Five things high earners wish they had known at the start of the tax year

John Clamp examines what high earners need to be aware of as the tax-year end looms.

The Covid-19 outbreak, and resultant social and economic catastrophes, arose without warning. We find ourselves in the midst of an unprecedented shake-up of the markets. The very fact that this event is caused by a global threat to our health, not just the financial system, means this pandemic is of justifiably greater concern than the financial crisis of 2008.

Clearly the uncertainty has thrown into jeopardy not just the future earnings of companies, but in many cases also their ability to survive. There will be some who will emerge stronger; those with significant “economic moats”, which enable them to weather the storm, while their weaker competitors perish. Small, nimble companies will use the environment to their advantage, as they are able to adapt more quickly and disrupt their larger more cumbersome peers.

Faced with significant losses on investment values, albeit on paper, can cause a sense of despondency. Particularly as we had all become used to the past 10 years of healthy year-on-year returns. We know the advice is not to sell, but everybody has a breaking point where they feel compelled to “take action now and ask questions later”.

It is in such situations as these that having a well-diversified portfolio can make all the difference. Investing across the spectrum of asset classes (not just diversifying by company, industry sector, or region) provides exposure to holdings that behave differently in different market conditions. Limiting losses is all the more valuable when you consider an investment that has fallen by 20% would subsequently need to make 25% just to return to par.

While the panic-selling of shares makes as little sense as the panic-buying of toilet-rolls, the smart investor will continually reassess their views in the face of new information. With stock market falls of 10% in a single day, we are compelled to consider how much of that is justified and how much is caused by hysteria. It prompts the question “are markets rational?”

My view is both yes and no. With so much uncertainty, there are two truths I find myself reverting to:

1) We cannot predict the markets;2) We can guarantee a positive return by engineering a known tax advantage.

Fast approaching the tax-year end, it is worth investors knowing that it is possible to generate a return of 60% guaranteed. Let me explain.

Earnings above £100,000 cause the Personal Allowance (£12,500 of tax-free income) to be tapered down to zero; so that those earning more than £125,000 do not have a personal allowance at all. By putting £20,000 into a pension, someone with £125,000 of taxable income could turn their £20,000 contribution into £35,000.

HMRC award £5,000 basic-rate relief into the pension, so £25,000 is the starting investment. In addition, HMRC pay £10,000 of higher-rate tax back to the individual. This kind of strategy is something high earners may want to consider. Additional-rate pension tax relief is also achieved for those earning more than £150,000.

For employees who receive options and restricted stocks units (RSUs) as part of their remuneration package, awards of company stock attract income tax, in much the same way as earned income. We can use such awards to help fund the pension contribution, while shielding the realisation of the options and RSUs from the tax charge that they would otherwise face.

The strict limitations on how much can be put into a pension, means that it is essential to take professional advice in order to assess your ability to “carry forward” any unused pension contribution allowance from the previous three tax years before it is lost forever.

Around this time of year, we also see a flurry of activity as investors look to secure the certainty of a 30% uplift in value using venture capital trust (VCT) investment. VCTs provide exposure to a listed portfolio of smaller, usually unlisted, companies. It is all very well engineering a guaranteed uplift by way of the tax reclaim, but it also pays to ensure the companies receiving your investment are of the highest quality.

Due in part to the restrictions on pension funding, VCTs have been in greater demand in recent years. By their nature of investing in smaller companies, this increase in demand means the best-quality VCTs fill up their funding target and reach capacity ahead of the tax-year end.

However, many VCT providers offer the facility to bank your allotment for the next tax year. By putting the money up ahead of time, it is possible to secure the best-quality investments and know that you have a further 30% tax reclaim “in the bag” to look forward to.

John Clamp, chartered financial planner at Citimark, the adviser to private clients, trustees and corporates.