Building your wealth
Making your wealth grow and being able to retire when and how you want is one of most people's important financial objectives. But achieving this goal takes planning and perseverance.
Putting your financial affairs in order against the current financial difficulties is a bit like completing a jigsaw, where the main pieces are savings, investment, protection, and taxation. If you get it right, the picture can be very attractive, but get it wrong and the picture can look very muddled. The problem is that life does not come with a picture on the lid.
- What do you do with your current investments?
- How can you gauge the difference between saving and investing?
- What sort of insurance do you need?
- How much should you be salting away for your retirement?
- Are you paying too much tax?
The answers to these questions are different for each person, depending on individual circumstances, but there are certain strategies that make sense in most cases. If you can identify the broad principles that are relevant to your situation, you can use them to improve your financial standing.
Use this section of our guide in the same way you would use the picture on the box of a jigsaw puzzle. The process is ongoing; you must monitor your plan and adjust it as necessary to ensure that you are moving in the right direction. It is a simple concept - yet many who build the framework for a plan fall short when it comes to implementing it. Don't be one of them.
What you need is a realistic framework so you can better seize financial opportunities as they arise. To develop this framework for your financial decisions, follow the five Ds:
- Decide where you are today - what has been the impact of the financial crisis?
- Define where you want to be in the future
- Discuss your goals and objectives with us
- Develop with us a plan to move toward your goals, and
- Drive forward to make it happen
This involves balancing head (financially prudent strategies) and heart (emotionally acceptable thresholds). You need to bridge the gap between what you can achieve financially with what you dream of doing.
Try to meet your objectives by setting a number of short, medium and long-term goals and prioritise them within each category.
Common goals include the desire to:
- Accumulate a sizeable estate to pass on to your heirs
- Increase the assets going to your heirs by using various estate planning techniques, perhaps including a lifetime gifts strategy
- Tie in charitable aims with your own family goals
- Accumulate enough wealth to buy a business, a holiday home, etc
- Be able to retire comfortably
- Have sufficient funds and insurance cover in the event of serious illness or loss
- Develop an investment plan that may provide a hedge against market fluctuations and inflation
- Minimise taxes on income and capital.
When determining your financial strategy, it is important to understand the difference between saving and investing. If you save money on deposit with a bank or building society you will earn [a low rate of] interest. If you buy shares or invest in a share-backed plan such as a unit trust or a life assurance policy, you will have the opportunity to earn dividend income and benefit from [potential] capital growth if the shares go up [and stay up] in value. Records show that in the long term the best share investments outstrip the best building society accounts in terms of the total returns they generate.
However, it is important to remember that shares can go down in value as well as up, and dividend income can fluctuate. If you choose the wrong investment you can get back less than you put in. The watchword, therefore, must be caution. You will need to consider the most important factors for you in your investment strategy.
Paying tax on your savings and investment earnings is obviously to be avoided if at all possible. There are a number of investment products that produce tax-free income, including some National Savings products.
A Guaranteed Income Bond is currently available with a yield of 1.45% (issue 63: 1.46% AER) and a further Bond of 1.90% (issue 58: 1.92% AER) after three years. Both of these investments have a maximum of £1 million per investor who must be over the age of 16.
Although the products on offer from National Savings are unlikely to be at the cutting edge, a tax-free return of, say, 1.45% is equivalent to 2.42% for someone paying higher-rate tax (40%) or 2.63% for someone paying the additional-rate tax (45%).
Premium bonds may be quoted as offering a low 'interest equivalent', but there is a chance at winning a tax-free million.
Those with a lump sum to invest might consider an investment bond. This is a life insurance product and the norm is to draw an annual tax free sum equal to 5% of the original investment for the life of the bond. On maturity, usually after 20 years, any surplus is taxable, but with a credit for basic rate tax. Higher rate tax might be payable, but 'top slicing' relief might apply.
Although, as we have already suggested, history records that long-term investment in shares will outperform savings with a bank or building society, you should not overlook (1) the somewhat higher degree of certainty over investment return, albeit current rates are less than inflation and (2) the (usually) ready access to your funds.
Interest is only liable to income tax on the excess over the personal savings allowance which is £1,000 for basic rate taxpayers, £500 for higher rate taxpayers and zero for additional rate taxpayers.
Such accounts are often held as emergency funds. An ideal solution is to have instant access to a sum equal to at least 2 months' income.
Investment in stocks and shares gives, in theory, the best chance of long-term growth. On the other hand, it is often a volatile market, and should perhaps be avoided by the faint-hearted. Investment in unit trusts and investment trusts are designed to spread the risk, and add an element of management, without the expense of broker advice, for the small investor. Capital gains are charged to tax, as are dividends.
Property, whether commercial or residential, is generally considered a long-term investment and there are signs that buy-to-let investors are returning to the market. The changes in tax relief for buy to let mortgages render the buy to let investment somewhat less attractive. Certainly, the prospect for returns is not as great as has previously been the case. Buy-to-let mortgages may generally be available to fund as much as 75% of the cost or property valuation, whichever is the lower. Those investing in property seek a gross return that covers all outgoings and a net return from rent which is greater than the interest that could be gained on deposit while the risk of the investment is weighed against the prospect of capital growth.
However advice on any property investment is always an area where advice is essential. That advice in particular relates to tax advice on the treatment of loan interest.
Up to £20,000 can be invested in an ISA this year, of which a maximum of £4,000 can be invested in a Lifetime ISA. The Junior ISA investment limit is £4,368 for this current tax year.
Income accruing in an ISA does so tax-free. All investments held in ISAs are free from CGT but not IHT as the value of ISA holdings are included in the value of the estate. There is no minimum investment period for funds invested in ISAs - withdrawals can be made at any time without loss of tax relief. However, some plan managers offer incentives, such as better rates of interest, in return for a commitment to restrictions such as a 90-day notice period for withdrawals.
Investments under the enterprise investment scheme (EIS) and investments in venture capital trusts (VCTs) are generally higher-risk investments. However, tax breaks aimed at encouraging new risk capital mean that EIS and VCT investments may have a place in your investment strategy. There is an even more high risk version of EIS known as Seed EIS which has advantageous tax breaks to investors in startup businesses.
Subject to various conditions, such investments attract income tax relief. The available relief is 30% this tax year on £1 million per annum. Contributions may be carried back by one tax year provided the maximum amount for which relief is sought is not exceeded.
More importantly, they will attract unlimited CGT 'deferral relief' on the investment of chargeable gains, delaying tax which would otherwise be payable on disposals. In addition, although increases in the value of shares acquired under the EIS up to the £1 million limit are not chargeable to CGT (as long as the shares are held for the required period), relief against chargeable gains or income is available for losses. The gross value of the company you buy shares in must not exceed £16 million after the investment and there are restrictions to ensure that investment is targeted at new risk capital.
Seed EIS is available only for investments in start up companies and has more restrictive conditions. It provides both income tax relief of 50% and a capital gains tax shelter on the funds invested.
With similar restrictions on the type of company into which funds can be invested, VCTs now allow 30% income tax relief on investments of up to £200,000 each tax year but there is no CGT deferral for investments in VCTs. Gains and dividends on VCT shares are tax exempt provided the minimum holding periods are met.
Talk to us to ensure that you understand the advantages and risks of tax-break investments.