Interactive Investor

What are your financial blind spots?

When it comes to growing or protecting your wealth, some of the biggest opportunities and threats can often go under the radar. Craig Rickman examines five financial blind spots for you to consider.

11th August 2023 08:54

by Craig Rickman from interactive investor

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In 1987, Belgian Rudy Beckers - inspired to stop his wife jumping out the car to safely direct him out of parking bays - invented the parking sensor.

It proved a seminal moment for the motor industry, with parking and motion sensors now ubiquitous in modern vehicles. We know we should check for blind spots when we reverse or switch motorway lanes, but not everyone does it all the time. Beckers’ creation is an invaluable bulwark against the risk of catastrophe.

Blind spots are evident in other parts of our lives too, such as our finances. But the technology to detect them is not yet developed. It’s therefore incumbent on us to frequently check that we’re doing the right things.

Failing to identify financial blind spots can be expensive. You could be hit with a heavy tax bill or fail to save enough for retirement.

But how do you know what your blind spots are? Here are five questions that might help detect some common ones.

1. Are you making the most of your company pension?

It’s fair to say auto enrolment has been one of personal finance’s biggest recent success stories.

Between 2012 and 2022, the number of employees paying into a pension scheme more than doubled, soaring from 42% to 88%.

The way that auto enrolment works is simple: if you pay 5% of your salary into a pension, your employer must pay in 3% (provided certain criteria are met). This is a legal requirement. However, these are only minimum contributions levels, and many employers offer to pay in much more – though they might require you to match their contributions.

According to government statistics, in 2021 55% of eligible employees received employer contributions that were higher than the minimum. However, the Financial Conduct Authority’s Financial Lives survey found over a third (37%) of savers contributing to at least one defined contribution pension are unaware of how much is being paid into their pot.

Making the most of your company pension can make a significant difference to your lifestyle in retirement as your employer is doing a share of the legwork for you. It’s worth speaking with your employer to find out how much they’re prepared to put in. You might get some free money that you weren’t aware of.

2. Have you thought about inheritance tax?

No tax rankles Brits quite like inheritance tax (IHT). Almost every time we’re asked to name which tax we loathe the most, IHT comes out on top. There is a collective sense that HMRC grabbing up to 40% on inherited wealth is deeply unfair.

But before you worry about IHT and its potential impact on your legacy, it’s worth finding out whether it’s actually a problem for you or not. You may be surprised to learn that only 4% of estates pay the tax.

A big reason for this is that you can take steps to mitigate IHT, or perhaps even avoid it completely. That said, IHT rules are not your friend here - some parts are extremely complex. The residence nil rate band’s (RNRB) introduction in 2017, while boosting some homeowner’s tax-free threshold to £1 million, has made things cloudier rather than clearer. For starters, it only applies if the house passes to direct descendants such as children and grandchildren. What's more, the RNRB reduces by £1 for every £2 on estate values over £2 million.

And with tax-free IHT thresholds frozen until 2028, and perhaps even beyond, while you may not have an IHT liability now, that could change in a few years’ time. More and more estates are getting caught out every year. As with any sound financial plan, the key is to assess your situation frequently, and get expert advice if you need it.

3. Are you using the right ISA for your goals?

Individual Savings Accounts (ISA) are the cornerstone of any savings and investment portfolio. That’s because any gains, interest or dividends are sheltered from tax, and you can access the money whenever you want.

But while the way ISAs work is relatively straightforward, the tax wrapper’s landscape has become needlessly complicated. There are now four to choose from - five if you include Junior ISAs – and selecting the wrong one can be costly.

During the 2021-22 tax year, savers and investors poured more than £72 billion into ISAs. And by far the most popular types were cash, and stocks and shares, attracting £36.8 billion and £33.7 billion, respectively.

But saving tax is one of several considerations when choosing the right financial product. Another is to make sure the level of risk is suitable for the goal you aim to achieve.

For instance, the stock market typically outpaces cash savings over longer time frames. So, if your goal is more than five years away, a Stocks and Shares ISA might be your best bet. Keeping your money in a Cash ISA can harm how quickly your money grows. That’s because if the interest rate you receive is lower than inflation, the value of your money can erode in real terms.

But if your goal is more immediate, for example to fund a wedding in a year’s time, then sticking your ISA savings in the market could give you a nasty surprise down the line. Stocks and shares can be volatile over shorter periods, and if markets performed badly over the next 12 months, you could end up with less than what you put in. This could throw your dream wedding into jeopardy. Therefore, a Cash ISA might be a better option here.

4. Is your business really your pension?

From flexibility and autonomy to no earnings cap, running your own business can come with many perks.

But one of the downsides of being self-employed is that you don’t have access to auto enrolment. The task of saving for your retirement rests firmly on your shoulders.

Some of you may view your business as your pension. And while your company may have significant value that could be realised into a juicy lump sum upon its sale, there can be risks to this approach.

First, there is no guarantee that your business will fetch the price you hope and expect when you come to sell it. Second, it means your retirement lifestyle is anchored to a single outcome; if things don’t pan out as expected, do you have a plan B?

Third, it’s important to be aware that a chunk of your sale proceeds could be swallowed up by capital gains tax (CGT). Business asset relief (BAR) may work in your favour here, as it halves the top rate of CGT from 20% to 10%. But in 2020 the BAR’s lifetime limit was chopped from £10 million to £1 million, which means more business sales are subject to higher tax.

A further blind spot is that you might be missing out on some prudent tax planning. The biggest of April 2023’s tax hikes landed at the feet of business owners, with the top rate of corporation tax jacked up from 19% to 25%.

But an effective way to reduce your limited company’s tax bill is to make pension contributions via the business, as these are classed as an allowable business expense. This means that not only can you save up to 25% in corporation tax, if you planned to draw that money as salary, you can save on national insurance too.

Furthermore, building up your pension can provide some useful diversification to your future retirement funds.

5. Are you paying too much in charges?

There’s no getting around it; when saving and investing for your future, costs really do matter. The more you pay in fees, the harder your money needs to work to grow. In fact, numerous studies have found that cost is the biggest predictor of investment returns.

It’s therefore prudent to periodically review what you pay for your investment portfolio. And you must look at the whole package. This includes the platform(s) that you use, any products such as SIPPs and ISAs, the management fees of funds and investment trusts you invest in, and any trading costs.

If you have sought financial advice, it’s wise to understand the costs for this too, and decide whether you feel it offers value.

That doesn’t mean your sole objective should be to hunt around for the cheapest options. You still need to make sure you can manage your portfolio in the way you want to.

But if you’re paying over the odds, it may take you longer to reach your financial goals. And you could even fall short.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.

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