16 Oct 2014, 11:32am
personal finance
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  • The difficulty of managing money in silos

    Pensions, ISAs, NS&I - they all break your capital down into silos isolated from each other  Image: dsearles/Flickr

    Pensions, ISAs, NS&I – they all break your capital down into silos isolated from each other Image: dsearles/Flickr

    Silos are bad for organising a lot of things where the contents should all be pulling in the same direction, singing from the same hymnsheet and other associated buzzword bingo 1. All through my working life companies have moaned about ‘silo mentality‘  – well WTF do they think is going to happen when you reward people for individual results using S.M.A.R.T. metrics, the stupid berks? Knowledge is power, and you don’t want to be an interchangeable outsourceable meatspace unit x – you want to be the irreplaceable kingpin…

    The same intractable problem is easily introduced into our personal finances – some of it by foibles such as mental accounting, but a lot of it is by government action – if you want to take advantage of certain tax breaks you are pretty much forced to split your money into different silos. Pensions are the obvious example, a one-way silo that you can draw on after 55 2, and ISAs, which only have tax protection inside the silo.

    The whole reason humans invented money was to create a divisible and fungible token of wealth – later on that became a fragile store of wealth 3 too. That’s all very well, but in practice we don’t really seem to like operating in a miasma of undefined cash or debt swilling around, so we often break it all up into itty bits and tackle each one of these on their own. In doing so we often lose the big picture – the classic case is somebody carrying credit card consumer debt who has savings, or even worse, has money in the stock market. There is no point in having savings if you have debt that is at a higher interest rate than the net return on those savings unless you have a specific reason for it. If you are carrying chargeable consumer credit you have no business being in the stock market – fight the nearest fire that is burning faster before worrying about the flames on the horizon.

    The Silos of Tax-advantaged Savings

    The biggest and most complex of these taxation silos is the pension. It has the greatest restrictiveness, and is therefore the hardest to manage. It’s also usually at a high-water-mark in your 50s.

    As you get closer to the magic 55 the problem of silos gets a lot more acute, and doubly so if you are an early (pre 55) retiree. For an early retiree with a defined contribution pension the decision is clear – draw the pension from the age of 55, because you have no other earnings income (that’s what retiring is) so you get more of your money back paying less tax by choosing the longest time period to draw it. That favours drawing from 55, all other things being equal. If you’re still working that’s nuts, but if you aren’t, knock yourself out.

    However, just before 55, you have pension silo that is a dead hand that demands maximum feeding at the expense of the ISA silo, or indeed your general free cash flow, because it is the most lucrative. For instance, the Ermine specifically took out a DC pension when Osborne’s pension reforms were mooted, because, well, it’s rude to turn down a guaranteed roughly 10% p.a.  uplift on about £7000 in cash, tax-free if you swing it right. The fact that this allows me to defer my main pension increasing it by 5% is an added bonus.

    Trouble is, you have to design your savings plan and glide path while you are still working, and I predicated mine on an ISA allowance of £9,000 p.a. and being able to ignore pensions, because I didn’t want to have to take out an annuity at 55 or wait until I was old enough for it to be worth it.

    I’ve only been retired for two years, and in the meantime they’ve mucked around with the silos so much that the original plan is in tatters. My original aims were simply to fill my ISA each year, basically by selling unwrapped holdings up to the CGT limit and tossing them into the ISA and topping it up a bit from savings. The increase in ISA allowance means I want to top it up a lot – there’s another £5000 p.a. to find. And then Osborne changed pensions so that it’s worth tossing £9000 into one to win £2000 of tax that I paid years ago back – even if you’ve never paid tax the deal is on offer, though it’s only really favourable for people close to being able to draw the prceeds in a couple of years.

    Fortunately I overestimated my spend rate; I expected to have to draw the pension after a year and a half, so the start of this year. When I do draw it I get hold of my 25% pension commencement lump sum which is a shitload of cash saved up for this, and then have to push that into ISAs for a few years. It is this which makes me keen to max my ISA allowance across the intercession between stopping work and getting hold of the AVCs.

    Then I needed to find about £10k for an opportunity that has come up, and so I am now up against the end of my free cash flow. I still have deep strategic cash savings in NS&I and a Cash ISA, which would easily cover that but I am loath to break into them, because God knows when I will be able to save and preserve cash in real terms with NSA&I again, and I don’t want to lose the ISA capacity. So heck, it’s time for the Ermine to borrow money!

    Lenders are all computers these days, and all lending is predicated on income

    The last time I borrowed money from a bank as a loan was in the mid 1980s. At that time there was this quaint custom of going into the bank where you would talk to someone about what you want the money for and what your income was etc, so I went into my bank in South Kensington and showed the fellow the payslips and how much I wanted to borrow for a car. Arguably what the bank manager should have said was don’t be such a damn fool you young whippersnapper, a car is a wasting asset that will depreciate faster than you will pay down the loan, but for some reason he didn’t, I had another £2k in my account and everything was fine. They got their repayments on time every time and that was that. It was a damn fool thing to have done, don’t ever borrow money to buy a car, particularly as cars as much cheaper now in relative terms. But I got away with it.

    It so happens that I am still with the same bank, branch and account because I can’t be bothered to fiddle about with this, I never go overdrawn so many of the so-called benefits of switching aren’t of value to me. So I spark up their website and inquire of a personal loan for £8k, using the non-credit referenced query. Income – 0 (I suppose I should have put in my ISA income, but what the hell). Now bearing in mind this is my own bank and they should damn well know that my Cash ISA has more than enough money to cover the £8k, but the answer is basically

    Computer say no, fuhgeddaboutit m8.

    There’s apparently a hidden assumption that has crept into lending money these days, and that is that you are a good li’l consumer trying to buy more consumer shit than you can afford at the moment, but your income is enough to service the debt. There seems to be no concept that a member of the consuming proletariat may have the money but because of the silo structure it is in the wrong place and he may lack liquidity. Let’s face it, who would you rather lend money to – some kid wanting to buy an iPhone or somebody with financial assets of many times your loan but ensiloed in a pension AVC or shares that can’t be sold till the next tax year? There’s no question – go for the iPhone toting kid any time 😉

    Now in the 1980s, I would have gone to see Mr Bank Manager, I would explain that I have these CGT embargoed shares to cover it, and if that isn’t enough that in two years I would have my AVC of way, way more than the loan amount and I am being sensible in deferring my pension so this loan is in fact there to use my capital to make more money. It isn’t for a wasting asset like an iPhone or a car, and he would look back over 20 years of running that account, figure £8k isn’t quite enough to do a runner to Rio and advance the cash. But we aren’t.

    Computer says no

    Now unlike many people I never go on the assumption that I have the right to have people lend me money, so that’s just the way the cookie crumbles, more loss Mr Nat West, because compared to most people they advance personal loans an Ermine is probably a good bet.

    Where can a skint Ermine borrow from – aha – Wonga and Credit Cards 🙂

    My main problem comes around the turn of the next tax year – I need enough liquidity to max the rest of this year’s ISA, and to max my SIPP this tax year. There’s no point in drawing money out of a Cash ISA to fill a S&S ISA – it’s the old Silo problem again, that money is already in the ISA silo so there’s no point taking it out the bottom and chucking it back in at the top. That silo needs new money.

    As soon as the tax year is done, however, I get a new CGT allowance, so I can sell some unwrapped shares and pay off the loan 4. For a short period I even considered Wonga or The Money Shop, despite taking the piss something rotten a while ago. A two-week period over the 6th April would actually be the correct use of a payday loan, but the thought of being spammed shitless for the next 10 years by their ilk wasn’t really an attractive proposition. This from Moneysavingexpert is pretty much all I need to know.

    1402__wrong_way_signage

    Yup, got that. Wonga is probably more crafty than I am clever…

    Mrs Ermine didn’t really approve, either. So let’s take a step back. Now it so happens that every month Barclaycard entreat me to borrow money from them. I don’t use the card, but I have it because I figured that after leaving work nobody will give me another credit card until I become a pensioner, so I may as well hang on to the ones I have got. Presumably Barclaycard still think I am working for The Firm, because I told them truthfully that I was when I took it out and they haven’t asked me since. So like clockwork, every month they send me something like this

    1410_bcard

    Now I don’t know how ‘king stupid Barclaycard think their customers are, but a 0% interest cash loan with a x% fee is not 0%. At first sight this is a loan for 9 months at 1.9%, ie a loan at an APR of 12÷9×1.9%=2.6%. It’s actually a little bit worse than that because you have to repay a credit card loan at quite a high rate, about 3% of the loan outstanding per month, so you don’t get to use all of the cash for all of the time. The car loan was so long ago I can’t remember if you have to repay a bank loan every month. Here in practice you either get not to use the full loan amount or you effectively borrow a smaller amount at a higher interest rate, say about 5%. And you must must must ensure you repay the minimum amount every month, I’ve always taken card firms up on the Direct Debit pay minimum amount off each month, so the first thing you have to go on getting the loan is chuck some of it into the debited account ready to pay the loan down.

    I actually prepaid the 1.9% fee – ie paid too much into the card account before taking the loan so the fee is taken from the existing credit balance and not the loan, because I suspect they would charge monthly card interest on the fee, which they can’t it it’s not carried 🙂

    Then I repeated the operation with MBNA, who offered me a year and a half loan for 5%. They also offer this every month or so. I still have a soft spot for MBNA – 25 years ago they lent me £15,000 interest free which was a significant part of the deposit on my first house. And I really didn’t pay any interest on it – in those days 0% interest really meant 0%, no fees involved. The fact that it was a tremendously stupid time to buy a house, very much like the present time, indeed, can’t really be blamed on them.

    That will take me into the time when I can draw my DC pension, and all of a sudden I am rolling in liquidity, particularly as the impending stock-market rumble means I can probably liquidate more unwrapped holdings CGT free as they fall to par. Which is dead good, as stock market rumbles are exciting and opportunities to get stuck in and pick up value. I love the smell of fear in the markets in the morning. And it so happens that I have a fair amount of uncommitted cash in my ISA. Maybe I can stop writing articles like this and write more like this. If I can have just one word in Mr Market’s shell-like, if he could just delay the denouement a teeny bit, so say Q4 of next year, I’d be in a better position to use it. If he has to throw a benny earlier, I may have to switch some of my AVC fund that is currently in cash into say a FTSE100 index. The trouble is my AVC fund is currently already exactly 25% of my pension capital by design, so I can’t really use any increase that much…

    Oh yeah, about that classic bad case of somebody carrying credit card debt but with savings, indeed who has the temerity to be in the stock market to. Well, that’s me. What the hell, do as I say, don’t do as I do 😉

     

    Notes:

    1. you can take the Ermine out of The Firm, but not yet the biz lingo out of the Ermine, it was drummed in over 20 years
    2. corrected 20 Oct from earlier version “only fill until you are 55” which wasn’t what I meant
    3. money in terms of cash is a fragile store of wealth because it tends to depreciate over time as it is created at a higher rate than the value accumulating in the economy
    4. I was dead chuffed when IDJV that I hold unwrapped fell to the price I paid for it in the current market loathing for all things European. That means there’s no CGT to pay, so I sold them and that will give me some extra liquidity at the turn of the tax year – or I can simply to an internal transfer of the cash into my ISA this tax year, leaving only 2k to find this year. It’s an ill wind…
     
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