personal finance reflections: avc employee share plans new year resolution tax
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Losing weight, getting fit – it’s all so passé IMO. What I want to change in 2011 is to reduce the amount of income that HMRC steal from me. I haven’t lived beyond my means over the last ten years and I’m damned if I want Hector the Taxman to swipe my cash to keep the bankers in champagne and dancing girls, or indeed the feckless to sit on their butts and breed us into Idiocracy.
Don’t get me wrong, I’m all for bankers, booze and birds as long as it’s not on my dime. I do think a pair of housebricks applied sharply to the offending organs might address Keith McDonald’s animal instincts but if he manned up and turned up for work to pay for them then 15 kids mightn’t be so bad. Either way, there’s enough that I seem to end up paying for, and I don’t want to pay for them any more, along these lines, though my bugbears are subtly different.
So how do you avoid tax, legally?
For wage-slaves like me on PAYE, there are only three easy ways to reduce one’s tax bill.
- Earn Less
- Spend Less
- Shelter taxable income in tax shelters like ISAs
1 and 2, the earns less/spend less do the heavy lifting here for wage slaves. If 3 is doing a lot for you you’re probably not on PAYE. What that means is to get a win here you have to be prepared to change your lifestyle. That’s why the taxman can raise enough money to waste on the aforementioned fripperies – because most people want to spend all they earn as they earn it.
Earn less, you might say, well, that’s like cutting off your nose to spite your face. However, there are ways you can reduce your taxable earnings while keeping hold of the money for deferred usage – things like pension AVCs (provided you can convert the saved money into a tax-free lump sum), some employee share plans and similar things like salary-sacrifice childcare schemes are ways to do that.
Of these, my weapon of choice is pension AVCs. Previously I have had a moderately successful run with employee share schemes, but you can only shelter £1500 a year that way and you take stock market risk. You can accept a lot of stock market risk in return for removing the risk of the taxman stealing 41% at source mind you.
AVCs are an easy win for me as I am probably within five years of drawing a pension. For younger people or those my age and not preparing to retire early the choice is harder, since a desperate government can change the rules at whim. At the moment one can draw 25% of a pension pot as a tax-free lump sum, and since I don’t want to draw this from the pension pot itself it makes perfect sense to save up 25% of my nominal pension pot on top in the form of AVCs, to withdraw tax-free rather than paying 40% tax on it. However I wouldn’t bet on that possibility remaining for ever…
I plan to use the £1000 extra tax allowance in 2011/12 that is one of the few useful outputs of the Lib Dem part of the Coalition. By controlling my taxable income I can avoid getting hit by the reduction in higher tax threshold and the increase in National Insurance to keep the money in my pocket, rather than Hector the Taxman’s. Incidentally, the same techique would enable Britain’s hard pressed ranks of impecunious middle-class parents to avoid the higher-rate tax child tax credit hoo-hah quite legitimately. Don’t want to lose your child tax credit? Don’t pay HRT. Simples. I think you have until 2013 to get ready for that change, so you can warm Tarquin and Jemima up to the fact they may have to share the iPad next Christmas rather than get one each…
Reducing tax by reducing taxable income is easy enough to understand, though harder for some people to implement that others. However, the the gains to be had by spending less is due to a nasty hidden tax bomb that people often miss. Say you choose to live in Hastings and work in London, so your train season ticket costs £5192. For sure, Hastings is probably cheaper to live in, but you are losing £6800 of gross salary each and every year for the enjoyment of being packed in like sardines every working day, since you have to pay 20%tax, 12% NI on the money earned to pay that season ticket. The taxman also gets 20% of the ticket price as VAT (no he doesn’t, thanks to Ken below for setting me right on that) , so in total you are paying 50% tax for the privilege of going to work. Or if you are on higher rate tax then 60-70% of what you had to earn to pay the ticket goes to the government. I am assuming that if you earn over £100,000 and work in London you probably don’t live in Hastings If you did then you are being rushed even more.
Live below your means to get the flexibility to pay less tax
So the way to pay less tax is to spend less and do more for yourself. You have to have space in your budget to be able to do that, ie live below your means. If you spend out every penny you earn, you have no room for manoeuvre. The Government is smart this way and knows that most people in a consumer society end up living at, or above their means. As far as consumption taxes go, Governments pump up taxes on two classes of consumables – things people can’t easily eliminate from their lives, and wants that people can eliminate from their lives.
Fuel duty is one example of the former – over 60% of what you pay at the pump goes into the Government’s hands (and remember you’ve already paid about 30% tax on that money before it got into your wallet). Eliminating this sort of cost is difficult in the UK. For all the greenwash, public transport is a joke in the UK. I live 6.5 miles from work and the cost of the bus round trip is over £5 which is way more than twice the cost of the fuel. I actually have a choice here, and have driven down the annual cost of fuel considerably by cycling to work. That’s obviously not an option for our Hastings dwelling London commuter, and it highlights one of the issues about living below your means. You have to gain flexibility and control in your budget, and that means be very careful about picking up ongoing commitments.
Ruthlessly eliminate fixed costs from your lifestyle, consistent with your values.
These come with alls sorts of price tags and timescales. They’re bad because they suck flexibility out of your life, flexibility you could use to bust sociopathic managers and bad employers out of your way. On the upside, these fixed costs make a lot of good stuff happen for you life keeping the rain off your head, and reality TV to deaden the pain of your existence as a wage slave.
Commuting is a big fixed cost with a timescale matching how long you want to do the job/live where you do. An iPhone is a fixed cost, but at least it is a smaller cost that you can get out of after two years. Sky TV is a fixed cost to keep you from doing something else with your time, and a way to amplify your need for thneeds that you didn’t realise you thneed.
Taking financial responsibility for something that eats is a fixed cost that tends to be associated with a long timescale of about two decades, be it a kitten or a child The costs, and rewards, are different for the kitten and the child, but they are fixed costs, and because the cost and the commitment duration are both high, it pays to be sure that’s what you want to do. Unfortunately for the country’s population of songbirds, and fortunately for the continuation of the human race both seem to find wide favour.
A mortgage is a high fixed cost, possibly one of the highest most people will take on, and it also has a long duration. It is crazy to take on a mortgage without a reasonable expectation that you will service it to the end (though accepted, not necessarily in the same house) since it hamstrings your flexibility and you lose so much on repossession.
Fixed costs are budget-killers because they are inflexible, though they are often associated with the greatest rewards. If you fall on hard times then you can switch from Waitrose organic salmon to ramen in a week, and you can forego the purchase of Manolo Blahniks and the spa session.
Reducing the mortgage, or the cost of your children’s clothes or kitty food are a whole different ballgame. Hence the personal finance stalwart of having an emergency fund of three to six month’s essential running costs in savings. Most of that emergency fund is there to address the fixed costs. My view is that three months is far too short. Take a look at this graph of the percentage of the unemployed who have been unemployed for more than 12 months
The data is taken from the ONS. Now you have to ask yourself, with 12-month unemployment being the experience of a third of the unemployed, how good do you feel about a 3-month emergency fund? Now, granted, that 12-month statistic does include chavs like Keith McDonald so perhaps the odds aren’t so greatly stacked against people who actually want to work. However, if we assume the feckless are represented by the 20% figure in the boom times of the mid-2000s, the current 15% excess are probably real people, and look where that graph is heading.
It wasn’t meant to be like this – in the 1970s we were promised more leisure time. Capitalism delivered on part of the deal, though its dark, evil Calvinist heart hates increased leisure time for its workers, because that increases switching time and management costs. Materially, if you want the basics that so enthralled people in the 1950s, you can have that, but nowadays you only need to work half the time to pay for it.
You could argue we sort of have that now – Keith McDonald has worked out how. All he needs is a mug working full-time to sponsor his lifestyle of 100% leisure. I have realised that I can’t have the job I was promised, a 20-hour week paying me half my gross salary.
I am closer to that 1950s lifestyle than many as I don’t have:
- an iPhone
- an iPad
- an i-anything
- a mobile (other than the work-provided one I use only for work)
- a flat screen TV (I am toying with outing my TV this year anyway as I don’t watch it enough)
- a wii/games console
- Sky/cable TV subscription
By storing the excess half of my income, preferably keeping as much of it out of the hands of the Government as I can, I can quit working about fifteen years earlier than my Dad could. I was slow on the uptake – other people like Dreamer and ERE have managed a lot earlier in their lives than me.
My extra time working hasn’t been totally wasted – I have more stuff than Jacob including a house, and living in a motorhome is not totally my idea of good living, and the harsh exercise regimen is also not to my taste, I’d rather not prolong life by hating a lot of it… Each to their own, however, Jacob will live longer than me
Sin taxes on elective wants
How about taxes that the Government puts on wants, that people can eliminate from their lives? The classic sin taxes on cigarettes and alcohol are examples of that, but there are others more nuanced, such as air passenger duty.
Although you wouldn’t think it from the way some people carry on, you don’t actually need to go on holiday, and even if you did, you don’t need to fly there. As for all that BS about air travel being good for people, well, it’s noisy for the rest of us on the ground, pollutes our air and buggers up our sleep. For the travellers, it is nasty, stressful and demeaning nowadays. If 80% of the travellers could be priced out of the sky I’d be all for it, I’d much rather save up and fly once a decade in comfort than once a year in a seething morass of humanity. Unfortunately, saving up to go business class wouldn’t help me, since it is the security theatre and airport experience which is the ugly part. I haven’t flown anywhere since a 2007 work trip which reminded me just how unpleasant air travel has become. Jean-Paul Sartre was spot-on, L’enfer, c’est les autres.
Warren Buffett has the right idea, if you want to do air travel, get a private jet. Since Warren is ever so slightly richer than me, I do without. By the way, if you really find the extra £100 APD an unbearable imposition then for heaven’s sake use your brains, APD is levied on flights from UK airports. Travel to Amsterdam-Schipol to start your long-haul flight, tax avoided, job done. Less racket in the skies for the rest of us above the UK too, what’s not to like?
Smoking. I don’t smoke, but if I smoked 40 a day it would cost me about £4380 a year according to the NHS. If I were a basic rate taxpayer I would have to find a job paying me £5840 a year more gross, to take into account the tax and NI I would pay before spending £4380. According to these guys, the cigarette duty on that hypothetical habit is £3942, so the total tax and duty in £5402.
Sin taxes are easy to avoid, don’t do the sin. I save myself nearly £4000 in tax by not smoking 40 a day. It’s kind of difficult to get a buzz out of the saving since I’ve never smoked 40 a day, but it’s there. There are also ways round some of that – if you have the capital to buy 7000 cigs every 6 months a regular trip to France may be in order, and indeed even pay for the holiday including APD…
Alcohol is the other biggie in sin taxes, and I get hit with £2 per bottle of wine roughly. So I know what to do if I want to reduce this
A New Year’s resolution that’s actionable and not too hard to do
Easy and fun is my approach to New Year’s resolutions, none of this cold showers and swimming in the sea. My aim is for the amount of tax taken in the 2012 P60 form to be less than the one in this year’s April form. That means I have to understand Osborne’s shenanigans in changing the basic rate and HRT thresholds. The first time I tackled this, in 2009, my aim was to pay no tax at all so I forced my pay down to close to the £6,500 p.a. that matched the tax threshold.
Athough I could live on this, I found it massively got in my way as far as investing in the business and funding my ISA so I became less hard-line on tax reduction. It was, however, good in the first six months to see a monthly tax of £8.70 rather than the figure I had been used to.
Now I probably need about £15000, to be able to fund my ISA and maintain running costs. Unfortunately I can’t see a way of funding the ISA without paying £3,000 tax on the money earned to go into it.
Everybody wants to pay less tax. And it can be done – but not while spending everything you earn. Therein lies the secret…