Do you like my click-bait attempt? You will hate me even more when you realise this post is basically relevant only to people living in the UK (ok…not exactly…every country in the world incentivise saving and investing via tax reductions in a way or another, there might be some food for thoughts even for you here).
Today I read this post on Monevator on how to fill your ISA account each year even if you do not have the means. Later I listen to Ryen Russillo interview to Matt Taibbi (I have a love/hate relationship with both guys) where they agree that arguing is a great way to build audience. So FU Finumus, you are an idiot!!!
Ok, joking again (I went to read his previous blog in the past and found it really interesting!).
I came to UK almost five years ago and I did not master yet all the tax nuances here, still learning. After reading the post I had some questions, thought about writing a comment but then I realised it would have been too long. It might also be that my assumptions are wrong, therefore my questions irrelevant, because as I said, I think I understand the system here but I am not 100% sure. So here we are, with a most likely quite short post that will never be read by the target audience.
Writing down my thesis helps to structure my thinking and expose incongruences. I am a sucker for problems that almost exist only on a spreadsheet; I also learned where you have to stop and take into account how reality really works.
Is this post just a “win more” solution?
In Magic The Gathering there are some cards that pros call “win more” and this post reminded me of that. A win more card is a card that helps you win faster if you are already ahead but does not help you if you are behind and need to close the gap with your opponent. They are ‘shiny objects’ that you might think are useful but in a world of limited resources you are better off looking somewhere else. Anything that push you further ahead is nice but is better to hold up in your sleeve a solution for when the s**t hits the fan.
“You would be excused for not quite being able to rustle up twenty grand of post-tax spare cash, year in, year out.
Especially in the early years of your career when your earnings are low, or when you’re trying to save for a house deposit. Or when you’re servicing a mortgage or wanting to go on holiday, or paying the school fees. Or for the kids’ university.
Oh, and what about saving into your pension?
Suddenly that difficult year is looking like your whole career.“
The post acknowledge this fact in its premise: having a big ISA allowance is relevant only if you hit big in the future with a bonus, inheritance or winning the lottery. The allowance will not protect you on taxes on this windfall, will only shelter future gains made with this cash.
Imagine ‘complaining’ because you got a six figure bonus but you will have to pay taxes on what you will do next with the cash…;)
How to borrow
The main regret I feel coming out of the post is “oh there is so much ISA allowance wasted in your 20s”. And I completely agree with it! Unfortunately, I do not think any of the proposed strategy to borrow can be actually put in place when you are young. To use an offset mortgage, first you need to be an homeowner, then you need to have equity in your house and finally you need to overpay your debt (and increase your overpayment by £20k every year). After years spent on personal finance content, I understand there are lads out there that would prefer to overpay their mortgage than spend a night out with Scarlett Johannson…but why instead of overpaying your mortgage you do not simply put the extra money straight away in your ISA (and invest in stocks)?
If you already have an offset mortgage and you feel most comfortable taking your debt down to zero the fastest possible way then yes, the option to grow your ISA balance on the side comes at zero cost. My objection rely more on the reason why you put yourself in that situation in the first place. Instead of owning a balanced and diversified portfolio, you are exposed to a single idiosyncratic risk: if something happens to your house, you will lose not only all your savings but also your (and your family?) shelter (OK, this is quite an extreme scenario but you get the point). With borrowing costs at all time low, your peace of mind is quite costly, not considering that an offset mortgage is also more expensive than a plain vanilla one, all other things being equal.
Borrowing Ramit Sethi verb, if you are such a conservative person (financially speaking) that is comfortable only investing in his mortgage, i.e. at a lower than 2% return, you will not jump head first into stocks or other high return/high volatility investment after winning the lottery. The example used by Finumus might overstate reality a bit, these days to get 2.5% in the fixed income world you need to accept at least a bit of junk or price volatility due to high duration. But even if you lose £5k/year in taxes, you are ‘crying’ for the wrong reason. It’s like smoking and complaining because your teeth become yellow…or not taking the vaccine because of the possible side effects: you have way bigger problems dude. Think about the lost opportunity of having a way sub-par asset allocation.
Turning to the other examples, to borrow from your business…you need a business. And you need your business to have 60k, then 80k, then 100k laying around; not impossible but not even a random venture. If you grew your company to this point, great, I get it is another way to further leverage your success (win more).
Maybe I am ignorant and I completely miss the credit card point, but if your aim is to create a 5k allowance and roll it every year I guess congrats, you got the equivalent of a free cocktail in central London at the end of your endeavour, cheers. Unfortunately I do not know any credit card that allows you to borrow meaningful amounts at 0%, shoot me a message if you have any hint!
I think the DeFi idea is the most promising of the bunch. Crypto is one of the few places where you can burn your savings in a blink but also multiply your capital in a short period of time. If you manage to create a small fortune, using your crypto riches to build a tax-free refuge is smart and savvy. You can apply the same strategy if you have a margin account on IB with free leverage: you borrow for few days against your portfolio et voila’, free space for your future equity gains (just hope the market will not tank EXACTLY one of those days).
Once you are ready to carry forward your ISA allowance using the above strategies, you are most likely in the position to have spare savings to invest directly in your ISA as well. Maybe my personal preferences and circumstances are clouding my judgment, what I mean is that in the real world the spare balance to carry forward might be lower than £500k, or it will take more than 25 years to arrive there.
At least we have Paris the Capital Gains allowance
Months ago I started to see messages on shop windows saying “Increase NHS salaries”. I told my wife it would be interesting to enter and ask the person who put the message how they were planning to fund this salary increase; given the area where we live, I bet it would be a mix of “defund the Army” and “tax the Rich”. I am 100% sure the “increase my taxes” reply would be used 0 times. I was on holiday with a Swiss guy (never met him before) that one day came out saying “I do not understand why we do not employ the Tobin Tax, it would solve all the problems we have”: the guy cannot distinguish a bond from a stock and…I find it quite telling the complain comes from a person that pays way less taxes than anyone else in Europe already.
Excluding the radicals out there that abhor the Government, I feel this statement explains well our shared relationship with taxes: we know they are a necessary evil but we have our personal opinion on how to ‘optimise’ the system and avoid waste. It is a complicated matter. In isolation, a 20% tax on capital gains looks quite high: why after all the effort I put to discover this neglected stock that later went to the moon I have to pay a fifth to Boris Johnson? On the other side, 20% is quite the bargain if I compare it to what I pay as an employee on my salary.
The idea I got so far living here is that with enough planning it would be quite hard for a normal person to ever pay Capital Gain taxes. Outside Pension and ISA allowances, in UK everyone has a yearly capital gain allowance of £12k (bit more in reality). IF all your savings are in stocks and IF you assume on average a diversified stock portfolio gains 10% a year, you need a portfolio bigger than 120k to pay capital gain taxes in an average year.
The allowance is not cumulative and resets every year: this means if you do not use it, it’s gone like the ISA. But there are lot of ways to avoid the tax payment. First of all you have to cumulate gains close to £12k. If you have a portfolio smaller than £120k and/or not fully invested in stocks, there are high chances you naturally reduce your cumulate capital gains every year when you rebalance your holdings: selling assets that performed well to buy assets that did poorly will generate some capital gains against the allowance.
You can always release capital gains against the allowance without fundamentally change your portfolio. The HMRC states that you cannot re-buy the same asset you sold before 30 days. There are a lot of ways to be compliant with this requirement, release some capital gains against the allowance and still have your portfolio looking the same. I am not a tax expert and this is not tax advice, do your research first…that said:
- if your Strategic Asset Allocation is 60% ETF linked to global stocks – 40% global bonds, you can sell part of both ETFs and buy a single ETF that is indexed to a 60/40 portfolio (or any combination of the three if you have different weights)
- with the explosion of ESG, there are a lot of ETFs out there that are ‘environmentally friendly’ and still do not have any big difference in risk/return terms from a plain vanilla S&P500 fund: switch between the two
- if you like factor investing, you can switch between two ETF providers of the same factor: if you researched for the best provider on that factor, you probably know which one is the second best (and most likely a blend of the two strategies will offer the best outcome anyway)
- if you use a Roboadvisor, they will use a tax harvesting strategy without you even noticing it
An Alternative Solution
Honestly, the real issue here is how messed-up is the tax system in UK. Dividends and bond coupons are not eligible for the Capital Gain allowance, even if for a company and its investors paying a dividend or buying back stocks is financially the same. Plus bond coupons are considered as income, so if you are a higher rate taxpayer you are going to pay a 40% tax while the capital gain tax is only 20%. Dividends have as well their own allowance, £2000k/year.
Let’s go back to Finumus example: you inherit £500k and you want a 2.5% tax free income per year but you have no free allowance under your ISA. You can build you ‘synthetic bond’ using cash and stocks. Assuming cash pays 0% and stocks gains on average 8%/year and pay no dividend, at inception you buy £156.250 of stocks and leave the rest in cash. After one year, you take your desired $12.5k of income out of your cash balance and rebalance your stock portfolio back to £156.250: this way on years where stocks gain more than 8% you stash further cash (sell high) and when they lose you replenish your stock allocation (buy low).
In the real world this works a bit different:
- Stocks pay dividends, so part of the income will come from there. If the dividends you get are more than the annual allowance, you will pay some taxes
- Every year you can move £20k to your ISA and buy your preferred bond
- You can only release £12.3k worth of capital gains tax free using the technique described above. In the first years you will pay some cap gain taxes
- if before receiving the inheritance you were not able to use all your pension allowance or you had past allowance left, you can use part of the funds there and defer your tax payment in the future (likely at a lower rate)
- all these considerations are valid in the case you are ‘alone as a dog’, as we say in Italy. If you have a wife and/or kids, they have ISA allowances, pensions or…ways to use the cash you previously accumulated in your ISA (were you saving for your kids Uni? congrats, that’s done)
The Planning
While it can be annoying to pay more taxes than what you feel you should, your issues are related to a windfall (have at least a dance about it). If you do not feel that your taxes are paying for NHS salaries, public schools, parks maintenance or free museums you can always donate a bit to a charity and choose who will benefit from your good heart, reducing your final Income Tax bill 😉
The bigger issue I see is when people can plan for future events, tax wise, and do not do it…only to complain afterwards. A guy investing in crypto because he knows it will be big and then do not formulate a plan at inception on the best way to minimise the tax bill. Having a sensible conversation with your parents about estate planning. Structuring your business in a tax-friendly way for when you will decide to move on (or a tax-efficient sale). If you prepare and do your homework, you will save not only some money but a lot of stress too!
Do as I say, not as I do…I still have all the papers I got from Seedrs to send to HMRC.
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