We have put some of your questions on financial planning to a true expert. Peter McGahan of Worldwide Financial Planning offers his advice on some of your burning questions.
Many business owners want to protect their family and so take out life insurance to pay out in the event of an early passing.
In the past, we used to be able to do that with pension term assurance where we received tax relief on the premium, but those days are back with Bay city roller haircuts.
And so you pay yourself an income, pay the tax and national insurance and are left with the measly net.
However, if you set up a relevant life policy instead and had it paid by the company, the premium is paid out of gross earnings saving 49% for a higher rate taxpayer.
You then simply place the plan in trust. Should there be an early passing, the benefits pass free of Inheritance tax and probate (lots of time-saving) to those you love.
The more obvious solutions for tax-efficient investing are Isas, pensions and on to more complex arrangements like Venture capital trusts (VCT), Enterprise Investment Schemes (EIS) and a Seed Enterprise Investment Schemes(SEIS).
There are others, but let’s first consider the corrosive effect that tax has on your investments. If tax was taken at source from an investment of £50,000 at say 20% (common within the oddly popularly sold investment bonds), and held for twenty years, the compounding effect is horrendous. For purely mathematical comparison reasons lets assume a growth of 8% over at twenty years.
Tax-free its £233,047. With tax paid its £172,903, over £60,000 difference.
Isa’s allow tax-free growth as do pensions, with the latter affording you tax relief on your premiums at your highest rate.
If a basic rate taxpayer pays in £400 HMRC pays in £100 in tax relief, which is immediate growth of 25% – See earlier point about compounding and the best returns. A higher rate/additional rate taxpayer enjoys tax relief at their highest rate so the cost is £300 and £275 respectively.
To them, the effective tax uplift is £200 and £225 to £500, which is a guaranteed 66% and 81% uplift respectively (£300 to £500 and £275 to £500).
EIS and VCT schemes are at the more technical end of solutions and have very attractive tax reliefs. A VCT has income tax relief at 30% up to £200,000 per annual investment, no income tax payable on ordinary shares in the VCT and no capital gains tax is payable by individuals the ordinary shares.
A SEIS and EIS attract tax relief at 50% and 30% respectively with capital gains tax exemption on the sale of the shares after three years.
Working with Whyfield, your Independent financial adviser will guide you through the most solutions for you to maximise on that aforementioned tax-efficient growth.
I can see pensions are popular from the questions! I’ll not go over the same points that I have covered in the previous question but in financial terms, a pension is considered the elite of tax planning.
20% relief for basic rate taxpayers, 40% for higher ratepayers and 45% for additional rate tax payers.
If you are a basic rate taxpayer, and you were to pay £80 the extra tax from that would be collected at source and added to the pension scheme to top up to £100. Higher rate taxpayers and additional rate taxpayers have to reclaim the remaining tax via their self-assessment form.
A cute method of saving for children is to set up a pension scheme. The tax relief is given at source so they automatically benefit from that tax relief, despite not paying tax.
The earlier they start, the better the returns. As an example, paying the maximum £200/month net into a pension for an infant in their first year produces over £1.64m in a fund at age 65.
Leave it to age five and the fund drops to £1.27m return, showing the power of that compound growth for those first five years contributions. Leaving it to start at age 18 leaves the final fund at £641k, an extraordinary £1m difference.
In short, the earlier the first contribution, the better.
I covered this recently in a seminar. The numbers were quite extraordinary.
Consider this moment:
You took out a pension at the same time as your next door neighbour and twenty years later, on tee one of the golf course, or drink one of a Friday lunch, your friend tells you how the pension fund of £100,000 had grown during that time.
You did the same but chose a different pension. You happen to have chosen the worst-performing managed pension fund (a household name) and they chose the best.
Your pension fund is worth £94,640 and theirs is worth over £1m. Yours will produce an income of £36.40 per week and theirs will produce £403 per week (simply assuming you drew down 2% of the fund per year and left the rest).
That’s the simple difference of choosing a pension fund and leaving it without checking if they are actually any good at what they are doing.
So if you have a pension pot or two stuck back in the drawer, bring it to an IFA and ask them to check for overcharging and adequate performance.
For many, there is a lack of tangibility with a pension fund. It’s hoovered away into another land and that’s the last you see, other than a random annual valuation you don’t really follow. One year it may be up, the next it may be down and you don’t really understand why. Sound familiar?
Many have decided to use their pension scheme for their own or business benefits.
You may have your own property or are thinking of one, and of course, have a pension fund working away in the background. You simply use the existing pension fund you have to buy the property, which now sits inside your pension fund growing free of tax, contrary to its taxable gains outside the pension.
If you owned the property outside your scheme and bought it with your pension, this would release cash from the property for your own cashflow usage.
If you didn’t have enough cash inside the pension fund to buy the property, the pension scheme can take out a mortgage for the difference. Now, you pay market rent to your own pension fund, the cost of which is tax-deductible and the payments are going into your own scheme.
There are rules which apply, and your Independent financial adviser can take you through those.
If you need further advice on any of the above please get in touch. Our team are available to answer your questions, Monday – Friday, 8:30 – 4:30pm.