This time of year is particularly busy in the world of financial advice as we focus on maximising planning opportunities before the end of the tax year. This planning can often involve significant investment especially when you consider that a couple maximising their 2018/19 pension and ISA allowances would be investing a minimum of £120,000. This amount can easily be more if they are looking to take advantage of unused pension allowances from previous years.
These larger, one-off actions can make a significant impact to a client’s tax position immediately. As such, it is easy to focus on this type of planning, but this should not be at the expense of the smaller opportunities. On the face of it, these smaller opportunities may seem too insignificant to give attention to however, when compounded over the longer term, they can make an equally large impact upon a client’s financial position.
The remainder of this article focuses on two areas where discipline in the little things can make a significant impact over time:
1. Regular Contributions
It is easy to set up a regular contribution into a pension or investment and forget to review it on an annual or bi-annual basis. Years can pass by and, without realising, that level of contribution effectively becomes less as inflation reduces its value over time. For example, a regular contribution of £50 per month back in 1965 would have been equivalent to £960 per month. Today, £50 would not even cover half of the average monthly council tax bill!
One of the best ways to fight the impact of inflation is to set a fixed or inflation-linked automated increase to a regular contribution, usually annually. By committing to future increases now, you are less likely to cancel or adjust them in the future. In the same way, you are unlikely to increase your contributions if they are not reviewed periodically. This is a behavioural economic principle called ‘inertia’ which is discussed in the excellent book ‘Misbehaving’ by Richard H Thaler.
To illustrate the impact inertia can have on your savings over time, below is a table based on commencing a regular monthly contribution of £1,000 per month over 25 years with a 3% net annualised investment return. One contribution stays level whilst the other increases at a fixed amount of 2.5% per annum.
|Contribution Type||Total Contributions||Growth (% pa)||Final Value (Growth 3% pa)|
|Increasing (2.5% pa)||£410,747||3%||£589,798.95|
As you can see, by setting an automated increase to the regular contribution, it results in additional savings of more than £110,000 over 25 years and increases the final investment value by more than £140,000.
2. Annual Gifting Exemption
When carrying out estate planning it is a similar story. A lot of our conversations revolve around making large gifts either to family members or into trust. These actions can help save significant amounts of inheritance tax on any person’s estate over the longer term. However, it is easy to forget the relatively small annual gifting exemption of £3,000 which is available to everyone. In addition, this exemption can be carried forward one tax year (if unused). These gifts do not take any time to leave one’s estate and therefore result in an IHT saving of 40% of the value gifted, immediately. Though this might seem small initially, the below table shows the value of a couple making these gifts over a ten-year period assuming the annual gifting exemptions have not previously been used:
|Gift Amount||IHT Saving|
|Year 2 to 10||£54,000||£21,600|
*Based on a couple who can carry their exemptions forward from the previous year.
As you can see, over ten years it is possible for a couple to make exempt gifts totalling £66,000. This equates to an IHT saving of £26,400 (40%) which is significant especially when added to the value of other larger estate planning opportunities.
In summary then, the above examples show that financial planning is just as much about being disciplined in the small things as it is in big things. When both (big and small) are combined and included as part of a client’s holistic financial plan, it will result in a greater chance of them meeting their long-term financial objectives, whatever they may be. If you are not already using the various allowances available to you or have not reviewed the level of contribution you are making into your pension or investment, then the end of the tax year is the perfect opportunity to do so.
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.