This is a bit of a meandering and personal rant. Feel free to skip it!
A new year, a wobbly stock market, and naturally a young not-so-young investor’s thoughts turn towards topping up his SIPP.
And as I pondered how big a lump sum to shock and awe the boys down at Hargreaves Lansdown with, two factors came to mind:
- From April, dividends will be taxed more heavily.
- Pensions are going to be revised again in the March Budget, too, and it’s unlikely that Monevator readers’ many sensible suggestions will be in the driving seat.
I’ve been self-employed for most of my working life, but I’ve only been set up as a Limited Company for about a third of it.
And to be honest, my earnings have only really been big enough to make much difference how I paid myself for the last four or five years.
(Before then I was mostly on borderline artist-in-a-garret rates, at least compared to my conventional London friends).
Now if I do nothing from April, the new dividend tax rates mean my tax bill will be around £2,000 higher than it would have been under the old system – thanks to a 6% rise in my effective tax rate.
We debated whether this was fair when the change came in, so let’s put that to one side.
What interests me now is how I find myself responding.
Fund-a-mentally
I’ll say right away that I’m not a very money motivated person.
That might strike you as an insane comment to make, given that I run a personal finance website and spend half my days clucking over my ever-growing nest egg.
But it’s sort of true.
I’ve never followed any line of work for the pay check, really (as my employers from my 20s would no doubt gleefully confirm).
And I don’t spend much money, either.
In fact I probably look like a bit of disaster to some of my peers.
What matters to me is freedom to do what I like – or more accurately to avoid doing what I don’t like.
That’s why I am self-employed, and why I far prefer to work from home.
It’s also my motivation for investing: I find everything about conventional work suffocating.
I don’t want a freedom fund or even a f***-you fund.
It’s more like a survival fund for me.
You’re having a half!
Given my ambivalence towards slaving away for mere money, taxation is a vexing issue.
Without wanting to get political (my post-Thatcher reflections were a better place for that, or even – contrarily – my lament about income inequality) I’m happy paying roughly 20% or so in income taxes.
And I guess I can live with 25-30%.
Any more tax than that and I strongly suspect I’m just supporting other people’s lifestyle choices, rather than the essentials of State and a worthwhile safety net.
Unfortunately, add together corporation tax and the new dividend tax and I will be paying an effective 46% tax rate1 on any income over £43,000 or so – and in reality I’ll be paying it well before then, given my portfolio still has unsheltered savings, bonds, and equities outside of my ISAs and SIPP, where any cash returned will register as income.
Now £43,000 might strike some of you as a lot of income, depending on how and where you live.
But trust me it’s very mediocre among my peers in London.
Yet striving to boost my income – only to hand over almost half of the extra to the Government?
I find the thought pretty demotivating.
Confused future pensioner
One obvious solution is to direct all the would-be higher-rated income into my SIPP instead.
As I say, I’m not in the mega-earner category or anything like it. So this could effectively shelter (or at least postpone) a good swathe of my income from the new dividend tax meat cleaver.
But sadly, that’s where those upcoming pension changes start to worry me.
Could George Osborne bring in new restrictions, or even retrospective measures?
It wouldn’t surprise me at all.
Friday’s off – tax-free
I have plenty of other thoughts swirling around about all this.
For example, it makes clear yet again how much better it would be to own my own home from a tax perspective.
While I desperately try to grow my investment portfolio as tax-efficiently as I can and to keep manageable the tax take on my income that after all has to pay the rent, my friends who own their own places see their (lottery winning) tax-free capital gains roll up year after year after year.
Of course they’re not paying tax on the imputed rent element of their home equity, either.
And then they bewilderingly declare that their £750,000-£1 million property is not a financial asset, just to further annoy me.
Home ownership in this country really is the killer tax break that keeps giving.
But with London prices having moved from extreme to insane to “oh, so this is what my grandmother meant when she said flinched at 50p for a bag of chips that used to cost a ha’penny”, that’s for another day.2
No, I’m thinking I should simply forget about earning more money.
Instead I could keep my lifestyle costs low and pay myself with free time.
Yes it will delay financial independence by a few years.
But given the upcoming tax whack and the unsheltered assets I’m already struggling to tuck away into ISAs each year, not by so much as it might.
And best of all?
They don’t tax free time.
(Yet.)
Note: Thoughtful responses about how you personally address these conundrums very welcome, but ad hominem attacks declaring that since I earn more than you or your cousin Nigel I should be happy I don’t pay 80% tax rates will probably be deleted.
- Note: 46%, NOT 52.5%. The combined corporation tax and income tax rate for a higher rate tax payer is 20% corporation tax plus (80% of 32.5%) on the dividend, which equals 46%. [↩]
- Or another country. Or another part of the country. Either would help deal with the income issue, too, in that I’d almost certainly have to earn less. [↩]
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It really annoys me when people complain about others that earn more than they do. I know from experience that the high pay goes with a lot of very hard work.
Anyway, free time is a good idea. As long as you are happy with what you have and can ignore the advertising to have the newest, fastest shiny thing you will be fine.
@LLG — Thanks for the thoughts. To be honest though, I personally don’t think high pay always goes with hard work — or certainly not harder work than many people on far lower pay. I have friends and family all over the spectrum, and there’s definitely no smooth plot of hard work versus higher pay. (Perhaps a bit more if you take into account all the education that went into the higher earners, but then they had the brains for it too. Some people can study all day and never get beyond a C-grade. They’re working just as hard).
The issue is it’s just not a very fruitful discussion. I have friends/family who would be aghast at a description of say £50,000 a year as a mediocre income, say. Where they live or in the circles they move in, £25,000 is doing very well. But then I live in a 2.5 bedroom house in London worth £700,000 – and it looks like a yellow-bricked version of a Coronation Street house, not some Georgian Terrace. Oh, and it’s in a nice but unfashionable bit of Zone 3, so no swanky neighborhood. It’s pointless considering one without the other. (That’s before you even get into factors like I wrote the above post at 9pm on a Thursday night, and I have spent the vast majority of my Saturday mornings writing my Weekend Reading blog posts for, basically, a pittance for most of it… but then we’re backing into the ‘hard work’ debate again).
I think we should probably concentrate in this thread on the balance between earnings and free time — and future free time (i.e. retirement) *for you*, and strategies for getting there, rather than debate whether I, say, earn a lot. That’s my point. 🙂
Hi, enjoyed the site for many years and its helped me in many ways. I think 52% tax rate is crazy and I recently took a remuneration choice for more holiday than pay, partly because I can afford to make that choice and partly as a micro statement. I can go for a promotion at work but those tax rates present no financial incentive at all and I dont work to deploy power so why would I? I worked in HK where tax is 15%. In that situation I happily worked for the promotion and associated benefits. My conclusion is our government, who I voted for, wish us all a better work life balance… BTW why do you choose to live in Z3 when it appears you are relatively location independent? No judgement, just curious because I make a similar choice in Zone 2 though my wife wants to move to places without tube lines, for something to do with dogs. Bewildering stuff.
Long time reader, first time commenter here. This is a “problem” I’ve been pondering myself. The dividend tax increase is a bit of a thorn in my side, but recent years I have been transferring money when it’s above the threshold into my SIPP (nice write off, at least), rather than keep it in business account earning no interest, or even worse, withdrawing over the threshold and paying even more tax on money that’s already been taxed.
What are you planning to do when you become financially independent though?
I don’t think it would be particularly hard to find a pasttime you enjoy which generated a small amount of income to contribute towards a living wage, so with that in mind FI becomes less of a binary thing you need X amount for, and more of a sliding scale where you can merge into it gently to defer taxation, so to speak.
I’m not sure I’ve articulated this all that well but I think what I’m saying is that I’m surprised you’re really striving to earn very far into the higher tax brackets – if you already have a frugal lifestyle and a steady income doing work you enjoy then you pretty much are FI already!
There is a separate discussion to be had about getting yourself a small property outside of London and ideally living in it, but I presume you have already considered this at length. It’s like an unlimited cap IUKP ETF ISA.
Your figure of 52.5% is incorrect. It should say 46% as the 32.5% dividend tax is charged to profits net of corporation tax.
You are there to be farmed by the rentiers. They do it primarily via land. Other times on this site they’ve been defended. They are taking years of your life.
(More stupid questions…)
Are you sure the marginal rate on your income is 52.5%? Are you taking the 32.5% dividend tax rate and adding it to the 20% corporate tax rate? If so then is that arithmetic right? I thought you pay 32.5% on *what’s left* after 20% tax rate. So on £1000 of company profit, you pay £200 of corporation tax leaving £800; if you pay all of that out as dividend and are a higher rate (i.e. 40%) tax payer then you pay 32.5% on £800, which is £260. So you have paid £200+£260 to Her Majesty’s Govt, and you are left with £540, i.e. you are subject to 46% marginal tax rate. Roughly what you’d be paying under PAYE. Not great, I agree, but below the crucial 50% psychological barrier.
One other thought – you could be investing in assets under your Ltd company. Then you only pay 20% on any investments that you are compounding up. Of course when you withdraw the money (to count it, I assume, if you are a sufficiently light spender) then you will be subject to the taxes as defined above.
There’s a lot to be said for having more whole days off to relax.
I work shifts and – at the moment – days of 10 hours. This means that instead of the approx. 104 weekend days off a normal person has a year, I have closer to 130-odd. Whilst I still work the same (or more) hours a week on average I have far more days at home to enjoy the fruits of it.
There’s talk of moving everyone to 8-hour days and slashing days off. Almost everyone not already working that will be very, very annoyed.
You should also factor in VAT into 52.5% … so that becomes 62%. I think you could get a better deal from a divorce lawyer if you were a father of two and decided to skip out on your family by moving to Barbados with your wife’s least favourite second cousin.
Frankly I don’t believe that April’s changes to pensions will be retrospective. (A triumph of hope over experience?) I do think the most likely outcome of the pensions review will be a universal flat rate of tax relief, say a 25-30%, applied at source, so higher earners will lose out on the difference between this and their marginal tax rate that they currently get to claim via SA. This also may be combined with some staggered reduction of annual allowance in line with income, the same way as with personal allowance. With the auto-enrolment coming in there will be less of a need for a carrot… since it will be more stick.
I’ll be topping up my SIPP in March.
It’s crossed my mind more than once, for broadly similar reasons and sounds like not dissimilar numbers. Major difference being employed vs self employed status, but perhaps that’s relatively unimportant for this.
Lets make up some round numbers;
Income – £50k (5 days a week)
Years to retirement – 20
changes to;
Income – £40k (4 day week)
Years to retirement – either;
* 20 still (take the whole ‘hit’ to expendable cash) or
* around 25 (proportionally reduce pension/investment etc by ~20%, still take a hit but less so)
* Or the danger area which is for those that’d want to not impact what they have to spend, and potentially go any further than that with pension/investment allocation. If they’re contributing 20% (lets assume salary sacrifice) and decide to stop that to finance the 4 day week, they’re probably setting themselves up for a fall.
I think personally it’d make sense to reduce investments by a maximum of 20%, otherwise you’re into the arena of doing your future self a huge disservice. Unless you run the numbers and are super-confident you’ll still get what you need/want in a sane timescale.
That said lets see what happens in the budget. If higher rate relief on pensions goes, I’ll quite possibly cut that to the bone and everything changes – probably tilting the game in this direction. But I can’t see how they can do that without still allowing salary sacrifice, unless they make employers contributions taxable (ouch… not a vote winner!)
I’d love to try something similar but our MD has actually used the term “part time shirker” for anyone who doesn’t do five days a week.
I say go for it if you can, we all know know people who’ve “gone before their time” and that is the risk with working your socks off to achieve FIRE.
I’m also piling money into my SIPP in full expectation that higher rate relief is about to go. I’m guessing some sort of flat relief is coming which would still be a lot better for me than the pension ISA option.
In addition to FvL’s comment, I assume you have setup the company with the entrepreneur tax relief – as then you can close the company and take a large slew of profit later tax free?
I have to say I find it galling when I look at my pay cheque and see how much tax goes out – yes I earn more than most people I know and yes I would say I worked hard for it (06:00am calls, 10:30pm calls, weekends etc.) so my actual worked hourly rate isnt that high, but it does offend me to see how much goes out as a permanent employee. All I can do is top up my pension, my and my other half’s ISA, I will then start using the dividend allowance, and when both of ours income from that goes over the top, it will go into my other half’s pension, and then we will need to start looking at more creative ways to get round it.
Of course, taking a month or more off between jobs helps to offset some of the tax I pay 🙂 And yes, we “own” our home in that we owe the bank a lot of money for the privilege of owning more house than we technically need.
For me, the amount of wastage I see from the government and all the scaremongering about people on benefits, its hard to know the real state. I support that the Government should be there as last resort, but it really should be that – not making it more worthwhile for people to be on benefit than work!
Good post TI – and something I’ve thought about myself (as a wage slave). Balancing time off now to enjoy the (mostly free) things I like which might put back the day I can actually stop work for good. Having a few family members die relatively early makes me think about trying to live more for now rather than invest for an uncertain future. The pension changes worry me too, I’m reluctant to stash too much in a pension when a rule change may mean I can’t get my hands on it until 60, or later
I’m in a similer-ish situation although not just a one man band, plus I contract out and do a lot of areas of my work. I have been thinking about popping more into the pension especially as 40% relief has to go.
What I have recently found disturbing is this:
http://moneyweek.com/merryns-blog/using-a-company-to-avoid-paying-income-tax-not-for-much-longer-you-wont-be/
For those who don’t want to click through:
“HMRC is alo unimpressed by those who hold cash not needed for trading inside companies so as to pay only 20% (the current rate of corporation tax) on the income on it (rather than 40%/45% outside). So they are considering new rules on close companies (those controlled by five or fewer shareholders). They might tax all unneeded profits at the shareholder’s marginal rate of income tax regardless of whether they are distributed or not, or they might tax those profits as dividends whether they are distributed or not.”
It seems HMRC is after taxing my business cash now. I need cashflow and emergency funds and hopefully future investment reserves, maybe this will be considered allowed for ‘trading purposes’, but I worry not. If that’s the case I hate to think what my tax bills will be when i have to realise these funds.
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I think £43k outside London is a ‘happy wage’ (like the $75k dollar supposed limit – any more and you wont get happier) – although if, as you mentioned, people keep seeing houses as the only free horse in this race – house prices wont stop and we’ll need all the money to pay our huge mortgages.
Here’s to 2016!
I write as a company owner who was once an employee
The ennui of which you are writing ay paying over 50% tax is simply the lot of any employee earning over £50,000 who is paying off a student loan
Also, as I understand it, marginal tax rates are even higher, for low paid empployees coming off benefits
Right now we don’t both work five days a week on the company
With the coming changes in dividend taxation and probably deemed distribution taxes on retained earnings to come, I doubt that will encourage us to work much harder
Dear Monevator, thank you for all the wisdom you have provided to me. I have found owning a company tax efficient. Firstly my wife is a shareholder and employee so we can make excellent us of maximising pensions and allowances, cash remaining in the business can be invested, and drawn down tax efficiently in your retirement years. There are many other benifits includingIHT. Don’t depend on your accountant for advice buy some of the good books on extracting income and benifits from your Company.
London Rob already commented on my first thought. Your company is not just a tax diffuser, it’s a real asset with a value. You can continue to grow the worth of your company and not expose it to some of the tax triggers. Eventually when you decide to change directions or stop working you have ER. If they don’t mess with that too. But you can do that anytime, within reason, to avoid the long term change to regulation risk. You may think this sophistry, being a one man band, but I’d disagree. Building up reserves open business change opportunities. You may wish to write a book, or take on the risk of an employee, or invest in some new equipment/training that you wouldn’t have otherwise done. In other words, entrepreneurial activity. Hence the relief available for entering into such practises in the first place.
@Geo that article seems the usual FUD trawled out most years. There are legitimate and prudent reasons for keeping value inside a company that should not logically attract a separate tax to corporation tax. But by all means increase CT to change that. I was surprised George decide to reduce CT while increasing dividend tax (companies earning more than 200k may make a profit). Then there are legitimate and prudent reasons to wind one company down and start another. Like entering a new company relationship with different shareholders, or doing a different type of work. Legislating what comprises a “different” line of work for tax purposes would be a nightmare. Or selling the company with 100k assets to someone else for 97k, rather than winding it down. So, FUD.
Thanks for another great restrained rant, I wish you would write more of them.. They are your best posts because they are honest, personal and make us think about your and our own positions. Much more engaging and it made me really think about your situation.
I agree taking on another job brings up all the old stuff about office politics, freedom, having superiors who tell you what to do, earn more than you and are utterly ignorant. To top it all you get taxed. I understand you’ll be better off not spending much and saving and having the free time as that doesn’t get taxed. You are fighting a constant tax battle.
It’s tiring.
But I think you might like the words from a recent Amber Run song (best band around in my opinion) “I don’t want to be the centre of anything, just a part of something bigger”. You might have been doing a bit of soul searching over New Year like the rest of us in our emotional, hung over and worn out states.
There is something to be said for going to work. It keeps you from over thinking these things and getting too absorbed in one place or thing. It balances us out as long as we have other stuff, plans and freedoms. True, when you’re out there slogging it and putting up with rubbish you feel like sticking the proverbial up and getting the hell out. But I always countered that by having extra little jobs vastly different to my main one that I could retreat to which helped me balance out my thoughts and provided variety and excitement. That’s not always easy to do but I think even voluntary work for a morning or two provides a great opportunity for this. It offers amazing insights and a bit of humility as it takes us out of our usual area of expertise and we learn about others and look outward for guidance for a change.
Hope I haven’t gone on too much 🙂 but as you’ve already alluded to the best returns aren’t always financial.
Great reply @minikins – makes me sound grumpy
@TT
Frankly I think you are wrong about close company taxation
The gap between income tax and corporation tax is now widening to nearly 30% so its pretty rational to expect the revenue to clamp down on close companies
This is exactly what happened when the gap between the two tax rates was at this level in the post war period
As an example, during the Callaghan/Heath era higher rate bands of income tax went up to 76% while corporation tax was about 42%
The additional taxes on dividends are just the first salvoes in what will be a long bombardment for businesses operating as close companies
The government needs money to fund an increase in the level at which higher rate income tax applies before the next election and there are only three places to get that money:
– buy-to-let investors
– close companies
– pension tax relief changes
I’m in a similar position. The changes to btl taxation, claiming child benefit, the removal of contracted out NI make earning my current salary an exercise in paying tax. So i have just booked off March as unpaid leave and in September i will work 3 weeks on 1 week off in order to bring me down to a basic rate taxpayer. Added bonus of being with little one as he grows up.
> Instead I could keep my lifestyle costs low and pay myself with free time.
Living in London is quite a large part of your lifestyle costs 🙂 But yes, this sums up the essence. Invest and spend wisely – both your money and your time. Sometimes it’s easy to burn too much of your time earning the money to fuel the furnace of consumption. Time is not a renewable resource…
@Peter Letts — Ack, you’re right. Thank you! I should spend more time calculating and less time fulminating late at night! Will amend the post ASAP.
This does make me feel slightly better (it’s less than half!) though only slightly. It’s still a high tax rate, and getting the balance right is still worth discussing IMHO.
@everyone — Great comments, cheers! Going to sneak off to amend the post but will have to leave other replies until later.
TI – excellent and thought provoking post. I guffawed a few times.
A common line of attack seems to be to leave your expenses alone and to increase your income, as there is no limit to this, but you can’t hit negative expenses. It’s a diminishing return though, like you’ve pointed out.
There HAS to be some step change where your free time is worth more than the additional income. A jump in tax rates is a pretty good candidate for that point.
With higher rate tax, taking some time off doesn’t delay the journey to FI as much as I thought it would.
A Survival Fund does seem more apt.
MrZ
Two options to consider:
1. VCT investments to reduce the personal tax bill
2. Allow money to roll up in the company to be eventually taken at closure benefiting from entrepreneur relief and capital gains tax allowance. In the meantime put this company to work on “short” term p2p investments
If I were in your shoes, no kids and renting, there is no way on gods green earth I would be spending winter in the UK
Unless you’re taking advantage of the geo-arbitrage that your situation offers (not just in cash terms, but weather and opportunities i.e. surfing skiing etc. etc.) then like you say – you really should just bite the bullet and buy a house. You can’t really afford not too.
I was lucky enough to buy a lot of highly levered UK property when young, without understanding the supply dynamics. I only learned later that the 1947 Town and Country Planning Act effectively removed the historical freedom to build nearly whatever you liked on your own land. Since then the UK hasn’t built anywhere near enough housing to meet demand. That’s why Paul Cheshire at the LSE found that rents in central London are eight times what they would be without the planning regime.
Now prices are so crazy that building sub-basements is economic but the NIMBYs are even fighting against those. So long as more than 50% of households (and a much higher proportion of active voters) own their own home, it will be difficult to muster the political will to increase supply radically. In the meantime it’s causing human misery (among the non-owners) and ever-increasing distortions in the economy.
My approach? Retire. As of the end of Feb I will work zero days a week.
As a (soon to be former) wage slave, if I carry on working the effect of next year’s LTA reduction is either £63k one-off loss or £13k/year for each year worked. Factoring in employer’s NI — otherwise recovered by salary sacrifice — my marginal tax rate on earnings I could have, but now no longer can, put into a pension exceeds 50%. Added to which I get an extra hit from missing out on future employer pension match. This increases the direct and indirect tax-related loss to over 60% at this margin.
No thanks. I’m out.
Thanks for writing and publishing this; it’s good to know I’m not the only one suffering the January Blues 🙂
I’ve been working 4 days a week for some time now and I thoroughly recommend it. I usually take Mondays off, and the weekend is so much more enjoyable without Sunday evening being ruined by the thought of having to return to work the next day. Now Mondays are my catch-up, admin and personal appointments day. Instead of 5 days on 2 days off it’s 4 on 3 off – a much more civilised working pattern, particularly if you have a family. Even small victories like having one less shirt to iron feel good.
In the long run it’s not going to be great for the economy if the highest earners decide to cut their hours or pack it in entirely. They may not be the hardest workers, but they probably include the greatest wealth creators as well as some key consultant doctors working in the NHS.
@D
The ‘one less workshirt’ alone makes it more appealing still 🙂
The 46% is comparable to 40% income tax plus 2% employee national insurance (at this income level). The employee’s employer would, however, also have to pay employer’s national insurance of 13.8%. Hopefully your company income reflects that. Overall employee take home is 51% of the company cost to the company, i.e. 58/113.8, and less than the 54% you retain.
I think this issue now arises for both categories of worker where the effective take home is just above 50%. Working less without unduly impacting your plans or your business is a valid response. Other responses could include keeping going if you are close to financial freedom, and reducing spending by moving further out than zone 3.
@JM – I’ve just been reading Bryson’s ‘The Road to Little Dribbling’ (very entertaining) in which Paul Cheshire features – he comes in for a little criticism w.r.t. his ‘research’ on the green belt
Great post, there has been tax on imputed rent income for owner occupiers in the past, a link here shows Margaret Thatcher was not impressed decades ago http://www.margaretthatcher.org/document/101063
There does come a point where taxation above a certain point, the petty hassles of managing a small limited company, employees, red tape, stroppy clients and the ability of running a small business to dominate your life, the difficulty of ever getting away form it, you think about it on holiday , you come back to firefight the problems your absence causes, the levels of taxation that exceeded my view of a reasonable ‘take’, the climate of suspicion that officialdom takes to the small company, led to a sudden decision one day just to stop playing the game anymore.
From making the decision on my forty ninth birthday, I was out in less than a month. Investing steadily had provided enough ( it didn’t seem that way at the time..) but investment returns have proved satisfactory and 8 + years later, it was clearly a wonderful decision.
The ISA tax breaks have been very welcome and it is possible to live comfortably as a couple, working a little as suits us, travelling extensively and not pay any income tax at all, by arranging one’s affairs carefully.
The attitude that the ‘doers” will do, regardless of how you treat them, whilst supporting a minority who don’t can lead to perverse outcomes for the country as a whole. IE if a business is not taxed as heavily as it is, forgoing some tax in the short term, then in our case we created specialist engineering services, machines, tooling etc , much of which was exported, created quality jobs, trained apprentices, paid property taxes, VAT and generated demand for other local suppliers.
A loss to the country as a whole, albeit a small one, cumulatively it adds up, because a government has abused a relationship with its more entrepreneurial class.
It’s unfortunate but a win for me on a personal level.
Thanks @The Rhino – I agree, Bryson is very entertaining but I’m not sure he’s done any serious study of the numbers. His arguments in that bit were answered here if you’re interested: http://www.theguardian.com/housing-network/2015/nov/26/scaremongers-like-bill-bryson-perpetuate-harmful-green-belt-myths.
First off, thanks for the heart-felt opinions, there is far too little honest & deep thought left in today’s go-go, 24/7, robotic world; these posts are as good as the practical advice, because as humans we are emotional too.
A quip attributed to Charlie Munger always sticks in my mind as so, so true …..the gist of which is ”Show me the incentivisation for anything & I’ll tell you the likely outcome”. It just immediately makes so much sense on all levels.
On a couple of stints in the third world, a place widely disparaged as a hopeless lost cause in the developed world, I noted high levels of entrepreneurship – avoiding starvation & other equally visceral pains on a daily basis does tend to focus the mind on looking out for & seizing opportunities.
So why do these peoples/cultures/countries fail? In any sort of kleptocracy or autocracy of whatever nominal political stripe, the disincentives in the form of gate-keeping & other barriers to improvement are just so total. These people are not stupid, they are just blocked & exploited at every turn, the playing field is at a perennially 90 degree angle – check out any trade agreement between the strong & weak if you are skeptical.
So, what has this got to do with the UK? ….. think a rentier economy, voodoo financial practices propping up the economy, taxation that dis-incentivizes the putative, hard-working, little entrepreneur while excluding freeloaders at the rich & poor ends of the spectrum, etc., etc. Who is the banana republic now? [or whatever fruit/vegetable is still grown here that the big supermarkets haven’t put out of business yet]
That is why Europe is stagnating so badly now, but still hypocritically preaching to the poor world where they’re going wrong – out of habit – while apeing all their worst practices …..including the undermining of any remaining real democratic choices.
@JM I did see that article when checking my memory was correct as to whether it was Paul Cheshire mentioned in the book. As Mrs Merton would say ‘let’s have a heated debate’ and I’m sure they will..
To be fair to Bryson, I think he was president of the rural countryside alliance and an honorary member of the Royal Society now, wouldn’t mind that sort of prestige myself although the letter seems to have failed to appear in the post thus far
Your time is running out, 24 hours every day.
As another poster has already noted, it is not a renewable resource.
You are dead right, that at the margins it makes sense to consider the drop in hours rather than automatically following the 5-days-a-week route.
I certainly considered that, when the child tax credit tapering was first mooted then introduced. At that time, I was earning low to mid £50,000s and working full time. With 4 children, my marginal tax rate jumped to (something like) 78%, and I was going to max the pension contribs and drop my hours. [they kindly made me redundant before the rules kicked in, and I went off contracting via Ltd Co, which removed the issue for me].
I am now in the great position of earning lots more, but suffering a marginal tax rate of 62%. Until April, I can mitigate this a little through pension contributions, but if the flat rate relief is introduced then it will give me no incentive to continue.
My rough calculations (feel free to critique!) are that, even if I optimistically can somehow grow my pension pot to the max £1m, then under a 4% SWR I will be showing £40,000 pa “income” in retirement, and will not quite reach the HRT threshold.
Thus instead of suffering 62% tax at the point of earning my money, I will suffer 15% upon its withdrawal from the pension pot (20% BRT less the 25% tax free cash allowance).
To me, that is the real justification for saving at the moment. Not the (low) company contribution. Just the marginal difference between 62% and 15%. That justifies the political risk I am taking in tying my capital up for a considerable time. (the equation is similar, if slightly less extreme, if I were a HRT payer and suffering a marginal 42% rate).
Showing this in £ terms: if I were to put £1,000 into my pension fund, then I would pay £150 tax on withdrawal and end up with £850 net; if I took that £1,000 in my salary, then I’d end up with £380 net.
Now if we move to a “flat rate” scheme, the way I think this will work is as follows:
My £1,000 gross pay becomes £380 net pay.
I put the £380 net pay into the pension, and the nice govt give me back some of my money. The 50% figure has been bandied around: this would mean I’d get £190 tax relief, and thus the total going into the pension would be £570.
When I come to draw the money out of the pension, I will suffer 15% tax ie £484.50 net.
Lots of numbers. And lots of assumptions.
The key summary for me is that today I either take £380 cash now or get £850 on retirement. At the moment it’s a no-brainer.
From April 2016 under a flat rate scheme, I either take £380 cash now or £484.50 on retirement.
(For HRT payers, not in a marginal band, it’s £580 now vs £739.50 on retirement).
That’s not a lot of benefit for a huge political risk.
What’s the political risk? Frankly I don’t know what might pop up between now and retirement, but the following suggestions or proposals are already on the table:
– moving the access age. What if I can’t get this at 55, but at 60, 65 or 67?
– tinkering further with the flat rate percentage.
– taxing investment income in the pot
– removing the tax free cash 25%, or limiting it to £50,000 (say).
– forcing pots to be invested in govt gilts
– confiscation
– reducing the lifetime limit further, leading to the 55% “penalty” rate if you exceed it
And the biggest one of all: retrospection! There’s a nasty cold wind blowing from HMRC and bringing the debate around retrospectively changing some aspects of tax law. It’s not yet hit pensions, but the money’s a tempting target for a government with empty coffers.
All of this can really be condensed into one word. TRUST.
At the moment, it’s pretty low. The last decade has brought a slew of pensions debates and changes, and I have not seen or heard any mention of bringing stability or certainty to the table. That’s what’s needed, above all.
There is an alternative, of course. There always is. A flat tax, rather than the present progressive approach, would remove all these inherent biases at a stroke. Perhaps supported by a “universal income” base, that might be the obvious, but politically untenable, solution.
Is postponing the realization of your income an option? You could pay yourself a smaller amount of money and leave the rest in the company.
Say your company brings in 1000 pounds a year. You work for your company an are paid a salary of 300 pounds, which is enough for you to live on. The rest of 700 pounds is left with the company. After 5 years you decide to retire – well not really, you will still be an employee in your own company, just not generating a lot of income. The company now has 3500 pounds in cash, enough to pay you a salary for 11.6 years or so.
Does this make sense in the uk?
@Chizgreen – I think Hong Kong gov doesn’t pay for military defence, the mainland Chinese do, so lower taxes there for HKers. A bit like Monaco where the French protect it. Before the ’97 handover British taxpayers paid for Hong Kong’s defence (not that it would have stopped Mao from invading if he’d wanted to, but curiously it was left alone anyway). Hong Kong’s public healthcare is rather basic from what I know – people are encouraged to buy heath insurance for fuller coverage. I believe Hong Kong’s national insurance is tiny, leaving the poorest elderly with little to survive on, not something we’d tolerate in Britain. Lower taxes come with their own costs.
Redistribution generally gets spent on goods and services, juicing stock returns in a roundabout way. Loads of benefit fraudsters get caught buying luxury goods according to the tabloid articles screaming about it, so as long as they’re not hoarding cash in the Cayman Islands it might not be too bad.
Nice article. Feel much the same. Conclusion have spent/invested more money in house this year and skipped SIPP contribution ..
TI’s first question – free time v money, I don’t know the answer, but being self employed with a limited company, makes me ask that question every time I take a day off. Certainly concentrates the mind ..
Yeah, vote in a Tory government and get a Labour one by proxy, yep I’m impressed!
SIPP is your answer I know Osbourne is going to change the rules but he hasn’t yet and I imagine we’ll get the next tax year as is and then it’ll change.
ISA is the other obvious thing keep moving that income generating stuff into an ISA.
It should be clear in April if Osbourne has wrecked pensions (as he has buy to let) and then it’ll be possible to decide.
I’ve always thought you’ve been wrong not to buy. Retirement without owning a property is a much more problematic gig, inflation + seems to be unavoidable with rents, whereas eventually there is much less cost to living in your own home an dtax is charged as you say when money changes hands (offset mortgages are great :-))
Plus the fringe benefits – no one can tell you it’s time to move on, if you want to drill a hole in the wall to run cat 5 it’s fine to do it, if you want pets no problem.
Find a nice wench to settle down and have children with her, life is good and there two tax allowances, two ISA allowances and two pension allowances.
Sounds like a lot of us have been having very similar thoughts… combination of taking time off over Christmas and bad weather induced introspection, no doubt…
For myself I have deliberately avoided going for promotions that would lift me into the next tax bracket as it isn’t worth taking on the extra stress unless you love what you do (which I don’t). I would definitely reduce my hours if it weren’t for the fact that I’m one of the dwindling band still in a DB pension scheme and I’d lose out as my final salary would be lower.
Ultimately it comes down to time vs money of course, but another critical factor is finding something I’m passionate about doing that makes giving up present and future income worthwhile – otherwise I fear I would just sit around playing computer games, or, worse become a day trader… For now I will carry on being a wage slave and putting as much as possible into both SIPP and ISA – and going running to alleviate the stress!
I dithered before topping up my SIPP (as a basic rate tax payer I could potentially gain by waiting until April) but in the end I made the decision to do so for investment reasons -the markets have kindly thrown up a few buying opportunities this week.
The utility value of free time today whilst you are younger, healthier and more time pressed than you will be for the rest of your life cannot be underestimated. However, as Stella R posted, best to find a decent pursuit before turning away profitable business.
As a ltd co contractor I’m pondering on similar lines. I’ve not tried keeping under the 40% tax rate band before as my priority was paying down a mortgage and living rather than stuffing everything into a pension. But the change in dividend tax is a tipping point.
I still have years to go on the mortgage, but have at least got to the point where I could manage it and live ok on £43k (for context I work in London but live just outside), and put everything over that into a SIPP.
It all depends what Osborne does from April. Even if he brings in flat rate income tax relief at a lower level there is a chance that company/employer pension contributions could be left alone. Likewise salary sacrifice for perm employees, which amounts to the same thing really.
But ultimately come April 6th the likely combined effect will encourage me to work less, have more days off and pay less tax. If everyone thought like that the tax changes would have the complete opposite effect to that intended. This is of course The Laffer Curve in action.
Back to The Investor, I agree with other comments made that being taxed on your income to pay London rent when you have loads of unwrapped assets also being taxed doesn’t add up. I would sell down the unwrapped assets to buy a house – or even a significant chunk of a house – probably outside of London.
Fabulous. TI is back and the year is off and at the races. No everything is the money and it’s hard to tax the time spent listening to the birdsong over a lazy coffee or the gratitude of your readership when the weeklies come out. Just to give you then encouragement for those long Saturday mornings of underpaid researching!
Tax is what it is, and the govt will keep changing the rules to try to get their hands on your stack. And we will keep shuffling stuff around to avoid it. ISAs and SIPPs have quite a lot of political pressure behind them (lots of people have them: raiding pensioners is unpopular with people who vote ie pensioners). BTL less so, cna close companies a lot less so. Most people don’t have them so you can squeeze them till their pips squeak.
Dangerous times. Flexibility would seem to be key.
Good for david (above) bringing up NI. The greatest trick the govt pulls is not including that in with income tax. Eer + Eee NI is huge, and gives lie to the myth that there’s a big step up when you become a higher rate tax payer.
The mathematics — as always — are to use all your tax allowances and spend little (relative to the allowances) so that a high proportion of your expenditure is out of untaxable income. The rest is gravy.
First time posting, but long time reader.
Moved from London to HK in 1998 and never went back.
In response to David I must say that HK’s public healthcare is run through the Hospital Authority and is excellent. Its along the lines of the NHS with the major difference that hospital visits, including A&E, cost HK$100 (around GBP8.50 per visit for resident and HK$350 (GBP30) for non residents so you don’t get the abuse you do at the NHS.
The defence point is valid but the PRC get it back through HK funding “white elephant” infrastructure schemes!
The main issue is that highest salaries rate tax is 15%, with no double taxing through either capital gains tax or inheritance tax, and no VAT either. And after all that the government surplus (mainly though land and property related taxes) is likely to be around US12 billion this year; not bad for a 7m population city- although the allowance given to the poorer OAP’s could well do with a revisit given this.
Not being taxed again on investment returns arising from earned income which has been taxed already makes such a massive difference to the basic compounding model that it makes HK one of the best places to live long term, financially at least!
Welcome to the dark side. I stopped working full time 6 years ago and dropped to a three day week, primarily because of marginal tax rates, housing costs that have continued to spiral out of control and just seeing zero benefit from all that work other than a bit extra to work out what to with it every month. And I’m not a spender either so invariably that money would just be invested or held.
I now have a tax rate of 1%, because despite taking the 40% drop in gross, I realised that I still was earning more than I needed for my simple life. Everything except a token amount above the personal allowance goes into my Sipp for now on salary sacrifice. If the rules change so be it, but I cannot see retrospective taxation on this, just a reduction in higher rate relief which I don’t agree with but doesn’t affect me either anyway.
i dont care what others do about housing now. I just don’t – I think the country has a cancer which is house price obsession and I’m not participating. The tax avoidance into the pension is part of that moral decision – I’m not finding a corrupt kleptocracy that supports help to buy, landlord benefit and working tax credits when they should be hammering landlords and corporate tax avoidance. I’m making sure I will have enough myself to never be a burden in a legal fashion. On housing I don’t see myself as being wrong even if it is to my financial detriment because a person must live according to their own feelings and morals. And it Works for me as my assets are spread properly and luckily my rent is very cheap by living in lodgings rather than paying a buy to letter.
And I have more free time than anyone else I know,like the schedule and don’t plan on retiring anyway now – I’ll just go at a slower pace, try and keep healthy and enjoy every day.
I’m dropping to a four day week as of April. As a result, I avoid pension annual allowance taper, avoid the personal allowance claw back, and as a result can put £10k more into my pension and pay £20kpa (yes!) less tax than I would for a five day week.
These measure were brought in to raise more tax. They will achieve the exact opposite.
Signals from the Treasury are for the end of higher rate relief not retro taxation on pensions or some other massive clawback which would probably amount to a ‘university tuitions fee’ moment for a Tory government.
Now’s the time to be stuffing your SIPP to the max not worrying about phantoms.
You’re used to taking a punt, I still think this one is worthwhile. The balance of risk for any government tilts towards making pensions look even less appealing than they already do. Fashionable as the talk of wealth confiscation is, I don’t buy it.
Most of the tinkering with pension tax has been to find ways of reducing the relief that already goes to the well off. colitically unjustifiable since 2008.
Ever since those seismic events we all knew we’d be taxed more heavily to pay for it. And so we are. But the personal allowance has gone up and the savers allowance is about to come in. Spend as close to that margin as you can and dunk the rest in shelters and finish the whole job as quickly as poss.
Meanwhile have a chuckle at the expense of those London peers who are being pick-pocketed more heavily than you.
Re: the house. I’m sure there’s a good reason not to, but could you buy a house outside of London? Even if you don’t intend to live in it.
This line made me larf: ‘and spend half my days clucking over my ever-growing nest egg.’
Urk, that is politically unjustifiable. I have no idea what colitically is.
With regards to tax, as an employee i just put enough in my sipp to get me under the 40% bracket.
As far as working hours go, I was on enforced short time during the recession, and despite having little money , I loved it.
Since then I’ve always only worked four (long) days , even though I could work five if I wanted too.
I’ve worked out I could retire 5-7 years earlier if I worked 5 days, but I’d much rather work a shorter week.
This is of course only possible because my employer is very flexible and I don’t mind the job I do.
I dropped to a 4 day week from last April and I haven’t regretted it. One less shirt to iron – yes, also one less commute – and I so hate the commute even though it is only 20 minutes each way. I was just in the higher rate tax band and have now dropped out of it, so I won’t even have a tax return to fill in any more.
As others have said, I am not sure why you would stay in London, perhaps family or other ties that you haven’t mentioned. Move down here to Dorset, it’s lovely.
On a practical note, the FTSE All Share Index is yielding more than 3%, Europe less than that and the US even less. So, I have always put the higher yielding UK tracker fund in my ISA first, or when re-balancing, that will help me below the £5000 threshold.
I commute by bicycle, which can be hairy but it wakes you up, and no shirts to iron as I work in t-shirts and jeans (which I guess my wife irons!)
I’d love not to have to do tax return, but have had to do one every year since final year at uni, and I even had to VAT register while still a student! My wife also has to do a tax return every year, even during her 20 year career break. Both now done for 2014/15 with her getting a £40 refund and me having an extra £4k to pay. Oh well.
@all — Well, I’ve learned over time that you never can tell which posts will strike a chord, and this one seems to have hit a bit of a Rachmaninoff-style seven multiple fingered job among the Monevator readership.
I can’t possibly reply to everyone individually so I won’t try, besides a special thanks to @Minikins and @Mathmo for the warm welcome back.
I’d also like to thank everyone for sharing so many different approaches to the issue. There’s a lot of food for thought here, for most of us it seems.
One thing that did occur to me from the several comments suggesting leaving the money in the company is that I haven’t even considered reinvesting it into the business. Somewhat telling I suppose that I am not fated to be the next Richard Branson!
Practically speaking, that means reinvesting in Monvator, since my own freelance work doesn’t scale. If I could invest £10 to get £12 from this website I would, even if discounted out over a couple of years, but currently most income trends are down (as we’ve discussed before, a combination of ad blockers, Facebook, and the move to mobile is dinging ad revenue). I could spend and probably should spend some of the money on time to figure out an alternative approach to monetization… but we’re getting seriously off-topic here!
Changing my circumstances and downsizing looks like it’s going to happen sooner or later. I have to accept I haven’t cracked London, due at least partly to the much-discussed property SNAFU, and some days it feels like it’s close to cracking me. I’ve always had this notion leaving on anything other than my own terms will be a failure, but there you go.
There are other reasons to stay here (I’m single and I’m not a kid any more — much easier to be that in a City than in the countryside) but I love the middle of nowhere, too. Perhaps that’s the issue — I don’t think I’d move from London to Bristol, more like London to a village outside Aberystwyth, or maybe outside Alicante for that matter! So quite a leap.
Finally, the link to Thatcher’s comments on imputed rent were very interesting. A concept some flatly deny exists was once recognised in the tax code! I’m not saying it should be today — just that it’s a reminder that clearly we as a society have run up against some of these wealth distribution outcomes before. Around and around we go…
Thanks for the efforts you put into this blog…I love it.
I’m an employee, so this comment is aimed mainly at other employees…I’ve found condensing hours rather than reducing them is the secret to a happier work life balance. I used to work ten hour days, and it was by far happiest work period of my life !
I did as many hours then as I did now (basic of 40 a week, reality between 45-48), but not shaving / ironing/ commuting that extra day made all the difference
I’m 29, live in London and now earn ~£250k and yet am only just in a position to buy a flat in a nice area (no rich parents or inheritance for me and majority of income is bonus.) What grates me more than anything else is seeing friends and colleagues who’ve inherited/been gifted hundreds of thousands of property related pounds, and not paid any tax on the money. It seems ridiculous that the tax bill of someone who earns £50k is well over double someone who earns £25k yet inherited a million from their parents and whose house has gone up 50pc in the last five years.
That said, there is zero chance of a conservative government changing any of this, so it’s set in stone until 2025. My advice is don’t put any money in a pension (though it looks good before April they will have clawed it back before you retire) and buy a property in the most prime location you can, somewhere in genuinely short supply, not in Acton, Clapham, Kilburn etc, prime rents (if not values) are still cheap and will likely go up in the next few years which will support prices at these seemingly ridiculous levels (though it makes sense that earnings ratios are higher than ever before, rates are never going back to 5pc)l
This absolutely struck a chord with me too. I’m bumping up against the hidden 60% tax band, so while I’m “lucky” to be earning that much, the tax take on my income really grates, and if I can’t make pension contributions to keep under the 60% band it’s going to really hurt. To make it worse, I seem to get continual hassle from HMRC about niggling bureaucratic aspects of tax payments which just add insult to injury; can’t they just take my money and leave me in peace?
I’ve had exactly the same thought about free time not being taxed, but I’m instead sucking it down and aiming to become FI in a few years time instead (at which point I will try to find satisfying if low paid work and pay no or minimal tax). While it’s probably going to be OK, I also worry a bit about my line of work becoming less lucrative and potentially more unpleasant as time goes on, so I kind of want to make hay while the sun shines.
While there is no direct tax on free time VAT is a pretty effective indirect one!
Re. This point
” I have to accept I haven’t cracked London, due at least partly to the much-discussed property SNAFU, and some days it feels like it’s close to cracking me. I’ve always had this notion leaving on anything other than my own terms will be a failure, but there you go.”
I moved to London for university and stayed for ten years and I could never understand why everyone in the country didn’t move there straight away. Then when I did move out it was as if a spell cast by the wicked witch was broken – it felt like I’d been in the grip of some kind of madness. I guess I’d move back again, but only if I could be supported by a great aunt Agatha in the same manner as Bertie Wooster.
Just for fun go on rightmove and see what you can pick up for 400k around Bromsgrove. Add on you can hop on your bike and be lost in some lovely quiet countryside literally on your doorstep, or hop on a train and be outside one of Europe’s best concert halls in 20 minutes, what’s not to like? And there’s no end of hi tech and finance work around here -HSBC are just about to move up to Birmingham from Canary Wharf I believe. And you can get to the west end in about the same time it takes you from Putney, if you need the occasional fix.
Another fan of condensed hours here – I spent the last 4 years in my current job trying to manufacture a decent reason to avoid Fridays in the office. Eventually my beautiful daughter arrived and in another 4 years, I get to have an actual day off once she goes to school 🙂
@TI
“I’ve always had this notion leaving on anything other than my own terms will be a failure, but there you go.”
Well, change your terms. Then you can still leave on them. 🙂
A very perspicacious post this week, as the comments attest. I too viewed the prospect in 2016/2017 of reductions in higher rate tax relief, bumping up against the annual allowance, scheduled deteriorations in my workplace pension scheme, higher NI (via removal of contracted-out reduction), changes to taxation of BTL, increasingly irritating and unsatisfying job, diminishing number of years in which to do productive/rewarding stuff and achieve ambitions before decrepitude removes those possibilities, etc etc, and …. as a result I jacked it all in at the end of last year. I am now FI. Since I’m far too young to really retire from productive activity and have got too much I want to get on and do, my plan is to work as, how, and when suits me (as self-employed) but I will not take a salaried post again, I will not work full-time again, and my total tax & NI bill is going to be kept very very low from now on.
Unlike some I have no ideological objection to taxation, just a visceral response dependent on the relationship between job satisfaction and the proportion of earnings. If I was being paid to do something I really loved doing and would want to do anyway, then even high rates of tax wouldn’t deter me from doing it. But once I’d got to the stage of feeling that 90% of my working time was spent on unreasonable hassle (often with people I didn’t want on my radar anyway), it occurred to me that for every unit of time spent doing things I detested I was putting up with 100% of the annoyance but receiving less than 50% of the compensation for it (and in this context I do think ‘compensation’ rather than ‘remuneration’ is the correct term). So, adios job. I should footnote here one of Ermine’s rants about the loss of autonomy in professional careers. Perhaps it’s starting to reduce the tax base?
The UK’s tax base has been heading in a worrying direction for many years with an ever-increasing focus on raising more and more money from a smaller and smaller percentage of tax payers. This may be a vote winner but it’s not healthy or sustainable.
Bertie Wooster had his own money, he wasn’t supported by any aunts, especially not Aunt Agatha!
It sounds like we are very much cut from the same cloth TI, I’ve come to very similar conclusions over the last year or two.
I would love to sit down and have a beer with you one day!
I never used to value time much, but nowadays I am valuing it more and more. I love to travel, and the master plan is have the time to slow travel around the world.
I’d also second the Firestarters opinion that you’d make an awesome drinking buddy – if you ever do a bloggers meetup, count me in.