Why It Is Important To Diversify Across Different Tax Wrappers

Tax Wrappers

We often talk about diversification especially when designing an investment portfolio for our clients. It is, of course, important to diversify across different asset classes as well as across different geographical regions and sectors.

It is also important to diversify across different tax wrappers.

The range of different tax wrappers can include:

Not all tax wrappers will be relevant for all clients and some clients may have more than one of a particular tax wrapper depending on their circumstances.

By diversifying across different tax wrappers, we can make the overall portfolio more tax efficient. It also enables us to diversify across different income streams in retirement and different tax wrappers can be used to meet different financial planning objectives.

The three main types of tax wrapper that clients will generally have are: A pension, an ISA and a GIA.

Pensions

A pension remains one of the most tax efficient ways to save for your retirement and, given the abolition of the Lifetime Allowance, there is no cap on the size of pension fund that can be accumulated.

Personal contributions attract tax relief at your highest marginal rate and the fund will grow in a largely tax free environment. The amount that you can pay in will be based on your relevant earnings and subject to the Annual Allowance which is currently £60,000.

If you are a high earner and have an ‘adjusted income’ of £260,000 or more then the amount you can contribute to a pension is tapered such that anyone who earns £360,000 or more will have a tapered Annual Allowance of £10,000.

Individual Savings Accounts (ISAs)

ISAs are extremely tax efficient albeit the maximum that can be invested into an ISA is currently £20,000 per annum. Having said that, making use of the ISA allowance each year over a lifetime could mean that you and your spouse/ partner can build up a significant pot from which a tax free income or capital withdrawals can be taken in retirement.

General Investment Account (GIAs)

Once clients have maximized their pension and ISA allowances, they will typically accumulate money within a General Investment Account which is an account on which tax is payable on any income generated or any gains when funds are sold or capital is withdrawn.

A number of successful professional clients will have more than one GIA. For example, I have worked with some management consultants and investment bankers who maintain a small ‘punting fund’ in which they will take often pretty risky bets on a particular single share that takes their fancy.

For the bulk of their family’s wealth, this is invested in a rather dull and sensible portfolio designed to achieve their long-term goals. We will also use their annual CGT exemptions to ensure the GIA is managed as tax efficiently as possible.

Other Tax Wrappers

Outside of the three main tax wrappers, we may use other tax wrappers where we believe it appropriate for our clients.

An Offshore Bond, for example, can be used to help children pay for university costs.

Some clients are drawn to helping micro companies and start-ups and find the tax benefits of an Enterprise Investment Scheme (EIS) appealing for a relatively small proportion of their overall wealth.

Other clients, looking at helping future generations and minimising Inheritance tax (IHT) may look at Trusts whereas parents and/ or grandparents may find Junior ISAs or Junior SIPPs appealing.

Buy-to-Let Property

Whereas not generally a separate tax wrapper, may clients do hold Buy-to-Let properties which can offer an additional income stream in retirement.

The attractiveness of Buy-to-Let properties is becoming increasingly questionable in terms of the overall yields that can be achieved once taxes and costs have been fully considered. There is also the added hassle factor of dealing with maintenance as well as difficult tenants which can be a huge burden in retirement.

Conclusion

Many new clients come to us with a hotch-potch of investments, tax wrappers or Buy-to-Let properties and our job is to work out how these can form the basis of a long-term financial plan.

For most clients, we will look to review these, sell down where necessary and introduce new tax wrappers where appropriate so that each tax wrapper is working hard to enable our clients to achieve their long term financial goals.

It makes sense to diversify across different tax wrappers, however, it is important to have a financial plan in place which is the glue that holds everything together – it’s the picture on the jigsaw box without which you won’t know how to put the puzzle together!