more than £150,000.”

• Extend the right-to-buy scheme to housing association tenants in England

• No income tax payable by those working 30 hours on the minimum wage

• Double free childcare allowance for three- and four-year olds to 30 hours

• No rise in VAT, national insurance contributions or income tax

• Clamp down on tax evasion and the “aggressive” tax avoidance

• Increase the minimum wage to £6.70 by the autumn and to £8 by the end of the decade

• Continue to apply the state pension triple lock system – so at least a 2.5% rise every year – and introduce a single-tier pension

You can read a summary of the rest of the manifesto at the BBC, or you can read the whole thing at the Conservative’s website.

Labour

• 50% rate of income tax for those earning over £150,000

• No increase to the basic or higher rates of income tax, National Insurance or VAT

• Unspecified pension hit for high earners. The manifesto speaks of: “…restricting tax relief on pension contributions for the highest earners and clamping down on tax avoidance.”

• Raise the minimum wage to more than £8 by October 2019

• Protect tax credits for working families so they rise with inflation

• Introduce guaranteed three-year rental tenancies and bring back rent controls

• Freeze rail fares for one year

• Extend free childcare from 15 to 25 hours for working parents of three and four-year-olds

• End marriage tax allowance

• Stop non-doms avoiding tax on overseas earnings

• New National Primary Childcare Service, guaranteeing childcare from 8am to 6pm

Read more of the manifesto via the BBC’s summary, or see the whole thing at the Labour website.

Liberal Democrats

• Increase the personal tax-free allowance to at least £12,500 by the end of the next Parliament

• Higher personal income and wealth taxes? (They say they will create “a fair plan” to reduce the deficit by ensuring the rich pay “their fair share”)

• Higher taxes on capital gains tax and dividends? (The manifesto promises: “…reforms to Capital Gains Tax and Dividend Tax relief”)

• “Refocusing” Entrepreneurs’ Relief

• Mansion tax on homes worth more than £2 million

• Hit on pension relief for high earners? Manifesto says: “Establish a review to consider the case for, and practical implications of, introducing a single rate of tax relief for pensions, which would be designed to be simpler and fairer and which would be set more generously than the current 20% basic rate relief.”

• Withdraw eligibility for the Winter Fuel Payment and free TV Licence from pensioners who pay tax at the higher rate

• Make sure rail fares do not rise faster than inflation over the Parliament

• Establish new “rent-to-own” homes, where your monthly rent builds up a deposit in the property

• Build 10 new garden cities. (All the parties say they have plans to build 200,000-300,000 new homes a year. I think it’s mostly hot air and tinkering at best, but this Lib Dem garden city plan is at least something different)

• Another remix of free/extended childcare

Read more of the manifesto via the BBC’s summary, or see the Liberal Democrat website.

Who would you vote for, from a personal finance and investment perspective, and why? Let us know below, but please note I will be deleting any swearing, frothing, or truly swivel-eyed ranting. (I’m allowed a small amount of the latter above. It’s my pub, and I’m the landlord).

Pssst! Want to know how to reduce tax in retirement? Want to avoid the taxman’s greasy paws legally? Alright, alright, keep it down. Let’s take this someplace quiet…

(Whaddya mean that’s this blog?)

Here are the main points of the tax avoidance in retirement plan…

1. 25% tax-free

Rejoice! You can receive 25% of your pension savings tax-free.

It’s a good deal – your money originally goes into your pension tax-free and a quarter can come out similarly unmolested.

But how can you best capitalise on the government’s largesse?

Spend it

Aaah, the hedonist’s choice. But this is not as extravagant as it sounds. Using your tax-free cash as income enables you to:

• Pay less income tax, because spending the tax-free cash enables you to draw a smaller income from other sources.

• Hold off buying an annuity in the hope that rates will rise.

• Defer your State Pension – Currently your pension swells by 10.4% for every year you leave it untouched.1 Deferring enables you to buy a smaller annuity, as the State Pension can take more of the strain when your tax-free cash runs out.

• Reduce your pension withdrawal rate – A particularly handy option if the stock market is having a rough time when you first retire.

Buy missing National Insurance Contributions

This enables you to boost your State Pension income and make a government-backed, index-linked gain every year for a one-off payment. It looks like being an especially good move when the flat-rate pension comes in.

Create an emergency fund

See below.

Buy a Purchased Life Annuity (PLA)

A PLA is a conventional annuity that is bought with assets from outside your pension pot, such as with savings or your tax-free wedge.

A PLA is like a non-stick pan when it comes to income tax, as less of it clings on than with a conventional annuity. That’s because a proportion of your PLA income is treated as a return of capital and is therefore tax-free. Only the interest part of the income stream is taxed.

The exact amount of tax you’ll pay every year is determined by mortality tables. The quote I received on behalf of a close relative saves her 75% in tax, for no loss of income versus a conventional annuity of the same price.

2. Emergency funds and ISAs

Siphon your tax-free cash into an ISA and it will remain safe from the taxman. Interest, capital gains, dividends, income – it’s all off the tax radar.

This makes an ISA the perfect place to shelter some of your wealth for a rainy day or stormy season.

Arguments rage in the forum firmament over the most tax-efficient way to use ISAs. The theory goes that many basic or non-tax payers don’t benefit much from loading equities into their ISAs, because they have a generous capital gains tax allowance and because they aren’t taxed on dividends.

I’d always put equities into my ISA first. The average soul has no interest in capital gains management, and by using an ISA you’re likely to save yourself a lot of work and worry in exchange for a slightly bigger tax bill on your cash.2

Also bear in mind that bonds are taxed as interest not dividends. They should definitely be tucked up in your Stocks and Shares ISA.

Bear in mind that an ISA’s tax benefits can now be inherited by a spouse or civil partner.

Finally, let’s pipe up a lament for the dearly departed National Savings Certificates. These tax-free, government-backed savings vehicles were last available in lots of up to £15,000 per person in 2011. Grab ‘em if they ever come back.

3. Pension income recycling

Surplus income can be recycled into a new pension to scrub it clean of income tax.

Even if you’re fully retired and not earning a bean, you can pop £2,880 into a pension and get an automatic £720 bunk-up from the Government to take you to £3,600.

Any income tax you pay on the £2,880 is neutralised by the 20% gain as it enters your new pension. You can then withdraw the cash and make a gain on the 25% tax free element.

If you can withdraw the cash and still stay within your personal tax allowance then the entire £720 boost will count as a tax-free gain. (Remember that withdrawing cash from a pension counts as earned income).

Note, you won’t gain the tax uplift after age 75 and pension recycling with your 25% tax-free cash is a HMRC no-no. It is widely thought that HMRC will ignore any recycling gains that are less than 1% of your lifetime allowance (£1.25 million this year and £1 million next) but there are no guarantees.

4. Avoiding tax when you die

Post April 6 2015, pension pots inherited from someone who dies before age 75 will not be taxed – regardless of whether they are taken as a lump sum or income. It also no longer matters whether the retiree had previously tapped into the pension.

Annuity income can also transfer to a spouse tax-free, if you die before age 75.

Payments from inherited pensions must begin within two years or the beneficiary will have to pay income tax. Tax will also be due if your total pension savings exceeded the lifetime allowance of £1.25 million (£1 million from April 2016).

If you die after age 75 then inherited pension pots taken as income are taxed at standard income tax rates.

Lump sums are taxed at 45%. After April 2016, lump sums will be taxed at income tax rates. That could push a beneficiary into the 45% tax bracket for one year if the lump sum is big enough.

A pension will not be taxed as long as the money remains invested.

Check out this table to see all the tax wrinkles at a glance.

If you make it to 75, it may make sense to accelerate your drawdown rate and squirrel any surplus income into an ISA, as an ISA’s tax-free benefits can now be inherited by a spouse or civil partner.

Also, check that your pension scheme allows your beneficiaries to inherit any remaining savings as income rather than as a lump sum and that your pension provider knows who your beneficiaries are.

Because the old 55% death charge has been abolished, some people are now paying more into their pensions in order to help their beneficiaries avoid inheritance tax.

5. Personal allowances

Retirees used to benefit from a more generous personal allowance, but this has been axed for anyone born after April 5 1948. Now they get the same as the young ’uns.

The age-related allowance has been frozen for anyone born before the threshold, and it will gradually be worn away as the mainline personal allowance rises.

The State Pension is taxed as normal, too, so any income you earn over your personal allowance will be taxed at 20%, and then 40% – and 45% if you’re doing very well.

The trick for couples is to make sure that you both max out your personal allowance when you retire so that the minimum amount of household income is exposed to tax.

There is no special formula for this. Just keep your eye on your retirement forecast and make extra pension contributions where they’re most needed, buy missing NICs, consider deferring your State Pension, and so on.

Any more?

That’s all the methods to reduce tax in retirement I know about. (At least without consulting high-fee specialists with offices in the Cayman Islands, Liechtenstein, and Bermuda…)

If anyone else knows any legal tax avoidance techniques then please post them in the comments.

Take it steady,

The Accumulator

Note: This article on avoiding tax in retirement was updated in April 2015. Archived reader comments below may refer to an older version or to outdated regulations, so check their date.

1. Deferral rates looks set to fall when the new flat rate pension arrives in 2017. [↩]
2. An especially worthwhile trade in later years as mental faculties could well decline. [↩]