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Tax breaks and a luxury retirement: why the financial elite often miss out

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A promise for the future

He had risen steadily through the ranks of London's financial-services industry and, after many years, had amassed a substantial cash pile that he knew should be invested, rather than sitting in his bank account. But he had never given serious thought to saving for the long-term. With long hours and demanding clients, who had the time?

That changed this year when the executive made himself a promise after turning 55 - to make the best use of his money, and to do so in a tax-efficient way. Yet there was still a problem: even though he made his living from giving specialised financial advice, he knew little about streamlining his tax liabilities.

Global financial illiteracy

Every year, high earners find themselves at a loss when it comes to developing a robust, long-term savings plan with an optimal tax profile.

Research suggests that individuals are far less financially literate than expected - even if they have experience in the financial sector. In a renowned 2014 study that posed three basic questions to adults on compound interest, inflation and investing in the stock market, only 30 per cent of Americans, 50 per cent of Swiss and 53 per cent of Germans answered all three questions correctly.

As Professor Annamaria Lusardi, one of the study's co-authors, put it, "the world is flat... financial literacy is very low in the US and other countries as well".

Pension tax relief

Tax rules and regulations also change over time, making it harder to keep up with how these affect individuals' savings plans. In 2016, the introduction in the UK of new curbs on pensions tax relief in the form of the annual allowance taper produced outcries from wealthy individuals - as well as from their advisers and employers.

In a clear sign of the shifting terrain, the amount UK residents can put into a pension fund over their lifetime while still taking advantage of tax breaks, is £1.03m – down from a high of £1.8m in 2010.

"Unless you are a financial advisor yourself, you won't always be reading about all the rule changes - not to mention how to implement them," says Charlie Cai, a professor of finance at the University of Liverpool.

"There are a lot of things that change every day and that you then need to recalculate and rethink in your portfolio," he says. "For ordinary people - even if you have £1m or £2m, it is a full-time job managing this stuff yourself."

Little wonder that even sophisticated individuals defer putting in place a detailed, long-term wealth management strategy. Yet Mark Insch, Insurance Product Specialist at Citigold Wealth Management in London, argues that failure to act carries potentially heavy consequences.

"When considering UK resident clients, an inheritance tax liability could be awaiting them," he says. "They have already paid income and gains tax, and stamp duty on their homes but effectively 40 per cent of their estate could be going to the taxman if they do nothing."

Where are you going to retire?

Offshore bonds have emerged as one potential aid in planning for the longer term in a tax-efficient way. They are, in essence, insurance policies drawn up outside the UK, which makes them exempt from capital gains tax.

Second, they allow you to withdraw 5 per cent every year of the original sum invested – meaning that you can pull out your entire initial investment, tax-free, over 20 years. They also provide a convenient way for investors to diversify risk, with a considerable chunk of their net worth linked to their employer via company shares and other bonuses.

Meanwhile, individuals planning for the long-term can draw down the financial gains from the invested funds in the policy – these are free of UK tax legislation as long as they remain in the fund – at a later stage, and possibly at a time when they have a lower taxable income such as in retirement.

Yet few people feel prepared to go it alone. As Stuart Ward, Head of Insurance Products at Citigold Wealth Management says, "a lot of our customers are not familiar with the details that come with a UK pension".

That is often true of the many foreign nationals living and working in the UK. As Charlie Cai of the University of Liverpool points out, "if you are not from the UK and you want to invest in this country, you need to have people with local knowledge and understanding of the history and evolution of the system itself".

A second potential partner in planning for the longer term is guaranteed whole-of-life insurance policies. These allow individuals to provide loved ones with a sum of money to settle some or all of any Inheritance Tax liability on the deceased's estate.

"Legacy planning requires a holistic approach," says Mark. "A lot of our clients are high net-worth individuals who benefit from our advice. We can work alongside their tax advisors, when necessary, to help their families retain inheritance through forward planning."

Of course, choosing the right vehicle depends on the individual and their particular circumstances. "A lot will depend on the prevailing tax regime," says Stuart. "Just one key question is, 'where are you going to retire?'"

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