Is Tax Planning a Piece of Cake?
Have you ever bought a cake and looked forward to eating it all day. Imagine getting home from work and seeing that scrumptious chocolate cake you were looking forward to devouring had a big bite taking out of it. This is what happens to your hard-earned savings if you don’t put it in a tax wrapper as the government will take a bite of your investments.
Do you want to have your cake and eat it?
Now taxes are important don’t get me wrong. They pay for schools, hospitals and trains to get you to work. However, another important element of taxes is that they encourage or discourage you from doing something. Think of cigarettes. We all know that they are bad for you. In fact, they will kill you if you smoke for long enough, that’s been proven. They cost a lot of money to treat smokers for lung diseases, which means that these beds are not being used to treat other people with other illnesses. What the government does is to put a tax on cigarettes to make smoking more expensive to encourage people to smoke less, meaning they will have fewer people to treat in hospitals. The same thing is true for investing. The government offer generous tax incentives in the form of an Individual Savings Account (ISA) or a pension to encourage us all to save and invest for the future.
What is a Tax Wrapper?
A tax wrapper is not the latest grime music sensation. A tax wrapper is like a cake box protecting your cake. This stops the government taking a big bite out of your chocolate cake. This means your hard earn money will be able to grow quicker and you will be able to spend more money on buying more chocolate cake to enjoy in the future. The government give a certain number of tax wrappers allowances every year (or cake boxes to continue the analogy) to give you the incentive to save more so they will have to spend less on looking people in their old age and more money on things like education, hospitals and transport, making sure that train you get to work runs on time or there to buy more trains so you are less squashed on your morning commute.
The two main tax wrappers that people in the UK should be using are ISAs and pensions. The main reason for saving into these is because of the tax breaks available. Saving into a pension or an ISA is the best way to avoid income and capital gains tax to help you grow your investments quicker in the future. The ISA allowance is currently £20,000 and a pension allowance is £40,000 a year.
Here are three practical tips for your money
1) Join your workplace pension scheme. This is as close to free money that you can get. You get a tax incentive and your employer also has to match your contributions up to a certain level. The downside to this is that you can’t access your money until you retire (currently 55 in the UK) but this gives your money a chance to grow.
2) Decide your spilt between pension and ISA. An ISA is also a tax wrapper however the incentives are not as good as a pension (This is discussed in more detail in my book). You can access an ISA at any time in your life, which makes it more appealing if you are between 25–40 years old as you may want more flexibility with your money.
3) Clear your bad debt first before thinking about investing. There is no point gaining 8% on your investments if you are losing 20% on credit card debt payments. Use compound interest in your favour by clearing any debt that you may have from credit cards or loans.
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Neil Doig is a Financial Times shortlisted author for the book Millennial Money Mindset: If you want the fruits you need the Roots (now available on Amazon in print, audible and Kindle), creator of the investing trading game Football Formation Asset Allocation, and speaker at WeWork in 2018 and at Picturehouse for the Feast Festival in 2019.
Neil Doig is the Founder of Money Tipps which is a money coaching company and educates and inspires better investing.