Financial Planning Module Four:

(Article by Andrew Neligan, an award winning Chartered & Certified Financial Planner at Informed Choice Ltd who specialises in providing Financial Planning & tax planning services to Legal Professionals.)

The previous Financial Planning module considered the questions you needed to ask yourself to help you make your investment decisions. The purpose of this latest module is to highlight how you can maximise tax efficiency with your savings and investments. The ultimate benefit is being able to live the lifestyle you wish by maximising the capital that you have but how can you do this?

There are three major taxes that we pay on our income and capital; income tax and capital gains tax (CGT) when we are alive and inheritance tax (IHT) on death. For the vast majority of legal professionals it is likely that all three taxes will be paid but obviously the less paid the better, this can be done by investing in tax wrappers that are tax efficient.

ISAs

ISAs fall into two categories, Cash ISAs and Stocks & Shares ISAs. A maximum of £10,200 can be contributed to ISAs this tax year but only £5,100 of which can be into Cash ISAs. Future ISA allowances will increase in line with annual inflation.

ISAs are typically the first box to tick when saving or investing because they offer the greatest tax efficiency; gains are free of CGT and income received is not liable to income tax (with the exception of a non reclaimable 10% tax credit on UK dividends).

ISAs also offer instant access therefore capital is not tied up when it may be required.

The disadvantage of ISAs compared to a pension is the lower contribution limits and the absence of any tax relief (see below). In addition, saving to Cash ISAs only will mean that the long term value of capital is unlikely to keep up with inflation.

Pensions

Pensions are the ugly sisters of investing in many people’s eyes following the bad press they have received over recent years but they do hold an important place in Financial Planning.

All personal contributions to pensions attract a 20% supplement from the Government known as tax relief and higher rate tax payers can claim back additional tax relief up to their marginal tax rate.

It is also possible to contribute more into pensions than ISAs; 100% of earnings up to the annual allowance, currently £255,000.

The disadvantages of pensions compared to ISAs include accessibility; pension funds cannot be accessed until age 55 and also tax efficiency; only 25% of the fund can be accessed as a lump sum (tax free). The balance has to be provided as a taxable income.

National Savings & Investment (NS&I)

Certain National Savings & Investment products are free of tax. These are:

·         Cash ISAs

·         Premium Bonds

·         Index Linked Savings Certificates

As well as being tax efficient, the other major attraction of NS&I is their security, they are backed by the Government so offer 100% security.

The disadvantage of the ISAs and the Premium Bonds is the lack of inflation proofing on capital (unless you are lucky enough to have a big win with your Premium Bond lines). This was where Index Linked Savings Certificates are attractive. In fact, they have become so attractive that new issues are not currently available!

Trusts

To provide inheritance tax efficiency capital can be put into trust for the benefit of others (usually children and grandchildren). By giving away capital future access to it is removed at outset IHT liability is reduced. Trusts are very complicated area of Financial Planning and should not be set up without professional advice but they can act as a suitable tax avoidance strategy.

Enterprise Investment Schemes (EISs) & Venture Capital Trusts (VCTs)

EISs and VCTs provide further tax efficiency once ISA and pension contributions have been made but do bring with them more risks. Both allow high investment levels, £500,000 and £200,000 respectively but access is lost for three years in the case of EISs and five years in the case of VCTs.

The big advantage is the tax relief on income tax; 20% for EISs and 30% for VCTs. EISs are also free from CGT if shares are held in a qualifying company for three years.

The real disadvantage of both investment types is investment risk, investors are investing in small companies which are often highly specialised start ups where insolvency is much more likely.

The above provides a snapshot of the ways in which you can ensure tax efficiency and should be considered a Financial Planning priority once you have ascertained your risk profile and your investment objectives. The relative tax efficiency of these wrappers are also subject to legislative change.