Death and taxes are the only certainties, right? Not entirely. In the world of investment portfolios in the UK, neither death nor taxes are what they once seemed.
Mrs FIRE and I are both UK resident, UK domiciled fully compliant UK taxpayers. The rest of this post is probably only of interest to similarly UK-based people.
My gross income puts me in the top tax bracket (45pc), and if my earnings were all from salary I would pay an actual tax rate of about 45pc. In fact my actual tax rate paid in recent years is closer to 30pc, and Mrs FIRE even pays less than this. Paying 30pc tax is pretty reasonable to me, so you won’t hear me griping about how the government (that same government which still spends almost £100bn more than it raises, every year) should be cutting taxes. How come as a high earner I pay only 30pc tax?
I avail myself of four key tax structures:
1) tax-free accounts. I load up in full on Mr and Mrs ISAs every year, and have done for several years. I have pensions (mostly a SIPP) which is due to breach the recently reduced lifetime cap before I reach the age of 55, all being well (ie my returns being decent).
2) buy-to-let. I have some buy-to-let property. My effective tax rate on rental income is less than 10pc, thanks to deductible expenses (mostly service charges, wear and tear, and mortgage interest).
3) investing tax breaks. I typically invest money each year in private companies (via the (Seed, occasionally) Enterprise Investment Scheme) and/or VCTs. These benefit from some very significant tax breaks on both income and capital gains.
4) offshore bonds. I have been sold a couple of offshore bonds by IFAs. These have not proven to be wise investments. The returns have been poor and the fees are very high. But at least any income inside them is not taxable at this point.
In total the above four structures cover almost half of my investment income. This effectively reduces my tax bill by about a third. I still pay a lot of tax…
I try in principle to tilt my tax-sheltered investments towards the higher yielding holdings. In practice this doesn’t work too well. I am mindful that I should probably use Acc funds in taxable accounts, but I don’t – yet.
For accounts, inertia plays quite a big role here. Mrs FIRE has only three accounts, to simplify tax reporting; one for her SIPP (which doesn’t need to be reported), one for share trading and one for holding funds. I have about 10 accounts, accumulated for various reasons over the years. Incremental ISA funds flow into one; incremental taxable funds flow into the lowest cost / most powerful broker. I rarely move funds from one broker to another.
At this point I should mention my IFA. As part of my early voyage of financial discovery, I tried using a couple of IFAs. While neither has delivered returns above the bottom quartile, I have found the interactions quite useful. And one of them has a clear communication style that I admire; I have in turn recommended him to a wealthy widow I know who has become a happy client. I haven’t pulled my funds because of the hassle, and because they don’t amount to much, but I certainly won’t be putting any new money to work with any IFA anywhere.
In the same vein as IFAs, I also have an account with a private banker. Most of what I have said about my IFAs applies here too, with one proviso: I do receive good service from my private bank. I pay a lot for this service, but the peace of mind is considerable. At some point I will sever the relationship but in the meantime I am grateful for the self-confidence that they have given me – if only that I know for certain I am better at managing my money than they are.
In the next post I look at my Target Allocations in detail.