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Family Investment Company: Frequently Asked Questions (The FIC FAQ)

by Finumus on February 2, 2023

This article on the pros and cons of a Family Investment Company covers some nuanced issues around accounting and tax. It will not be relevant to the finances of 99%+ of readers – though we expect many more of you will find it interesting, and anyway we want the 99% to understand what the 1% are up to. The article is certainly not personal guidance. You should not act on ANYTHING in this post without seeking professional advice. This article is for entertainment purposes only.

Can you avoid dividend tax by investing through a limited company – specifically by investing via what’s sometimes called a Family Investment Company (FIC)?

And with the pending cut in the dividend allowance to £500, is it worth setting one up, pronto?

I’ve been running a Family Investment Company for nearly 20 years. In that time I’ve made many mistakes, and been asked many questions about the structure.

Today I’m going to answer (nearly) all of them.

It’s a long one. Grab a coffee. Maybe pack some sandwiches.

Family Investment Company 101

Here’s a somewhat idealised scenario for a potential Family Investment Company owner:

You’re an additional rate taxpayer and you expect to remain so for the foreseeable.
You have a £1m portfolio of dividend-paying equities held outside any tax shelters.1
Your £1m portfolio yields 5%.
That’s £50,000 a year of dividend income.

There currently exists a £2,000 dividend allowance (falling to £500 soon). At the additional rate tax band you pay a 39.35% dividend tax rate.

(£50,000 – £2,000 allowance) * 39.35% = £18,888.

Subtracting that tax from your £50,000 of dividends leaves you with £31,112.

Why is this portfolio so exposed to tax?

In this scenario you’ve already used up all the other tax-efficient wheezes.

You already fill you and your spouse’s ISAs every year. You’re both over the Lifetime Allowance (LTA) in your pensions. You’ve paid off the mortgage. You’ve maxed out the kids JISAs. You have £50,000 worth of premium bonds each. You’ve realised VCTs are a rip off…

…you get the idea! You’re out of options for sheltering your investment income.

If you do have any of these other options left, then you can stop reading right now. A Family Investment Company is going to be much more hassle.

However if you are out of alternatives, then you could use a limited company to defer – and perhaps avoid that dividend tax.

But before we dig into how it works, there’s a couple of things you need to be familiar with.

UK corporation tax for limited companies

UK companies pay corporation tax (CT) on their profits (at 19%) and pay dividends to their shareholders after tax.

Corporation tax is rising to 25% in April 2023 (to pay for Brexit). But that doesn’t matter for us from a FIC perspective, because our limited company doesn’t intend to ever pay it.

Companies don’t have to pay corporation tax on dividends that they receive from their shareholding in other companies.

Why? Because the company that made the profits has already paid the corporation tax. The exemption avoids double taxation.

Realised capital gains on those shareholdings, however, are taxable at the corporation tax rate. And this has serious implications that we’ll come to later.

Directors’ loans

Directors can lend money to their company. If there’s no interest charged on the loan – and as long as the company owes the director money2 – then there are essentially no tax consequences, for either the director or the company.

By simply keeping a spreadsheet of loans and repayments, you can just wire money in and out of your limited company.

That’s all the tools we need to make the Family Investment Company route potentially attractive.

Enter the Family Investment Company

In our stylized example:

We set up the FIC with, say, £1 of share capital and ourselves as sole director.
The company is furnished with banking and brokerage accounts.
We lend the company £1m.
And then transfer that £1m to the company brokerage account.
We buy a magical share that pays out a 5% dividend yield and has absolutely no price volatility. (Let me know if you find one!)
Every year the company receives £50,000 of dividends and uses that cash to repay the directors loan.

The cash flows look like this (with costs ignored for clarity):

Your company receives £50,000 a year in dividends (tax-free), and uses the full £50,000 to repay the director’s loan. You therefore receive £50,000 per annum from your £1m invested instead of £31,160. Saving yourself £18,888 per year – or £377,760 over 20 years – of tax.

(I ignored the change in dividend allowance, again, for simplicity).

Getting the million back… after tax

At the end of 20 years – with the director’s loan having been paid off with the dividends – you’d obviously like your £1m back, please.

How do you do that?

The company sells its shares (for zero profit, so no corporation tax), and pays out the £1m cash as a dividend. On which, of course, you need to pay 39.35% dividend tax, so approximately £393,500.

Hence you’ve not actually avoided any tax at all! (Nor mitigated tax, which is a better way to think these days).

We didn’t even include the various costs to pay. In fact we seem to have gone to a great deal of trouble to simply enrich our accountant.

And this is the main objection to this structure. Because whatever you may have heard, a Family Investment Company does not necessarily avoid dividend tax at all, but merely defers it.

Is deferral useful? Well… it depends.

My Family Investment Company

Let’s move beyond our stylized example, and get down to the nitty gritty.

But first an important reminder and disclaimer:

Wealth Warning You should not act on ANYTHING in this post without seeking professional advice. This post is for entertainment purposes only.

What’s the point of deferring tax?

Once money is gone it’s gone. Obviously I’d rather avoid the tax altogether, but I’ll take deferral if that’s the only option.

The Family Investment Company structure essentially enables me to choose the timing of the tax incidence of the dividends. And the FIC decides to pay me dividends when I’m paying the 8.75% rate, rather than the 39.35% rate.

I’ve enjoyed a feast-or-famine career – years when I’ve earned a great deal of money, and years when I’ve earned nothing at all. Dividend payments from the FIC can be stuffed into the lean years.

I have no DB pensions (sadly), so I can control the timing of withdrawals from my SIPPs. There will potentially be years in retirement when I can engineer being a lower-rate taxpayer.

Unfortunately, obvious wheezes like moving abroad for a year don’t work – there’s a specific anti-avoidance rule for ‘close companies’ in this situation.

Winding up the FIC at CGT rates may be possible. But I’ve never done it, so can’t attest to the process.

What if taxes go up?

You can certainly make a reasonable argument that deferral is bad – because taxes in the future will be higher than they are now.

My personal experience is taxes only ever go up. The dividend allowance cut itself is a case in point.

Allowances are cut, or withered away by inflation, or ‘tapered’, or ‘withdrawn’.
Reliefs are removed, restricted, or ‘means-tested’.
Lifetime ‘Allowances’ are introduced, where before you didn’t need to be ‘allowed’ at all.
Taxes are ‘simplified’ in a supposedly neutral way, and then the motivation is quietly forgotten and rates ratcheted up a few years later.
The indexation allowance is removed because we no longer have inflation.

And so on. It only ever gets worse.

Given that the only escape from this is economic growth – something both the UK government and the opposition now appear to be ideologically opposed to – there’s every reason to expect taxes to continue to rise. Indefinitely.

In which case you’d be better off paying taxes now rather than later. And not bothering with a FIC.

How is my Family Investment Company structured?

I’m the sole director. My wife is the company secretary. I own about 30% of the shares. My wife 25%, my children the remaining. My wife and I therefore control the company.

One of my kids is an adult, the other is not.

We have ‘Alphabet’ share classes. Different individuals own different mixes of share classes.

There is some flexibility around paying different levels of dividends on different classes. Lower tax-rate shareholders may happen to enjoy larger dividends than other shareholders. This is slightly complex to set up and the consequences of getting it wrong can be severe, but it does provide some flexibility.

For example, family members may be having a career break, or be in full-time education.

We didn’t pay dividends to non-adult children though. In the opinion of my accountant, this is generally treated as parental income for tax purposes.

How does a FIC compare with setting up a trust?

I’ve no idea. I Googled around a bit and I didn’t think there was much in the way of tax benefits to trusts. That seems to be more about control of assets.

I would say that the directors of a company, if the articles are drafted properly, have a great deal of flexibility to do whatever they like with respect to taking risk. That would not necessarily be appropriate in a trust where there are fiduciary duties.

Does the FIC open up inheritance tax (IHT) options then?

Not obviously. Unfortunately shares in the FIC don’t qualify for IHT Business Property Relief.

Also – and inconveniently – gifting shares in the FIC is a disposal for the giver and are therefore subject to capital gains tax (CGT). Especially inconvenient with the CGT allowance also being cut soon.

My accountant is happy with the value of the shares being the proportional NAV of the FIC at the time, for CGT purposes. So you can do this early on, before the company has accrued much value. But giving away more than 50% potentially introduces control issues.

And don’t be thinking you can just fiddle with the rights associated with each share class to make the kids shares ‘worth’ more. The tax man will see straight through this.

There’s nothing to stop you setting up a second Family Investment Company and giving 49% of the shares to your kids on day one. But then you’re doubling your admin and costs.

Our (loosely held) plan is that once the next generation are proper adults, we (or perhaps grandparents) can subscribe for shares, at NAV effectively, and gift them immediately to the (grand) kids. These are a Potentially Exempt Transfer (PET) under the IHT rules

Our intent is to do enough of this to pass majority control to them during our lifetime. We’ll then leave the minority shareholding to the generation after in our wills. (Yes, subject to IHT).

Someone has suggested holding the FIC shares in a trust… but my head hurts already.

I personally would prefer to just live forever.

Which broker do you use?

Most brokers offer a company or corporate account. We use Interactive Brokers (IBKR).

Why do we use IBKR?

Cheap margin loans. As any Private Equity associate will tell you, debt interest is tax deductible for companies. So if you’re going to apply leverage anywhere in your portfolio then the FIC is by far the best place to do it.

There was a good decade when my FIC was borrowing money from IBKR at about 2% (tax deductible), and repaying my directors loan so that I could use it to offset my mortgage (costing about 3%, not tax deductible).

You probably shouldn’t have one of these structures if you still have a mortgage though.

If you think Interactive Brokers is for you, then please DM me on Twitter for an affiliate link.

How much leverage do you use?

Lots! Between 50-100%. (Where 100% means the FIC owns £100 of stocks for every £50 of capital)

When interest rates were very low – and the interest is an allowable expense to offset against capital gains – why would you not run it hot?

How do I manage the leverage?

In theory the size of the margin loan never exceeds cash that I could feasibly access at close to zero notice and lend to the FIC as a director’s loan. We keep an effectively un-drawn offset mortgage against our Principal Primary Residence (PPR) for just this purpose.

In reality this rule has been ‘passively breached’ on one occasion, when I had to draw down the entire mortgage at the peak of the COVID slump. That was, as they say, ‘squeaky bum’ time.

(For quants-only: I also ensure that there are always sufficient available free funds in the brokerage account to cover the max of the parametric and historical two-day 99.9% Expected Shortfall.)

We’re reducing leverage now that interest rates have risen.

Which bank do you use?

Pretty much all banks offer a business account. Turn up with your incorporation documents and ID, and you should be good to go.

I’ve heard from others that banks don’t like FICs. I’m not sure why this would be, or what would cause the problem. It’s not something I’ve experienced.

If you’re only used to personal banking, then you might be annoyed to learn they could expect you to pay for things.

We use a Santander business account and don’t pay any fees, I guess because we don’t do the things you might pay fees for. (Paying in cash would be an example).

This was not an active choice. We used to use Abbey National, and it merged. Possibly our free account was grandfathered in.

What stocks do you own in the FIC?

This is my most favourite question, because anyone familiar with my stock picking skills would think I was the best person in the world to answer this question.

We’re looking for stocks that don’t go up – something I do appear to be an expert on!

Actually, we’re looking for stocks where most, if not all, or even better, more than all, the returns come from dividends.

This is because dividends are tax-free to the FIC and capital gains are not. So we want lots of dividends and the minimum capital gains – or even capital losses.

For example, all the assets below deliver the same returns, but the tax consequences are very different. (RIP Modigliani & Miller).

Stocks with high yields that never seem to go anywhere are what we want.

Why do you want to generate capital losses?

The FIC pays corporation tax on any realised capital gains, although we can offset expenses and losses.

Effectively we try to avoid ever paying corporation tax by ‘sterilising’ gains. That is, by only realising them if we have sufficient offsetting losses in some other stock, or running costs.

For this reason we want a portfolio of stocks and not just a high-yield dividend-focused ETF like Vanguard’s VHYL, for example. We’re after some dispersion of returns.

This does still lead to some shareholdings being sufficiently ‘in-the-money’ that it’s hard to have the tax capacity to sell them.

When you see the portfolio in a minute, there’s some stuff that’s been held for a very long time for this reason that is no longer particularly high yield.

Any other constraints on potential stocks?

Yes. It’s very important that the dividends are actually tax free to the FIC. There are some specific examples of cases where they are not. The source of the stock has to be a ‘qualifying territory’ on this list.

Tempted to stuff the FIC full of London-listed infrastructure or renewables trusts? Large capitalisation, high-yield, low volatility – perfect, right?

I’m afraid not. They are pretty much all domiciled in Jersey or Guernsey, and guess what? The Channel Islands are not on the list.

But most proper countries are, including, importantly, Ireland (where most LSE-listed ETFs are domiciled) and the US, with over 50% of global stock market capitalization.

However, and I’m sorry about this, but we need to talk about dividend withholding tax before we go any further.

A word about dividend withholding tax (WHT)

Explaining dividend withholding tax fully is beyond the scope of this post.

But in summary…

Most countries level a withholding tax on dividends. This means you don’t get the dividends ‘gross’. You get them ‘net’ of withholding tax.

For example, the Netherlands WHT rate is 15%, so if a Dutch company pays a €1.00 dividend, you will receive €0.85.

As an individual UK taxpayer you may be able to use the 15% as a credit against any dividend tax you owe in the UK. But as a limited company we can’t, because we don’t pay (UK corporation) tax on dividends anyway.

In theory, the tax treaty may say we can get a reduced rate. But good luck getting your broker to take any interest in that. “Sorry they are held in ‘street’ name”.

You could also ask the foreign tax man for the money back. Good luck with that, too. “Sorry, your broker shouldn’t have withheld the tax in the first place”.

So what does WHT mean for a FIC?

It is a long way of saying that we only really want the FIC to hold stocks domiciled in countries that don’t levy dividend withholding tax.

Significant countries where this is the case are the UK, Hong Kong, and Singapore – plus funds in Ireland.

Hong Kong is, of course, not on the qualified territories list, and Singapore is not very interesting.

So this leaves us with… UK-domiciled companies and Ireland-domiciled ETFs. Although we may break this rule if the (post-WHT) yield is high enough.

The ETF / fund structure doesn’t avoid this issue, by the way, it just hides it. (There’s the exception of ‘swap-based’ ETFs tracking US indices. Maybe we’ll cover that another day.)

Individual US stocks that pay dividends should be held in your SIPP, where you should pay no withholding tax.

We also want to avoid things where the distributions are interest not dividends, because interest is taxable for the FIC.

So we might buy preference shares – although they are usually not marginable – because they pay dividends. But not AT1 bonds, because they pay interest.

Great, but what have you actually got?

I just alluded to another, personal, constraint – I want my stocks to be marginable at IBKR. Which means big and liquid.

I’d also prefer they were denominated in GBP and paid their dividends in GBP because otherwise it complicates the accounts. This is not much of an additional constraint given the dividend withholding tax issues above.

I’m left with a portfolio that looks very much like the sort of thing a classic UK equity income investment trust might own.

What can I say?

GACA is the only non-marginable share. And I think we can all agree there’s not much danger of these stocks going up much.

Aren’t you letting the tax tail wag the investment dog?

Yes, absolutely, I am. But look at it this way – maybe my portfolio outside the FIC is the global market portfolio minus these stocks in these weights?

I mean, it’s not, obviously, but it could be.

We’re aiming for this:

How actively do you trade this portfolio?

I have an ambition to go a whole year and not do a single trade. I’ve not succeeded yet. We do a handful of trades a year, but some of these positions haven’t changed in at least a decade.

Do companies still benefit from the ‘indexation allowance’ on capital gains?

Sadly not, this was quietly removed in 2017. In my opinion it made the FIC structure substantially less attractive.

What other expenses can I get away with charging to the FIC?

One way of essentially withdrawing money tax-free is to have the FIC pay expenses that you would otherwise have to pay yourself. (‘PA’ as they say).

These effectively get you, as an individual, ‘tax-free’ money out of the company, and are tax deductible for the company. A double win.

The extent to which you can do this appears to be down to the judgement of your accountant. You have to be able to make the case that it’s for legitimate business purposes.

We don’t do as much of this as we should, probably. The company pays for the occasional bit of computer equipment. “It’s for managing the portfolio!” This is depreciated over three years, so basically we get a laptop every three years.

We could probably expense the Financial Times subscription and our mobile phones, but we don’t.

I once tried to persuade the accountant that the FIC should pay from my MBA, but failed.

Can I expense my accountant’s bill for my personal tax return to the FIC?

No. I guess you could come to an ‘understanding’ with your accountant. One where they overcharge you for FIC work and under-charge you for your personal stuff. But I don’t have that kind of accountant.

Do you hold UK REITS in the FIC?

No. This could be quite a good idea, because the FIC should receive the Property Income Distributions (PID) gross. Although PIDs are taxable.

It might work if we have sufficient expenses. However Interactive Brokers don’t pay the PIDs gross, regardless of what the tax rules say.

Attempting to reclaim them from HMRC is theoretically possible, and something my accountant would be delighted to help me with – at a cost.

We don’t really have enough tax-capacity to make this worthwhile.

Can you have direct properties (buy-to-lets) in the FIC?

Actually, yes! We have one, un-mortgaged, rental property in the FIC. We sold it to the FIC in early 2016. Just before the extra stamp duty for companies came in.

The income from the property is, of course, taxable, but it is tiny. We run enough general ‘management’ expenses to offset the income.

I have thought about moving one of my other buy-to-let properties into the FIC, but I’ve not been able to make it make sense.

To be honest if I’m going to sell it – with all the (personal) tax and hassle – I’d rather sell it to some other mug.

Do you have any other assets in the Family Investment Company?

We once did quite a bit of peer-to-peer lending. You know the sort of thing: Lendy, Archover, Funding ’Secure’.

At least it provided us with a deep well of tax-deductible write-offs.

Could I just use the FIC for all my shares?

You could, but it would likely be a bad idea, especially now that the indexation allowance has gone.

Your minimum tax rate on capital gains is 19% (rising to 25%) – and it could be as high as 54.51%. (The company pays 25% tax on gains, then you pay 39.25% on the dividend to you. That’s: 100 -> 75 -> 54.51%).

You’re much better off just holding those assets in your own name and paying 20% CGT.

This all sounds like a great deal of work. Is it?

I spend less time administering the FIC every year than I spent writing this article.

The ongoing obligations are:

File a ‘confirmation’ statement with Companies House every year. (Takes five minutes. It’s nearly always the same as last year’s).
File accounts with Companies House every year. (The accountant does it).
Prepping the information for the accountant and checking their work takes about as long as it does to do our (again, fairly complicated) personal tax returns.
Filing a tax return with HMRC. (Again, the accountant does it).
There’s a bit of other admin, like renewing your Legal Entity Identifier periodically. (Interactive Brokers does that for us.)

How much does it cost to run?

It costs us about £2,500 per year. This is almost all accountants’ fees.

I know, I know, it should be less than that.

The costs are proportional to the nature and volume of transactions. But they are essentially fixed with respect to the size of your balance sheet.

(That said, I suspect an accountant would charge the £10m company a bit more than a £1m company, even if they did the same amount of activity).

How much do I need to put in to make this worthwhile?

Well, you know the costs now . You do the maths. Maybe £1m, if you’re starting from scratch?

It might be less if you’re using an existing company, or setting up a FIC that has a relationship with your trading company. I’ve never done this though. Once again, seek professional advice.

Can you recommend your accountant to help me set up a similar arrangement?

No.

Does this cause a problem with your employer?

Potentially. My employment contract explicitly forbids me from owning more than some percentage of a company, or being a director of another company, without my employers ‘written permission’.

The key here is to ask for the ‘written permission’ in good time.

I simply asked, by email, for them to confirm there was no problem with the arrangement in the same email I accepted their job offer. I have done this four times now and it’s never been a problem.

This sort of arrangement is a lot more common than you might think. Human Resources have seen it all.

In jobs where I was subject to compliance ‘personal account dealing’ rules, the FIC was obviously subject to the same rules.

Again, never a problem, if you follow the rules.

While we are talking about transparency…

Anyone can go to Companies House, click ‘Search the Register’, put in your name, find the company you are a director of, and look at the accounts.

There is nothing you can do about this. If this is going to cause you embarrassment, then a FIC probably isn’t for you.

Can I pay pension contributions for directors?

Yes, you can, but I’m not sure why you would?

These are ‘employer’ contributions that are made gross to the scheme – and are a tax-deductible expense for the FIC. You’re saving the company 19/25% corporate tax on the contributions, but you’ll pay anything from 15%-55% on withdrawals (from tax-free amount and basic rate all the way up to the LTA charge). So is there any point?

Again, this is a deferral of tax liability, more than an avoidance. It might be worth considering if the FIC is otherwise becoming liable for corporate tax and ‘needs’ some expenses, and if you have directors who are unlikely to get to the LTA and will be basic-rate tax payers in retirement.

But, again, if you’re rich enough to make this structure worthwhile, you probably don’t have those people in mind.

Can I pay salaries to the family members instead of dividends?

Yes. You could make the kids (once they are adults) directors and pay them a salary – although there’s quite a bit of paperwork involved with having employees that I could do without to be honest.

The advantage over dividends is obviously that their salaries are tax-deductible for the FIC – and you’re just using their nil-rate allowance. (I’m assuming you’re only doing this while they are students, basically).

Into the weeds

Can the company pay interest on the director’s loan?

I believe so, but you do have to do some withholding / filing with HMRC. It’s a bit of a pain – and, again, why would you do this? Presumably the last thing the director wants is taxable income?

Can I convert a regular trading company into a FIC?

I get this question quite a bit.

The classic case is the 1990s/2000s City IT contractor type who contracted through a pre-IR35 personal service company. They now have a few hundred grand sitting in their limited company and don’t want to pay dividend tax to get it out.

Be very careful here. There are some reliefs associated with being a proper ‘trading’ company that you may jeopardise.

This, as with every other word in this article, is something you should take proper professional advice on.

How does a FIC compare to some sort of ‘offshore’ arrangement?

I have a high level of confidence that the FIC structure is 100% above board and has zero retroactive compliance risk from HMRC.

This does not mean that the rules won’t change to make some aspect of it not ‘work’ any more.

The only thing I’m confident about with offshore arrangements is that they are expensive to set up.

In any event, it’s not trivial. You can’t just set your FIC up in the Caymans and pay no tax. HMRC will treat any company that is ‘controlled’ from the UK as if it were UK domiciled and tax it accordingly.

I do know people with offshore companies that they don’t ‘control’ – but are controlled by a chain of shadowy proxy entities that they also don’t ‘control’.

I am sure this is all completely legit, the way they’ve done it. But I also don’t have the sort of money that makes this level of risk or complexity worthwhile.

Is a FIC a ‘close company’ and does this matter?

Yes, most likely your FIC will be a close company. There are a few anti-avoidance measures that target close companies specifically – for example, targeting manoeuvres such as you moving abroad for a year and paying yourself a big fat dividend.

Unless you’re trying to use those avoidance methods, being a close company shouldn’t really make much difference.

There have been different tax rules for close companies in the past. This is certainly a potential vector for the government if they wanted to attack this sort of structure.

Is there anything you haven’t mentioned?

Yes – there are a few other tricks that I don’t want to discuss openly on the internet!

Thanks to Foxy Michael, who met Finumus on Twitter and was kind enough to review this article for gross falsehoods. If this Family Investment Company FAQ has whetted your appetite, visit his site. You can also read more from Finumus in his archive, or follow him on Twitter.

Ideally you’d own them in tax shelters, of course, but you might have a larger portfolio or some other reason for owning un-sheltered assets. This brings the FIC into the picture. [↩]
Not the other way around – going overdrawn on the directors’ loan account. [↩]

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FIRE: Emergency midwinter broadcast

by The Accumulator on January 31, 2023

Often times when somebody goes a little off-piste with their investments, I will make clear in the introduction that this site is for informational purposes only. It is not personal advice as to what you should do. Well, with my co-blogger apparently having gone off his rocker, I’m double underlining that today. Read on for enjoyment – but subscribe to his kind of cool at your peril!

One unfortunate development liable to banjax, derail, or otherwise severely stress-test a financial independence plan is galloping inflation and a cost of living crisis.

Oops! One minute my energy bill was a national average £1,200. The next I was being quoted north of £4,0001 as my old-skool affordable tariff expired – with me clinging on to it like Rose to a freezing Jack at the end of Titanic.

Time to dust off the emergency action plan I’d devised for precisely this scenario.

Ahh, about that…

Chapter 12: How to respond in the event of quadrupling energy costs.

I found I’d left that page curiously blank. Someone hadn’t covered off all the angles had they?

But I wasn’t entirely naked in the face of danger (and at these temperatures, thank God!)

In fact, my best way out of this, I decided, was to clothe the bejesus out of myself.

Cold comfort

“Wouldn’t it be fun…” I said to Mrs Accumulator in that disarming way that instantly puts her on her guard.

“…if we challenged ourselves to use as little energy as possible this winter?”

Thankfully Mrs Accumulator’s action plan on “How to respond if TA turns out to be an utter nutjob” is also remarkably underdeveloped.

I mean, it’s not as if she hasn’t had fair warning.

“Yeah, alright then, Romeo,” she said.

So we set off on an adventure – like the Natural Born Killers of energy-saving.

Just how low could we go? Both on the thermostat’s dial and in terms of the social unacceptability of our chosen course?

And how many layers of thermals, fleeces, winter woollies, and the very best in technical gear would it take to live comfortably* in a house as warm as a tomb?

*Your mileage may vary.

Enter the Chillbreaker

His and Hers survival suits made everything seem possible.

Get a load of this bad boy:

Several togs worth of quilted, walking sass.

Added bulk pour homme et padded booty pour femme.

Made by Refrigiwear and rocked by Americans working in industrial freezers or extreme Midwestern winters, this quilted beauty was the answer to our prayers.

Indeed I am writing to you from within its cosy confines now.

Polyester fiberfill insulation? Tick.
100% Taslon nylon 3-Ply outershell? Tick.
Storm flaps for the front zippers. Double-tick!

The Chillbreaker comes in any colour you like. As long as it’s Mao’s Workers’ Paradise Blue. Guaranteed to automatically crush any attempts at individual expression or insurrection.

Excellent news! Especially as I wasn’t sure Mrs Accumulator was 100% committed. (And we might both be committed by the time this experiment is done – so that padding could come in doubly handy.)

Have I mentioned the hip length leg zippers? Perfect if you start to boil in temperatures of over 12°C, or want to give a cheeky flash of your thermals.

IWOOT

I know what you’re thinking.

Where can you get one of these dream-makers?

I’m glad you asked.

These babies are not available in the shops. Not in the UK at any rate.

But for a mere $110, plus shipping, import duty, VAT, and handling fee, you too can be the proud owner of your own adult romper suit.

In GBP, they cost us around £243 each. Plus some “can you ship to the UK hassle?” with US vendors.

But let’s not get bogged down in the details. The goods should pay for themselves in cubic metres of gas not burned.

So has the plan ‘worked’? (Put that in scare quotes, please – Ed.)

Do we live in an icebox sustained by our suburban space suits and balaclava helmets?

Does net zero now refer to the temperature of our house?

The icebox challenge

This was the temperature reported by my smart thermostat during the depths of the December cold snap.

The outside temperature was -8°C while inside at Chez Accumulator we were enjoying a positively ~~balmy~~ barmy 6.6°C.

I could tell I was still breathing because I could see it. Great gusts of exhaled air condensing into fog. Fun.

Actually somehow it was fun.

A greater challenge than living at 6.6°C will be persuading the sceptics that I’m not living in frostbitten misery and that Mrs Accumulator hasn’t left me for any dude with his thermostat set to 21.

But let’s give it a go.

Draught dodgers

A big part of what’s made this work is we set it as a challenge for ourselves. One that we’re solving together, while taking it in stages, alongside regular check-ins to make sure neither of us is hating life.

Starting in late October we rationed ourselves to two hours of heating a day in the morning.

When it’s freezing outside, our draughty old Victorian home struggles to get over 17.5°C, even with the heating on 24/7.

We’ve never been able to ponce around in T-shirts and pants in the depths of winter anyway.

In student days, we spent one winter in a flat sans central heating. And we have heard plenty of tales from boomer parents about nights spent huddled together in front of the one fire in the house.

Britons didn’t used to live in dwellings heated to 21°C. More like 12°C.

That sounds bleak by today’s standards. But we started out thinking no more ambitiously than: “Let’s find out what we can put up with. Let’s save some energy. Let’s put the money to better use than heating a house that doesn’t want to be heated.”

And we wouldn’t be eschewing all mod cons – as the short, sharp fashion parade above makes plain.

A big difference between Britain today and Britain before central heating is that most of us can now afford whatever clothing it takes to give us a personal tog-rating worthy of a double duck duvet.

Just chillin’ in my crib

The science of thermal insulation using clothing is also now widely understood. Indeed you’ll know most of it already.

The bulk of the work is done by wearing three distinct layers:

The base layer that wicks moisture away from the body. Ideally this is made from merino wool or appropriate synthetic fabrics.
A thick insulating mid-layer that traps air. Think heavy wool jumpers (as worn by a fisherman) or a fleece. (Those sheep know what they’re doing).
A windproof outer layer. Not needed indoors unless your windows are outrageously gappy.

There’s even a US unit of measurement of clothing insulation called the ‘clo’.

A warm clo inside

You can award every garment you’re wearing a clo rating. Add up your clo units to find out whether your outfit can handle the prevailing temperature even as your sweet backside is parked on the sofa.

That last distinction is not only a beautiful image. It’s also a crucial part of maintaining our thermal comfort zone.

Experience tells us that our 21st Century sedentary lives do not help us stay warm.

But 1 clo’s worth of clothing is enough to keep humans comfortable at 21°C while at rest.

An example of a 1 clo ensemble is a military uniform. A three piece suit – plus undies – is also worth a clo.

Interestingly, 1 clo equals 1.55 togs, which is the British unit we know and love from our duvets.

Anyway, every extra clo you wear means you can comfortably lower the temperature another 1°C. Which saves another 10% in energy use.

A superb article called Insulation: first the body then the home by Kris De Decker shows you how to use this clo-business to throw together outfits from your wardrobe that can handle any temperature.

But I didn’t do any of that.

I just kept piling on layers as the thermostat ticked down like the depth gauge in a bathysphere:

16°C – a comparative doddle.
14°C – was totally bearable. I took to wearing my woolly hat indoors.
12°C – felt quite hardcore. Mrs Accumulator and I exchanged glances. Neither one of us caved.
10°C – I appeared on Zoom wearing full body bag, muffler, and hat. My mum pished herself.
8°C – I regularly popped a hot water bottle down my padded pants. If this thing burst I was done for.

Mrs Accumulator sensibly used a microwavable heat pack instead. No third-degree crotch burn danger for her.

How are we doing now? Still smiling?

I couldn’t believe it. Though we needed to adapt at every stage we were both completely comfortable.

Granted, I felt cold at times. But no more than living in this house during a normal winter – when the heating was on full blast but we didn’t think much about what to wear.

The heat pack is genius. As long as your core is warm then that good-time glow extends to your hands and feet.

We both spend too many hours tapping into keyboards (witness the waffle above.) But even that’s not a problem at 8°C when you’re inside a heated Chillbreaker.

And it’s never going to get any worse than that. Because it transpired 8°C was our minimum room temperature provided we got two hours of heating. And that on the coldest day ever recorded in my part of the world. (Right now it’s 5°C outdoors and 12°C indoors.)

You quickly adapt to a new mean temperature. (With the emphasis on the mean.) I used to feel chilly at 17.5°C. Now that temperature seems like tropical spa break luxury.

And how’s Mrs Accumulator holding up?

She just challenged me to do without our two hours of daily heating.

Gulp!

Back to The Good Life

I’ve told you this story for your (possible) entertainment. It’s not meant as a “Come on Britain, put your bloody backs into it!” polemic about how we’ve become a nation of softies.

I’d prefer to live in a Putin-less world of wind turbines and heat pumps keeping us all toasty. One in which the Chillbreaker remains hanging on its peg because power is too cheap to meter.

Nor do I think state-sponsored Selk’bags should be compulsory for the frail and elderly, the very young, or those with illnesses exacerbated by the cold.

If we have visitors then we don’t write “dress warm” on the invite. We crank up the heating to make everything seem ‘normal’ by the time they arrive. We get that not everyone will dig our ‘frugal casual’ look.

But you’d be mistaken if you read into this a tale of forced frugality and the folly of FIRE. We could burn the cash on heating if we wanted to.

We’ve just got better plans for it.

Take it steady,

The Accumulator

Bonus appendix

Our annual energy bill looks like it’ll tot up to around £1,200 on the standard rate if we stick to our current regime. That’s roughly what we would have paid before the energy crisis.

Whereas our energy provider is now estimating £2,750 for the year if we opened the gas taps like it was 2021.

If anyone would like to buy a Chillbreaker, then may I recommend purchasing from Legion Safety. They were the one company I found in the US who would (a) send the goods to the UK and (b) charge a reasonable shipping cost.

Their online reviews aren’t uniformly brilliant, so I thought I was taking a chance. However, Legion’s customer service was very good. Getting the item through UK customs was straightfoward, too.

I’ll write a brief guide in the comments if anyone’s interested.

There is a French company who will ship Chillbreakers, too, but it was more expensive.

I’d also love to hear people’s thoughts on alternative outfits. Sleeping bag suits look viable. What about skiwear?

Finally, apparently the British unit of insulation, the ‘tog’, was derived from ‘togs’, the classic slang term for clothing. Togs was borrowed in turn from ‘toga’ – the Latin word for the famed Roman fashion item. Love that.

This was before the UK Government’s Energy Bills Support Scheme was announced. [↩]

{ 55 comments }

Weekend reading: we shouldn’t have to think twice about energy demand

by The Investor on January 28, 2023

What caught my eye this week.

After several false alarms, the past week saw National Grid throw the switch on its demand flexibility service.

Like much else in modern life, there’s a bit of double-speak going on here.

The ‘service’ on offer for those taking part actually involves degrading something we in the UK take for granted – electricity at the flick of a switch, whenever we want it, and the luxury of use without guilt or much thought.

Instead those who sign-up (and who must have a smart meter) are paid an incentive for using less power than they normally would during set peak periods.

For example, on Tuesday from 4.30pm to 6pm window.

According to The Guardian:

During the trials, typical households saved about half a kilowatt hour, which will be worth about £2 on Tuesday, putting the cost to National Grid at £2m. Those funds will be passed on to those participating, with suppliers keeping a share to cover their costs.

In total, National Grid is expected to pay just over £3m to suppliers for the service over Monday and Tuesday – with about £850,000 on the first day, and £2.1m for the longer session on Tuesday.

Octopus Energy – which has been running trials since early last year – reckons 400,000 of its customers took park in Tuesday’s session. They were offered £4 for each kilowatt hour of electricity they avoided during the hot zone.

(Interestingly, that incentive had been bumped up on account of National Grid lifting its payouts. Competition counts.)

In total more than £1m was paid out to Octopus customers on Tuesday. That’s meaningful money. But of course you have to divide it by the large number of customers taking part.

Which in turn leads to headlines like This Is Money’s ‘Would you switch off your cooker and washing machine for an hour to save 39p?’

Cognitive load

While the This Is Money angle rankles, I don’t blame it for going there. The small amounts saved do seem derisory if you pay attention to them.

Even doing it every week isn’t going to move the dial for many families. It’s been estimated that Octopus customers who took part in 25 powering-down events over winter might save just £100 in total.

That’s not nothing, but there are easier ways to save money than having to think about how you’re using energy a couple of dozen times for three months.

Instead, just remembering to never use big electrical appliances between 4.30pm and 6pm every day would cut the cognitive load. But at some point you’d presumably stop saving money that way, as your smart meter would get wind of your new pattern of usage.

Which means there’s actually an incentive to keep using power at peak times during the rest of the week. That seems a perverse incentive!

Vanishingly beneficial

With all that said, as a prophet of environmental danger myself I’m all for this direction of travel.

The key is for the system to become invisible, and ubiquitous. All consumers should have smart meters and their bills should be lowered whenever they use more energy outside of peak demand. These peak times should just become generally known, the same way we all understand that if we want to travel at rush hour there will be crowds.

Consumers shouldn’t have to police their bills to ensure they see savings. And in time AI and other smart home features should respond to known patterns of demand, too.

For example, you might switch on your washing machine at 5pm only for it to chirp back: “Do you want to wait until 6pm to save money?”

An emergency load can still get done. But I’d bet 90% of washes would simply be punted forward to beyond the peak period.

Every little helps

Apparently Tuesday’s scheme saved energy equivalent to the city of Liverpool shutting down for an hour.

That’s a result, and I think this will scale.

Critics of renewables understandably raise issues about intermittent supply, peak demand, storage and so on. There’s no single killer fix, but I believe there are myriad small fixes – from using electric vehicles as a vast distributed battery to devising fossil fuel power stations optimised explicitly for short-term back-up, to these sorts of energy demand schemes.

Nobody said it will be easy, but if saving the planet involves not tumble drying my underwear at 5pm on a Tuesday then sign me up.

After that signing though, I don’t want to have to think much about it. That’s crucial.

Enjoy the links, and have a great weekend!

[continue reading…]

{ 38 comments }

Swap rates and mortgage rates

by The Investor on January 27, 2023

A diagram showing two arrows, one labeled Fixed Rate (for the swap rate) and one labeled Floating Rate

For sure I’m not the only homeowner who has been refreshing their mortgage options every day for the past few months. But are you also following swap rates?

Swap rates might sound like the relative popularity of Lionel Messi versus Cristiano Ronaldo in the Panini sticker trading game.

But they’re actually a vital bit of the financial system plumbing.

Swap rates largely determine mortgage rates, as well as much else that’s numerical and curvy in the financial world.

By keeping an eye on swap rates, you can better understand why you’re offered a particular mortgage rate.

True, you probably won’t bag a huge bargain on the back of it. Your mortgage offer will mostly depend on your income and deposit.

But at least understanding swap rates can help you judge why a given mortgage may be slightly more attractive than another, say, compared to if you didn’t know how they were priced at all.

Let’s dig in.

What are swaps?

In finance, a swap is an agreement between two parties to exchange – or ‘swap’ – the cash flows from one asset for another, for a certain period of time.

Typically one stream of cash flows is fixed and the other variable.

Swaps are derivative contracts and the market is vast and deep. Estimates vary, but think hundreds of trillions of (notional) dollars, globally.1

There are various kinds of swaps, differing by whether the variable cash flow is tied to an interest rate, a currency exchange rate, or some kind of price level.

For example you may recall the Credit Default Swaps (CDS) made infamous by the financial crisis and The Big Short. CDS enable investors to swap or offset credit risk on fixed income assets.

The swaps we’re interested in today are called interest rate swaps.

Interested in interest rates

In an interest rate swap, the cash flows exchanged are interest rate payments.

Most commonly, the swap exchanges a stream of fixed-rate payments for floating-rate payments.

Investment banks arrange swaps for a fee. The investment bank later offloads the risk via brokers to other investors, who want exposure for their own reasons. (Hedging or speculation, say).

Commercial and investment banks, big corporations, and very large traders typically make up the two sides (counterparties) of swap contracts.

What is the swap rate?

The swap rate is the fixed rate demanded by one party in the swap for the uncertainty of having to pay the variable (floating) rates that the other party wants to exchange, over some period of time.

Here’s what’s going on:

The receiver demands a particular fixed interest rate – or ‘swap rate’ – from the payer. In exchange, the receiver agrees to meet the payer’s (uncertain) floating rate payments over time.

The swap rate reflects the expected value of those future floating rate cash flows, as predicted by the money markets when the deal is struck.2

At the time the swap is agreed, the two cash flows net out to zero and neither side stands to profit:

Source: PIMCO

In practice, variable rates are called variable for a reason. As the floating variable rate rises or falls, the contract will become profitable for one of the parties.

Note though that this doesn’t necessarily make the deal a bad one for the ‘loser’.

Think about when you take out a fixed-rate mortgage. The right reason to go for a fixed rate is to lock-in a regular and known cost for your future payments. It’s not to punt on interest rates.

Similarly, one party in a swap wants rid of the uncertainty caused by floating interest rates. If it loses a little money over time, that’s the cost of insurance.

Price moves everything around me

This all probably sounds very complicated, and on a deep level it is.

However, just as you don’t need to do a fundamental company analysis to buy Apple shares at the prevailing stock price, so participants in the swaps market basically follow the prevailing swap rate, which fluctuates with supply and demand.

Here’s one data provider of current swap rates.

How do swap rates affect mortgage rates?

Swap rates are what determine mortgage rates (but see below for a bit on bank margins).

Of course you might ask “what determines the swap rate?” but this article would go on forever. The short answer is interest rates, and expectations and uncertainty in the market.

But back to mainstream lenders and mortgage rates.

Let’s say a mortgage bank is in the mood for lending.

Many of us believe High Street banks lend out the cash deposited by savers as mortgages, but this isn’t exactly how it works.3

A bank can create new money for loans via fractional reserve banking.

Alternatively it can tootle off to the money markets. There it might secure a couple of hundred million pounds worth of wholesale funding from other market participants.

It pays variable (/floating) rates on this money. However the lender wants to offer its customers fixed-rate mortgages, on which it will receive set monthly repayments. So there’s a mismatch here.

Even if the bank creates new money to make the mortgages, it’s in the business of providing retail customers with savings and loans, not in gambling on future interest rates. Also many of its liabilities will be related to floating rates, such as the interest it pays to savers.

So again, it will want to get rid of the risk inherent in offering a fixed-rate mortgage.

Enter the bankers’ bankers

In order to offer fixed-rate mortgages in a prudent and mostly risk-free fashion, our lender heads over to an investment bank.

These guys are only too keen to temple their fingers, smile menacingly, and arrange an interest rate swap that exchanges a variable cash flow for a fixed-rate cashflow.

Hey presto! The mortgage lender now has say £200m of money on which it will pay, for example, 4% for the next five years, thanks to the swap.

The investment bank is stuck with the risk of meeting the floating rate payments – but that’s its problem. (Which as I said earlier it will probably soon offload itself. But they are not the hero of this story, so we’ll leave them there).

The mortgage lender can now proceed to offer its customers £200m worth of fixed-rate mortgages at 4%. (Or a little more than 4%, because it wants to make a profit).

Crucially, the mortgage bank doesn’t have to worry about the variable rate going up to say 6%, and these fixed-rate mortgages becoming unprofitable.

It got rid of that interest rate risk, via the swap.

Bank competition also affects mortgage rates

If swap rates and mortgage rates were one and the same, then we’d have no need of comparison sites or shopping around. All banks would offer the same rates. At least for the same terms.

But in practice mortgage rates vary across lenders.

As I write, the average five-year fixed-rate mortgage is charging 5.27%, according to data provider Moneyfacts. But home buyers with a 25% deposit can bag a five-year fixed rate from Yorkshire Building Society costing just 4.18%.

This chunky gap between the best rate and average rate – more than a full percentage point, or 109 basis points in City lingo – reflects the difference in margin the banks aim to make from their mortgages, and how keen they are to win business.4

It’s not rocket science to see that a lower mortgage rate will attract more borrowers, all else equal.

But charging a lower mortgage rate will earn the bank less money – margin – too, reducing the profit per customer.

A lower margin also means there’s less ‘buffer’ in the cash coming in to meet the bank’s other obligations. This will especially matter if mortgage delinquencies rise (and it subsequently receives less of those expected fixed-rate cash flows).

Hence cheaper rates also reflects a bank’s willingness to take on more risk.

Banks juggle all this according to their strategy – market niche, confidence in their mortgage underwriting, and their balance sheet – as well as their usual herd behaviour.

(Bankers like to do what everyone else is doing!)

Remember when the Mini Budget blew up the market?

You can now see why mortgages got so expensive in the midst of the 2022 Mini Budget dysfunction.

Swap rates skyrocketed, partly because interest rate expectations spiked on the prospect of additional unexpected and unfunded government borrowing, but also because of a huge rise in uncertainty.

Spot the Liz Truss moment in this graph of two-year interest rate swaps:

Source: Investing.com

The spike in swap rates immediately impacted the future pricing for mortgages.

But the tumult also had a secondary affect, which was that mortgage lenders got the willies. They pulled thousands of their mortgage products in order to buy time to wait and see, and to price their products properly.

Thankfully, even this generation of Tories realized that the Liz Truss spectacular was a step too far in their post-Referendum battle against Britain’s prosperity.

So Truss got the chop and more sober politicians came in.

And we can see this clearly in the chart. Two-year swap rates are now back to where they were before the whole debacle.

Note that’s despite more interest rate rises from the Bank of England since. The market had already priced in those rises, prior to the possibility of additional ones due to ‘Trussonomics’.

Where does this leave the mortgage market?

The money markets have hugely calmed down since Liz Truss and Kwazi Kwarteng were ousted in favour of the comparatively trustworthy Rishi Sunak and Jeremy Hunt.

Whatever their pros (they’re not Tory ultras) and cons (they still spout fantasies about economic ‘Brexit benefits’), the pair have promised fiscal sobriety, no funny business, and to show their workings.

Foreign and domestic capital has taken them at their word. The bond vigilantes have stood down. The so-called moron premium in UK rates has mostly dissipated. And swap rates have declined from the distressed levels we saw during The Muppet Show of September 2022.

As you’d expect, that has brought mortgage rates down. Although sadly not quite to pre-Mini Budget levels.

For example:

The average new two-year fixed rate mortgage was 4.74% just before the Mini Budget.

The average rate for the same mortgage is 5.5% at the time of writing.

Why the 75 basis point gap?

It’s true the Bank of England has continued to hike interest rates. However the forward curves implied this even before the Mini Budget.

Sure, nailed-on rate rises are more convincing then ‘almost certainly’. But only unexpected increases in the rate or duration of higher interest rates should lift swap rates.

More probable I think is the outlook for the UK economy – and its housing market – has worsened since early September 2022.

That could imply the Bank of England won’t raise rates so aggressively.

Indeed the current swap rate curve implies the Bank of England will be cutting Bank Rate from the today’s 3.5% within a couple of years:

Source: Bank of England

However the Bank of England’s focus is currently on bringing inflation down to target. And progress here is still only modest. Visible, but modest.

What’s more, there’s clearly a ton of economic strife going on, with workers everywhere demanding double-digit pay increases. Big wage hikes are certainly inflationary.

Given all this, I wonder whether most of the banks have simply been looking at the fatter margins on their mortgage products versus last year, and not feeling any great rush to trim them?

In other words, the mortgage lenders remain more skittish than before the Mini Budget.

On the other hand, mortgage experts always said it would take a while for mortgages to re-price following the September ructions.

And mortgage rates are still inching down each week. The best fixed-rate mortgages are much cheaper than the average, if you can get them. Maybe the spread over swap rates will continue to close.

What does it mean for a would-be borrower today?

So should you look to get a variable or tracker-rate mortgage, at least for a while, and wait for lenders to bring fixed-rate mortgages down further?

Mortgage rates will probably continue to decline, but this isn’t a certainty. If the last year’s Russian war, energy price ructions, and political turmoil taught us anything, it’s that things happen.

On the other hand, while a variable rate mortgage will probably be more expensive to start with, it might be a price worth paying if you can switch to a sub-4% five-year fix in a few months time.

That’s not a prediction – but others are making it.

From FTAdvisor:

Brokers have shared their latest predictions on when fixed mortgage rates will fall below 4 per cent, with some saying they are likely to come down “by March” while others are “doubtful” rates will fall that low for at least the next six months.

As I noted earlier, one lender is already offering a 4.18% five-year fix. Others should follow.

However, as always, fixed-rate mortgages are chiefly about the certainty of forward payments, not interest rate speculation.

If you can truly afford (a) higher standard variable rate payments today and (b) the risk of having to eventually lock into a more expensive fix because ‘something happens’ tomorrow, then there may be a case for waiting a few months.

But what’s most important is to buy (or remortgage) at a rate that you can comfortably budget to and manage.

I’m keen to hear from other readers who’ve recently had to negotiate these mortgage markets. Anyone else watching swap rates? Or unfortunate enough to have remortgaged under Truss?

The majority of these contracts net off against each other. The actual cash flows involved are much more modest. [↩]
In the UK that future is predicted by the forward SONIA (Sterling Over Night Index Average) curve. SONIA is the more transparent successor benchmark to LIBOR, which was rigged by banks during the financial crisis. SONIA is administered by the Bank of England. [↩]
Savings aren’t irrelevant. But they are mostly cheap funding that bolsters the bank’s balance sheet, helping to enable its various other activities. [↩]
It may also represent how much funding the bank has previously secured via swap rates. Once this tranche is used up, its rates will change with the cost of new funding. [↩]

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