This has consequences for personal finances and further emphasises the need for proper investment and financial planning. The subject is large, the choices are wide and the legislation is complex and ever-changing. The Government’s finances are in a poor state, which has led to rising taxes. There is also great uncertainty in the investment world – volatility in equity markets has been extremely high, corporate bonds are still recovering from their worst year since the 1930s and, bringing us back to public sector finances, the gilt market is under threat from an avalanche of new issuance. Pension, trust and
tax legislation has been anything but simplified and takes more time than ever before to properly understand. To achieve some measure of integrity in the face of these competing forces, comprehensive approach to investment and financial planning is paramount. This year, therefore, poses many financial challenges for those trying to plan effectively and protect and grow their capital. A changing political and regulatory landscape adds to the risks.
With the introduction of the 50 per cent tax rate now only a few weeks away, anyone with taxable income exceeding £150,000 should turn their attentions to financial planning. The main points to consider are:
- While we have less control of personal income, we have much more control over personal expenditure. Due to the theory of compounding, a pound spent today represents multiple pounds taken out of the future, so cutting out any unnecessary expenditure can be very productive. Focus on your outgoings, including investment advice and management charges.
- Protecting against inflation is critical to maintaining the long-term purchasing power of your capital. Directly held index-linked gilts are not subject to capital gains tax therefore a 5 per cent gross gain is a 5 per cent net gain for a low risk investment, although it should be noted that this excludes the coupon, which is taxable.
- For those wanting to increase tax efficiency in the short- to medium-term it would be sensible to (i) transfer non-tax-sheltered income-producing assets to lower-rate taxed spouses or civil partners; (ii) hold higher yielding investments in tax-sheltered wrappers such as Isas or existing pension funds; (iii) position non-tax-sheltered investments for capital growth; (iv) utilise remaining pension contribution allowances in 2009-10 and 2010-11 where higher-rate income tax relief is available; (v) utilise capital gains tax allowances worth £10,100 per person, transferring assets between spouse/civil partner as necessary; (vi) crystallise gains while the tax rate remains at 18 per cent; (vii) utilise Isa allowances – though relatively small, these add up over time and can be very powerful if significant gains are made; (viii) invest in National Savings and Investment Certificates; (ix) encash single premium investment bonds with inherent gains before 6 April 2010, possibly at a lower rate than in subsequent years, as gains are taxed as income; and (x) use single premium investment bonds, subject to an appropriate level of charges, to defer investment income to subsequent tax years, if taxable income may then be lower than £150,000.
- For longer-term tax planning, it is worth considering how much capital you can gift. The main consideration is to identify how much you want to gift, to whom and when. These are important questions to answer prior to deciding the method of implementation.
- Proper risk assessment is essential – you should examine your asset allocation position relative to your needs. One of the key longer-term questions for most people is ’how much money do I need before I become financially independent?’ Regardless of the answer, it may be easier to achieve if unnecessary investment risks relative to the potential rewards are avoided.
- Where there is mortgage debt, which is often the case when lawyers make partner, it is normally preferable to repay it if possible. This is because gross interest payments are made out of net income, meaning a 5 per cent interest rate would require a 10 per cent gross investment return from an alternative investment to break even with the efficacy of repayment. The risk of being invested in assets that could produce this type of return is likely to be high and the likelihood of losses is greater. It is therefore generally preferable and efficient to repay debt.
- Liquidity is something that is often forgotten when investing. If cash is needed, it can often be expensive to release funds. It is for this reason that many illiquid products should be avoided.
Receiving advice on a conflict-free basis, as offered by a law firm to its clients, is essential for proper management of your assets. In the financial services industry, there remains too much commission-driven product selling, which can sometimes be unhelpful. The focus should be on you and your needs and you should settle for no less than true independence when receiving advice on any financial planning and investment matter. Using an adviser who charges on an hourly-rate basis could make sense.