Saving money is an age old principle that acknowledges we need to work hard to achieve our goals and plan prudently for unexpected events/disasters.
Savings enable us to accommodate surplus capital which can then be expended on our stated goals, to improve our lifestyle, utilised as an emergency fund, or to help other family members.
Collective Investment Schemes
A collective investment is one where many people’s investments are pooled into one large fund. A collective investment allows the investor to share in the investment returns of the pooled fund which is professionally managed.
This enables an investor to have a wide spread of investments in one fund that often would not otherwise be cost effective to achieve on their own. The main benefits of using a Collective Investment Fund is the resulting diversification and professional fund management offered by the underlying product provider.
Typical examples of Collective Investment Funds are:
- OEICs (Open Ended Investment Companies), Unit Trusts and UCITS (Undertakings for Collective Investment in Tradable Securities)
- Insurance Company funds, such as those availalbe in pension plans and Investment Bonds
- Investment Trusts
- Offshore Funds
Open Ended Investment Companies (OIECs)
Most people choose to invest in an investment fund rather than buying shares directly. An OEIC is a popular option because it provides professional management.
To invest in an OEIC you buy shares in the company. Its business is managing the investments of its shareholders. As investors buy and sell shares, the size of the fund grows or reduces. The OEIC does not have a set end date and is not limited by size. Hence it is known as an open ended fund.
The investments making up the fund of the OEIC are valued and each share represents an equal part of the investments. To pay for the the research, investment expertise and administration of the investments in the OEIC fund, an annual management charge is applied.
Unit Trusts are a common form of collective investment where investors money is pooled and invested into a variety of assets in order to provide professional management. Its capital structure is open ended as units can be created or redeemed, depending upon demand from investors.
Unit Trusts are open ended funds meaning that the size of each fund can vary according to supply and demand. Unit Trusts provide a mechanism of investing in a broad selection of shares, thus reducing the risks of investing in individual shares. Typically, a Unit Trust is worth anything from £5m to £300m. There are thousands of Unit Trusts and hundreds of OEICs to choose from, so it is important to select the right fund to meet your needs.
When you invest in a Unit Trust you buy a unit, which means a portion of the total fund. Each Unit Trust has its own investment objective and the fund manager has to invest to achieve this objective.
Unit Trusts are separated into categories so they can be compared against other funds with similar objectives and underlying assets, for example, Japan Smaller Company funds are grouped together.
The fund manager will invest the money on behalf of the unit holders. The value of your investment will vary according to the total value of the fund, which is determined by the investments the fund manager makes with the fund’s money. To cover the costs of running a fund you will usually have to pay an initial charge when units are purchased, and an annual fee for ongoing costs such as professional management and administration. Some fees are declared as a percentage of your investment, others are built into the price. You can invest into a Unit Trust through an ISA (Individual Savings Account). Usually, there are no additional charges for having an ISA, and you have the advantage of the investment being tax-free.
How will I be taxed?
Unless you are holding your Unit Trust or OEIC within an ISA (Individual Savings Account) or PEP (Personal Equity Plan), or you are a non-taxpayer, you may be liable to tax on the income and capital gains.
Any capital gains made within the fund are not taxed and although you are liable to CGT (Capital Gains Tax) when you cash in the units, you will not have to pay tax if the total gains you make from all your saving in the tax year are within your annual CGT allowance.
Income from Unit Trusts and OEICs is liable to tax, but the tax is deducted before the income is paid out so basic rate taxpayers will have nothing further to pay. Higher rate taxpayers are liable for extra income tax.
An investment trust is a company in which shares can be bought, and which must be quoted on a Stock Exchange, usually the London. It is a ‘pooled’ investment, with many investors owning shares in the same trust.
The investment trust makes its profits by investing in the shares of other companies rather than by manufacturing a product that it then sells. There are no specific investment restrictions for investment trusts, therefore some investments trusts are heavily invested in unquoted securities or the riskier emerging markets.
An investment trust has a fixed issued share capital, which means that the number of shares allowed in an investment trust is fixed – it is a close-ended fund.
The value of the shares in an investment trust is determined by stock market conditions, and the value may fall or rise and is not guaranteed.
Investment trusts can trade at a premium or a discount to the actual value of its underlying investments.
Investment bonds are designed as a medium- to long-term investment product, and can be used to give you an income. They also include some life cover.
The bond includes a small amount of life assurance and, on death, will pay out slightly more than the value of the fund.
For most investment bonds, you take the risk of losing some money for the chance of making more than you could get from putting money in a savings account. Some investment bonds offer a guarantee that you won’t get back less than your original investment, but this will cost you more in charges.
Any growth in investment bonds is subject to Income Tax. The investment will pay tax automatically while it is running so, if you are a:
- non-taxpayer – you will not have to pay any further Income Tax but you cannot reclaim any tax;
- basic-rate taxpayer – you will not normally have to pay any further Income Tax; and
- higher-rate taxpayer (or close to being one) – if you withdraw more than 5% of the original investment amount in a year or you have made a profit when you cash in the investment, you may be liable for more Income Tax.
Depending on your circumstances, the overall amount of tax you pay on investment bonds may be higher than on other investments (like a unit trust, for instance). But there may be other reasons to prefer an investment bond. For example it may be that the policy can provide a tax-deferred income (see below) where other investments would incur an immediate tax liability. Or you may want to set up the investment within a trust as part of your inheritance tax planning (but note that you normally lose access to at least some of your money if you do this).
You can usually take out some or all of your money whenever you wish but there may be a charge if you take money out in the early years.
You can normally withdraw up to 5% of the original investment amount each year without any immediate Income Tax liability. The life assurance company can pay regular withdrawals to you automatically. These withdrawals can therefore provide you with regular payments, with Income Tax deferred, for up to 20 years.
Individual Savings Accounts (ISAs) are tax efficient because investors pay no capital gains tax or income tax on returns and are intended to encourage savings.
ISA’s are a very popular form of investment and are key building blocks for long term wealth accumulation.
ISAs offer a choice of investments in:
- Cash Deposit funds – maximum annual contribution £5,340 (2011/12).
- Equity Based funds – Stocks & Shares, including Unit Trusts, OEICs and Investment Trusts – Maximum contribution of £10,200.
- The overall maximum permitted contribution is £10,680 (2011/12) to both Cash and Equity ISAs. Cash ISAs can be transferred into Equity ISAs but not the reverse.
- Where there is a temporary facility to hold cash in an Equity ISA the interest is taxable at the basic rate of tax.
Every country has a unique set of tax regulations. So, depending on your circumstances and where you live, offshore investing could make a big difference to your personal finance plans. In addition to potentially saving taxes, some funds based offshore give you investment opportunities that stem from a far wider range of markets than onshore funds. It’s important to note that the minimum investments level are often much higher than UK-based funds.
Offshore investing can be a big attraction if you’re a more adventurous investor, and you’re willing to take greater levels of risks with your money. But while there can be upsides to Offshore Investing, it’s important to remember that investment opportunities based offshore are sometimes not covered by the regulations we look to for guidance in the UK. And on top of that, currency fluctuations may affect their value, too. Making plans for offshore savings is not straightforward, but with expert guidance, it can be highly beneficial.
Cash Deposit Accounts
Bank & Building Societies – Instant Access / Fixed Term
Banks and Building Societies pay interest on the funds deposited with them by Investors.
The amount of interest paid is determined by competitive market rates which take into account the Bank of England base rate and the term selected. Usually, the longer the term the higher the interest rate.
Investors who deposit funds with Banks and Building Societies who belong to the Financial Services Compensation Scheme (FSCS) are individually covered up to £85,000 with each Banking Group.
The credit crunch of 2007/2008 hughlighted the prudence of spreading your cash assets with several deposit takers in order to reduce the risk of a default.
National Savings products offer total security for any capital you invest as they are backed by the Government. However, interest rates tend to be lower than those offered by Banks and Building Societies.
Guaranteed Growth Bonds and Guaranteed Income Bonds are usually issued in either 1, 3, or 5 year terms and basic rate tax is deducted at source.
Income Bonds pay a lower rate of interest as they offer easy access without penalty and interest is paid gross but is subject to income tax.
Fixed Interest Certificates and Index Linked Certificates are issued on fixed terms of up to 5 years and are paid free of tax.
Children’s Bonus Bonds offer tax free compound interest over 5 years at a fixed rate and can rollover until 21st birthday.
There are limits on the amount you can invest. The Financial Services Authority does not regulate National Savings.
Gilts are British Government bonds that can be bought and sold on the stockmarket.
Various types are available, most have fixed redemption dates. A few, issued during times of crisis, are undated and will probably never be redeemed. In the case of dated gilts, the investor knows how much the Government will pay to redeem the bond and precisely when that payment can be expected. In the meantime, investors requiring access to capital can sell them on the stockmarket.
The price obtained may be more or less than the Government would pay on redemption, depending on such variables as interest rates and the rate of inflation. Capital losses are therefore possible.
For individuals, gilts are exempt from capital gains tax, so profits are tax fee and losses are not tax deductable. Any accrued interest in the sale proceeds is liable to income tax.
By putting money aside on a regular basis you can accumulate wealth in order to use at some future date.
Typical investments suitable to regular savings are:
- OEICs/Unit Trusts
- Investment Trusts
- MIPs (Maximum Investment Plan)
- Friendly Society Plans
Enterprise Investment Scheme (EIS)
The Enterprise Investment Scheme (EIS) is designed to help smaller higher-risk trading companies to raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies.
Income tax relief: 30% (2011/12) of the cost of the shares, to be set against an individual’s income tax liability for the tax year in which the investment is made. Relief can be claimed up to a maximum of £500,000 invested in such shares, giving a maximum tax return in any one year of £150,000 providing you have sufficient income tax liability to cover it. Relief cannot be offset against dividend income and the shares must be held for 3 years otherwise tax relief will be withdrawn.
Capital Gains Tax Exemption: If you have received income tax relief (which has not subsequently been withdrawn) on the cost of shares, and the shares are disposed of after they have been held for a period of 3 years, any gain is free from Capital Gains Tax.
Capital Gains Tax Deferral: The payment of tax on a capital gain can be deferred where the gain is invested in shares of an EIS qualifying company. The gains can arise from the disposal if any kind of asset, but the investment must be made within the period 1 year before or 3 years after the gain arose.
There are minimum or maximum amounts for deferral. Unconnected investors may claim both income tax and capital gains deferral relief.
There is no minimum period for which the shares must be held (to qualify for CGT deferral); the deferred capital gain is brought back into charge whenever the shares are disposed of, or are deemed to have been disposed of under EIS legislation.
Loss Relief: If the shares are disposed of at a loss, you can elect that the amount of loss, less any income tax relief given, can be set against income of the year in which they were disposed of, or any income of the previous year, instead of being set off against any capital gains.
Inheritance Tax Exemption: EIS investments are generally exempt from Inheritance Tax if held for at least 2 years.