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Archive: Oct 2018

  1. How much should you be saving for your retirement?

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    In most cases, the answer to this question is more than you’re putting in now! The minimum that you should be putting aside for your retirement plans, if you’re free of unsecured debts like credit cards and loans, is 12.5% of your income.

    But why 12.5%? Because it’s the first hour of an eight-hour working day, so the first hour you work every day goes to paying yourself before anyone else, including HMRC. That’s not the maximum proportion I recommend – it’s the minimum. If you’re nowhere near 12.5%, then it’s a case of trying to build up to it.

    An important step in doing that is to cut out all unnecessary expenses and follow my Bank Account System to reduce your outgoings.

    Mindset matters

    There’s no hiding that 12.5% is a chunk of anyone’s income, and we need to enjoy life now as well as in the future; we want to take holidays, have a great Christmas with the kids, enjoy new experiences – retirement is not the target of our life.

    12.5% is a starting point. Some people will think, ‘no problem’. Others will think I’m off the planet, because every month they have more days left over than pay cheque.

    That comes back to step 2 of my book The Money Plan: get financially well organised. You’ve got to know what you want in life and have a plan in place to get there. You’ve got to get your mindset right, which is why I spend about one-third of The Money Plan on financial mindset. It’s that important.

    If you are miles away from your targets, go through your expenditure items and see if you can squeeze them down. Look at all payments coming out of your account and ask the holy trinity of questions about each: do I need this, do I want this, can I get a similar experience for less elsewhere?

    You’ve got to plan for your future, and 12.5% is just the start; if you’re in your 50s or 60s with little in your pension pot, you’ve got to make big sacrifices to put more away so you can make your pension income last longer in your retirement.

    With that said, I’m realistic. If your employer pays a significant contribution to your pension, say 10% or even 15%, then that can make a big difference. You might even decide to redirect your savings onto your mortgage.

    The 40/40/20 principle

    After all unsecured debts are repaid and the financial fundamentals such as emergency cash, a will and power of attorneys are in place, I refer to what’s left over between your income and expenditure as a snowball, a surplus.

    A good way to be financially organised is to take that snowball and allocate it 40/40/20: 40% goes to overpaying your mortgage, 40% goes into your retirement plan, and 20% goes back to you to enjoy today.  I repay 20% back to enjoying today because I strongly believe that although we need to plan to ensure we have sufficient income for when we decide to stop working and retire, we should not live our life for our retirement – for the last quarter of our life, the 40/40/20 rule helps us achieve this financial balance in life.

    So while 12.5% might seem like a huge proportion of your income to start off with, what I’m trying to do is shift your mindset from 1% or 2% to a bigger figure. The 40/40/20 ratio allows you to change how you think about things, without missing out on enjoying the here and now.

    Market unease

    Stock markets have been in the news again, with some substantial drops around the world recently. It’s easy to think of the markets as a plaything for the rich, but the reality is that everyone with a pension is invested in them. Should you be concerned about a bigger market correction (fall) coming soon, particularly if you’re trying to increase your pension contributions?

    It comes down to mindset again: we should only worry about things we can control. You can’t control the FTSE or other stock exchanges, but you can control your asset allocation – how your money is invested. That’s determined by your risk tolerance and your risk capacity.

    Your risk tolerance is how much your investment i.e. pension could fall in value before you begin to feel uncomfortable, before you start to worry. Your risk capacity is how much can your investment can fall before it starts affecting your lifestyle, what you can afford, and whether you have time for the value to recover after a fall.

    A 100% stock market exposure portfolio, which almost nobody has, will typically fall around 50% in value during a significant market correction (such as the dotcom bubble bursting in 2000 or the financial crisis 2007). That can happen more than once if you’re investing over the long-term, such as with a pension.

    A 50% stock market investment portfolio is therefore likely to fall around 25% in value during a correction.

    To work out your risk tolerance and capacity, put the numbers above into real pounds for your circumstances. If you have £100,000 saved in your pension and it dropped in value by 25%, do you have long enough left before retirement to wait for the market recovery and an increase in value again? Or are you going to be sick with worry and upset?

    If the latter, you’ve got too much stock market exposure and you need to reduce it. When investing, time is your friend, you need enough of it to ride out the inevitable waves in the market.

    As a very general rule of thumb, think 100 minus your age to work out the rough proportion of your retirement plan investment that should be allocated to the stock market. If you’re in your 20s, you could have 80% (100 minus 20) of your investment in the market, because you’ve got 40-plus years until you need access to it. If you’re in your 50s, around 50% exposure to the markets is likely more sensible, because you have less time to see out the peaks and troughs.

    And remember, even if you’re in your 80s, this rule still leaves 20% exposure to the stock market. You don’t want to remove it altogether because it’s your engine for driving growth and returns.

    The Budget

    The Budget takes place on Monday 29 October. Pretty much every year since I’ve been in financial planning, there have been rumours that it will include measures to tinker with higher rate tax relief and how it works with pensions. This year is no different.

    If you’re concerned about it, then make your pension contributions early if you can – squeeze as much in as you can before the Budget, don’t wait until afterwards.

    I think politicians are more focused on Brexit at the moment, but they do need to find more money, so it’s worth keeping an eye out for any announcements on Monday.

  2. Capital gains tax on second homes; liability & planning

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    More people are selling second properties. This could give rise to substantial CGT liabilities. How are those CGT liabilities calculated? Advance planning can reduce those CGT liabilities.

    It would seem that some of the tax measures announced by George Osborne in his Budget in 2015 are beginning to take effect.  More and more people are selling their buy-to-let investments.  This naturally leads into considerations on potential capital gains tax (CGT) liabilities.

    Capital gains tax is payable on the profit made from the sale of property that is not the taxpayer’s principal private residence, as well as assets such as shares (that are not held inside a pension or ISA).

    Whilst no CGT is payable on the profits arising on the sale of a private residence, CGT is a reality on the sale of a buy-to-let property. After deduction of the CGT annual exempt amount, tax will be payable on the gain at 18% (to the extent it falls within the investor’s basic rate tax band) and 28% (to the extent it takes him or her into higher rate tax).  It should be noted that the top rate of CGT on residential property is therefore 28% – even for 45% income tax payers.

    And we can expect that HMRC is taking a keen interest in these transactions.

    It has been reported that HMRC is apparently cracking down on those who sell a second home or buy-to-let property but fail to pay tax on the profits.

    In this regard, apparently HMRC is to write to 1,500 people it has identified as having sold a property in the 2015/16 tax year but not declared a profit on which capital gains tax would potentially be payable.  The letter will ask recipients to explain why they have not declared the gain and paid any tax.  Failure to respond to the letter or provide an adequate explanation could result in a formal investigation and fines.

    As mentioned earlier there has been an increase in sales of buy-to-let properties after a series of tax changes, that began to come into force in April 2016, reduced their attraction to investors.

    The question is, is there any way in which the CGT tax bill can be reduced?

    The tax is levied on the capital gain that arises on disposal – this is the difference between the purchase price of the property and the price at which it is sold.

    Each individual has an annual capital gains tax exemption of £11,700 in 2018/19.  This is £23,400 per couple where the property is in joint ownership.  This, of course, is an investor’s total annual exemption and so, if the investor also has taxable capital gains elsewhere, these will count towards it. Losses from, say, the sale of shares or another property can be offset against gains.

    Furthermore, the investor can deduct from the gross gain any costs incurred in the process of buying and selling the property, such as legal fees, agents’ fees and SDLT.  It is also possible to deduct the cost of improvements, such as a kitchen extension or putting in a new bathroom.

    It is not possible to deduct mortgage interest, repair costs or the cost of replacing items, (known as running repairs).  However, in the case of buy-to-let properties, such costs will typically have been claimed against income in the year they were incurred. Matters can get complicated if an item is replaced with one of a higher specification, (in which case part of the cost can be offset against income and the other part against any gain.)

    If a property has been the principal private residence of the investor for part but not all of the time it has been owned by the investor, in principle, CGT will only be charged on the pro rata gain for the period during which the property was not the investor’s principal private residence. It is also possible to claim an exemption for the last 18 months of ownership whether the property was occupied or not.

    If a property that has been occupied as a private residence has been let out, it is possible to make use of lettings relief, which will reduce the gain by £40,000 — or the amount of the gain that is chargeable, whichever is lower. For investors who have more than one home that they have used as a private residence, they can nominate which will qualify for principal private residence relief. It does not have to be the one where they have lived most of the time.

    Generally, it would make sense to nominate the one expected to make the largest gain when the property is sold.  The problem here is that the investor needs to act quickly as they only have two years from when a new home is bought to make the nomination.

    Unmarried couples can each nominate a different home as their main residence and therefore benefit from two “principal private residence” exemptions. This does not apply to married couples or civil partners.

    When is the tax due

    The deadline for paying CGT is the last day of January after the end of the tax year in which the taxpayer realises the gain. For example, if the taxpayer sold a property on 1 August 2017 (in the 2017/18 tax year) the deadline to pay the tax due would be 31 January 2019.

    There are plans to change the rules to require tax to be declared and some paid on account on such properties within 30 days of sale. This is expected to come into force on 6 April 2020.

    Example – Frank

    Frank bought a house on 1 February 2006, for £120,000, lived there until 31 July 2010, and let it until it was sold on 31 January 2018 for £260,000. He will have made a profit of £140,000 over the 12 years he owned it.

    He is entitled to the principal private residence (PPR) relief for the time it was his main residence — in this case, the initial 54 months. A further relief is available for the final 18 months before it was sold, allowing him to claim PPR relief for 72 of the 144 months of ownership.

    Deducting £70,000 from the total gain of £140,000 (72/144ths) leaves £70,000 that is subject to capital gains tax (CGT) — assuming no other capital expenditure that could be used to reduce the gain further.

    Because Frank had let the house, a further £40,000 letting relief can then be deducted, reducing the gain to £30,000. From this he can deduct the annual CGT exemption in the tax year the property was sold — £11,300 in this case — pushing the taxable gain down to £18,700.

    If he were a higher or additional rate taxpayer, Frank would pay 28% tax, giving a bill of £5,236. If the gain kept Frank in basic rate tax, he would pay 18% or £3,366.10