Where to put Tax Savings?

[innocuous]

Hi,

My wife is self employed and has some tax savings to meet her tax obligations. As the tax is taken on account each year, her existing savings from that year always meet the requirements of the tax on account....so her tax savings from her first year have never yet been touched as they will be collected when she stops working - i.e. she stops working she will have to settle her last tax bill whilst she is not earning and that will complete the cycle.

So we have about 12k that is sat boringly doing nothing in a savings account and I am wondering how to get that money working in a reasonably low risk way. My first thought was to buy some form of UK Government bonds, maybe inflation linked if I can find something or a decent ETF to spread the risk further. Vanguard U.K. Government Bond Index Fund - Accumulation for example.

With the talk of negative interest rates, still don't think it will actually happen, there is an intrinsic risk of keeping the money even in a basic savings account so doing something with the money would seem to make sense for me. What would you guys invest this money into?

Thx

Jon

PS - I have quite high earnings, as does my wife, plus we have about 70k stashed in ISA's and Trading accounts in a gone-fishing style investment strategy so the risk of the 12k losing value from an significant event is absorbable.

[JohnW]

ETF to spread the risk further

What risk do you have in mind that an ETF is going to reduce further, that exists with a government bond? I don't seem any significant shortcoming in a single or several government bonds.
Secondly, £12k seems a small-ish amount of money to be pondering over in view of how much seems to be sloshing around your household in earnings and savings, and the liability for it possibly a good few years off?

[Adamski]

We have investments in - premium bonds which have a prize rate now of 1%, or if happy with some risk: Capital Gearing Trust or Vanguard LifeStrategy 60, which both have similar performance, 40% bonds and low volatility.

[johnhemming]

It is actually a difficult issue and is a special case of handling cash flow issues whilst maintaining a sensible risk balance and obtaining at least some return.

If the tax bill is the tax year ended earlier this year the first payment based upon this is likely to be the end of January and my view is to leave it as cash in some form of deposit account. Although I expect things to be more positive by then given that a chunk of cash needs to be paid then it is probably best not to have any cash flow worries.

[innocuous]

It is actually a difficult issue and is a special case of handling cash flow issues whilst maintaining a sensible risk balance and obtaining at least some return.

If the tax bill is the tax year ended earlier this year the first payment based upon this is likely to be the end of January and my view is to leave it as cash in some form of deposit account. Although I expect things to be more positive by then given that a chunk of cash needs to be paid then it is probably best not to have any cash flow worries.

This isnt a problem of working out where to put the money until Jan. We have that put aside in a savings account. When you are self employed there is always a bit of money that you have because you are in effect behind on paying Tax even though you are meeting the Tax man's timings. This mean that the 12k probably wont need to be touched until my wife stops working in 25+yrs. She is always earning enough month by month to pay the next tax bill, but when she stops working she could easily have stopped working and have a final tax bill 5 months later. The 12k covers the gap of the rolling tax bill.

Stashing 12k in a bond and earning compound interest on it at say 5% for 25yrs would yield interest of about 30k - worth having I would have thought.

I am guessing by the comments therefore that a government bond or the Capital Gearing Trust is likely the best way to go. CGT seems expensive though at a annual charge of 1.71%.

[johnhemming]

Stashing 12k in a bond and earning compound interest on it at say 5% for 25yrs would yield interest of about 30k - worth having I would have thought.

There are various options, but apart from Government Bonds which have their own form of risk (but not for paying tax necessarily) they all have a range of risk options.

VSL for example and DGOC both pay over 10% (but some tax is deducted) and you need to make a risk assessment.

I think preference shares are running at around 6% interest at the moment.

The danger on "risk" is that there is always also a risk of inflation.

[PinkDalek]

I am in a similar boat and have started to use Premium Bonds for tax liability. ...

The OP is talking about 25 years, not short term.

[Dod101]

It is actually a difficult issue and is a special case of handling cash flow issues whilst maintaining a sensible risk balance and obtaining at least some return.

If the tax bill is the tax year ended earlier this year the first payment based upon this is likely to be the end of January and my view is to leave it as cash in some form of deposit account. Although I expect things to be more positive by then given that a chunk of cash needs to be paid then it is probably best not to have any cash flow worries.

This isnt a problem of working out where to put the money until Jan. We have that put aside in a savings account. When you are self employed there is always a bit of money that you have because you are in effect behind on paying Tax even though you are meeting the Tax man's timings. This mean that the 12k probably wont need to be touched until my wife stops working in 25+yrs. She is always earning enough month by month to pay the next tax bill, but when she stops working she could easily have stopped working and have a final tax bill 5 months later. The 12k covers the gap of the rolling tax bill.

Stashing 12k in a bond and earning compound interest on it at say 5% for 25yrs would yield interest of about 30k - worth having I would have thought.

I am guessing by the comments therefore that a government bond or the Capital Gearing Trust is likely the best way to go. CGT seems expensive though at a annual charge of 1.71%.

Do you know that in 25 years time the tax regime is going to be the same? Even if so, you cannot know what the tax liability will be. I suppose since, as taxable profits will vary, then so will the tax on them. What you seem to be looking for then is some form of secure long term investment which can be expected to grow in value over that period. Thus some sort of Investment trust would seem suitable but I would not go for something like CGT. Your wife can afford to hold something a little more adventurous. In fact most international generalist trusts ought to fit the bill.

Dod

[dealtn]

So we have about 12k that is sat boringly doing nothing in a savings account and I am wondering how to get that money working in a reasonably low risk way. My first thought was to buy some form of UK Government bonds, maybe inflation linked ...

Seriously, how do you know that is low risk?

What kind of swings in value are you prepared to tolerate, that meet your low risk criteria? You could lose half your money in gilts over the next 10 years. Should that outcome occur are you sure you wouldn't rather of had the money sitting "boringly doing nothing in a savings account"?

You could even lose half your purchasing power in simply holding an index linked gilt to maturity.

[JohnW]

You could even lose half your purchasing power in simply holding an index linked gilt to maturity.

That will be alarming to some readers I imagine. Do you mean at this time, or as a general proposition?
Can you indicate what conditions would need to change, such as inflation rate and interest rates, in what direction and roughly in what sort of magnitude over a particular time period, to bring that concerning if not alarming outcome, please?

[dealtn]

You could even lose half your purchasing power in simply holding an index linked gilt to maturity.

That will be alarming to some readers I imagine. Do you mean at this time, or as a general proposition?
Can you indicate what conditions would need to change, such as inflation rate and interest rates, in what direction and roughly in what sort of magnitude over a particular time period, to bring that concerning if not alarming outcome, please?

Buy any Index Linked Bond with a price of >£200 and hold to maturity. That's pretty much all you need to do. (You will get a small income typically a 0.125% inflation linked coupon to offset that huge capital loss though!)

In fact I find it alarming that anyone buying such a bond doesn't realise that is exactly what will happen. You don't need any change in interest rates or inflation as you are holding it to maturity. If you didn't hold it to maturity you could lose more (or less).

https://www.fixedincomeinvestor.co.uk/x ... oupid=3530

Can anyone spot any Index Linked Gilts above 200 in price? Can anyone spot any Index Linked Gilts with prices below 100?

[JohnW]

Can anyone spot any Index Linked Gilts above 200 in price? Can anyone spot any Index Linked Gilts with prices below 100?

Yes and no. Well, yes to the first and no to the second.
Always informative.
You'd have to buy the wrong linker to lose half your money it seems. The one maturing in 2 years will rob you of £100 in principal, and even though I don't know how that relates to its negative yield of 2% (/annum presumably), then you can only lose another 4% in two years, at worst.
But mystifying is why another one with only about 4 years to run will cost you so much more in lost principal, despite a similar coupon. Mind boggling.

[dealtn]

Can anyone spot any Index Linked Gilts above 200 in price? Can anyone spot any Index Linked Gilts with prices below 100?

Yes and no. Well, yes to the first and no to the second.
Always informative.
You'd have to buy the wrong linker to lose half your money it seems. The one maturing in 2 years will rob you of £100 in principal, and even though I don't know how that relates to its negative yield of 2% (/annum presumably), then you can only lose another 4% in two years, at worst.
But mystifying is why another one with only about 4 years to run will cost you so much more in lost principal, despite a similar coupon. Mind boggling.

Ignore the 2 1/2% 2024, 4 1/8% 2030 and 2% 2035 as they are the only remaining old-style 8 month lag linkers that have a different methodology of price/yield (For those that don't understand the difference they are confusing and visual outliers).

The negative yields are annual, so imagine compounding at that -2%+ rate annually and you see the destruction, rather than preservation of purchasing power that most seem to associate with linkers.

Whether it is misunderstanding, reliance on past performance, or something else I don't know, but the default position is that Gilts are les risky, less volatile, don't lose money etc. when the reality is that they can be extremely volatile (check the price action in some Gilts in the space of a month earlier this year), and can lose significant monies (check some of the annual returns of the asset class - admittedly mostly a long while back).

This perhaps isn't the thread to go into any further detail. A long position in Gilts can still have the potential for large gains, should we see significant moves into negative interest rates, and perhaps associated deflation. However significant losses are possible too should interest rates rise, or inflation return on a much bigger scale than now priced in. What do you think more likely a continuation of recent history, or a return to a period of more "normal" interest rates? The capital return position between those 2 "extremes" could be vast.

[JohnW]

the one maturing in 2 years will rob you of £100 in principal

Pick the obvious mistake.....
The linker maturing in 2 years, now costing £100 will be redeemed for ........I have no idea how you know what the inflation adjusted face value is from that table, but presumably £100 as a minimum. Or do I really not understand linkers? So you'd only be robbed ?£10, and slugged with negative 2% interest each year for two years.

[dealtn]

the one maturing in 2 years will rob you of £100 in principal

Pick the obvious mistake.....
The linker maturing in 2 years, now costing £100 will be redeemed for ........I have no idea how you know what the inflation adjusted face value is from that table, but presumably £100 as a minimum. Or do I really not understand linkers? So you'd only be robbed ?£10, and slugged with negative 2% interest each year for two years.

To make the maths easy, assume current RPI Index is 100.

Buy £100 nominal of that linker and it will cost about £110. You will get back an inflation adjusted £100 on maturity, so will lose £10 (inflation adjusted). You will get some compensation from receiving (inflation adjusted) coupon of 1.875% in that nearly 2 years, lets call that £3.75.

So -110 +100 + 3.75 = -£6.25 and £6.25/£110 is a loss of about 5.7% over 2 years or about 2.8% annually.

The maths is more complicated than that, but that shows approx. how the real yield of 2.9% is calculated.

The point is that regardless of what happens to inflation, and the actual returns and cash flows in £s that is what the inflation adjusted return is. If prices doubled in 2 years (extremely unlikely) the linker will give a vastly superior return to a conventional gilt, but what your £110 could buy in the way of goods today would then cost £220, and your linker investment return would be about 5.7% short of that, so your purchasing power has been eroded.

Over 2 years you lose about 6%, over 5 years about 15%, over 10 years 25%. I think earlier in the thread a 25 year time horizon was mentioned, that would be an approx. 50% loss.

[mc2fool]

the one maturing in 2 years will rob you of £100 in principal

Pick the obvious mistake.....
The linker maturing in 2 years, now costing £100 will be redeemed for ........I have no idea how you know what the inflation adjusted face value is from that table, but presumably £100 as a minimum. Or do I really not understand linkers? So you'd only be robbed ?£10, and slugged with negative 2% interest each year for two years.

Yeah, I found it all confusing at first glance, but then you have to spot the note above the table: "Prices shown for the "conventional" IL gilts are "real" prices. The "new" or "Canadian style"Il gilts are shown clean. The real dealing price for the latter will be subject to adjustment by the "index ratio". "

So, the prices for the "conventional" ones are the actual prices you'd pay in the market, whereas the "new"/"Canadian style" ones show unadjusted-for-the-inflation-upgrade prices. This is a little further explained in https://www.fixedincomeinvestor.co.uk/x ... tml?id=206

"The next complexity for investors to get their heads round is the pricing convention. “Old-style” linkers trade on an inflation adjusted basis. ... However, the “type two” or “Candian-style” linkers trade on what is known as a “real price” basis. This means that the inflation has been stripped out and as a result prices tend to gravitate around par. However, when the bonds are settled, the consideration will reflect the accrued inflation.".

I suppose the advantage of the new approach is that you can see at a glance that, e.g. the TSY 0 1/8% 2024 I/L Gilt at £110.563 is running at £10.563 above par, whereas with the old approach with the TSY 2 1/2% 2024I/L Stock at £358.557 ... well, if you click on it you'll see that the (8 month lagged) RPI was 97.67 when it was issued in 1986, and now (March) it is 292.6, so inflation-adjusted par would now be £299.58 ... if I got that right!

[JohnW]

Excellent.
Gentlemen, or whatever you are, we thank you.

[hiriskpaul]

PS - I have quite high earnings, as does my wife, plus we have about 70k stashed in ISA's and Trading accounts in a gone-fishing style investment strategy so the risk of the 12k losing value from an significant event is absorbable.

This part is key. Instead of compartmentalising the £12k, think of it in terms of your overall asset allocation, saving and spending plan. If you had £1m in ISA's, the one off £12k tax bill is neither her nor there and can easily be settled without too much concern over the current value of your investments.

If you had zero savings, than the £12k debt is far more important. I understand that you don't think it will be payable for many years, but stuff happens to upset the best laid plans and you might end up having to pay the debt earlier than you had hoped. Keeping the whole lot in a cash deposit would likely be the best scenario.

As you have £70k saved and say "the risk of the 12k losing value from an significant event is absorbable", I think you would be better off adding most of the £12k into your "gone-fishing" portfolio and leaving a smaller amount, say £2k, on cash deposit.