Personal Finance

Monday 28 July 2014

Be careful how you dodge the tax bullet on savings

Louise McBride

Published 06/04/2014|02:30

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Illustration: Tom Halliday
ELECTRICITY: Watch the bills

THE punitive tax on savings interest which kicked in at the start of this year has encouraged once-cautious savers to eye up investments they would never have touched in the past. Some of these investments come with enormous risk – and savers who jump in blindly could lose all of their money.

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"There is certainly a big increase in the number of savers who are seeking out alternative investments to deposit accounts," says Paul Earley, who heads up Kildare-based financial planners Earley Consulting.

"The combination of very low interest rates and 41 per cent Deposit Interest Retention Tax [Dirt – the tax paid on savings] means the after-tax return for many savers is not beating inflation. That's a big concern as the purchasing power of their money is being eroded over time."

The interest paid by banks on savings is a fraction of what it used to be a few years ago – yet savers are now losing almost half of this interest to tax. As well as being hit with 41 per cent Dirt, most people now have to pay 4 per cent PRSI on their savings interest. Up until January 2014, it was largely the self-employed who had to pay 4 per cent PRSI on their savings interest.

To get a reasonable return on their investment, savers have therefore been forced to look elsewhere and many savers are eyeing up shares, according to Earley. For conservative investors who have never dipped their toe in the stock market before, this can be dangerous territory. Furthermore, the amount of tax paid on any returns could be higher than the savings tax they were looking to dodge in the first place.

* Stock market newbies

People who move into shares for the first time often choose to invest in a share with which they are familiar, such as a household name or a well-known bank.

This approach has had disastrous consequences for many investors – particularly during the Irish banking crisis, when many people lost their life savings after pouring their money into a bank whose shares later tanked.

"Investors need to be very careful if they are investing directly in a portfolio of shares," says Earley.

"If the shares are not well spread geographically and in a number of different sectors, the risks are higher. If someone holds shares in three or four companies in the same sector and the same country, the chance of losing a lot of money is much higher than if they hold 20 individual shares in different sectors in different locations."

Another mistake often made by those new to equities is choosing a share which pays a dividend – on the assumption that dividend-paying shares are less risky than others. Again, the experience of the banking crisis shows that this isn't always the case.

You could also lose more than half of your dividend income to tax because you must pay income tax at your higher rate of tax, as well as the universal social charge and PRSI. Higher-rate taxpayers who move their savings into dividend-paying shares in a bid to dodge Dirt will therefore end up paying more tax on their dividend income than they did on their savings interest.

If you want to invest in shares that pay a dividend, it can work out more tax-efficient to do so through a gross roll-up investment fund, according to Vincent Digby, founder of the financial advisers, Impartial. You will still pay 41 per cent exit tax on your return – but the returns are allowed to build up tax-free within the fund for eight years.

Tax savings can be made on shares if you're purely investing in them with a view to making a profit when you sell them. If the shares have increased in value by the time you sell them, you will pay 33 per cent capital gains tax (CGT) on the profits – compared to the 45 per cent tax you would pay on any return made on savings.

Earley warns that "savers who are moving from cash to equities need to be very aware of the high risks involved as they are essentially moving from one end of the risk spectrum to the other."

If you're investing in shares purely for capital gain, choose your shares wisely and don't put all of your eggs in the one basket.

* Investment funds

Although absolute return funds (funds which aim to beat stock market returns) and low-risk funds might appeal to conservative investors, you won't usually be able to dodge the 41 per cent tax bullet with such investments. If you invest in a fund which is based outside the country or which is not regulated, the tax could be higher.

For example, if you invest in an unregulated offshore fund which is domiciled in the EU, the European Economic Area (EEA) or the OECD, you must pay tax at your higher rate of income tax, PRSI and the universal social charge on any income you receive from the investment – even if Ireland has a double taxation agreement with the country where the fund is based. You must also pay 33 per cent capital gains tax on any profits you make when you sell the fund.

Six smart ways to minimise your tax exposure

* Invest directly in non-dividend paying shares. You'll pay 33 per cent capital gains tax (CGT) on any profit you make when you sell those shares. Choose your shares wisely however so that you make a profit – and not a loss. Invest in a range of shares, so you don't lose all your money should one perform badly.

* Consider a medium-risk structured investment. "Merrion Capital's Kick out Bonds and Partial Protected Eurostoxx Bond are examples of structured investments which are not fully capital protected," says Paul Earley of Earley Consulting. "As investors' capital is at risk, and they are not wrapped in a life policy, any gains are subject to CGT at 33 per cent." Only invest in these products if you are comfortable with the risk that comes with them. When an investment doesn't come with a full capital guarantee, you can lose some or all of the money you invest.

* Invest more money in your pension. "Both income and capital gains within a pension fund are completely tax free, and the compounding effect of tax-free growth over time is very powerful," said Earley. Furthermore, if you are a higher-rate taxpayer, you also get 41 per cent tax relief on any money paid into a pension – up to certain limits.

* Invest in property. If you buy an investment property before the end of this year, you won't have to pay CGT on any profit you make on the sale of that property – as long as you hold on to it for seven years. You will usually have to pay tax on any rental income you receive however – but if you make a big tax-free profit after seven years, that profit could dwarf the tax you paid on rental income. Choose your property and location well however – if the market value of your property doesn't increase over time, you won't have any CGT to pay because you won't have made a profit. So you'll get no benefit from the CGT exemption.

* If you are a cautious saver, but have not yet put your money into any of the State savings schemes, doing so could be your best way to escape the tax on savings interest. "In terms of tax-efficient investments, the various State savings schemes are currently our top pick," said Vincent Digby of Impartial. The annual return on the three-year savings bond is 1.32 per cent but as this interest is earned tax-free, the rate is higher than it seems. "If paying DIRT and 4 per cent PRSI, a bank deposit for the same period would need to make an annual return of 2.37 per cent to be equivalent," said Digby. Similarly, the four-year National Solidarity Bond pays 1.47 per cent interest a year – but as this return is tax-free, a bank would need to pay 2.62 per cent interest a year to match it, according to Digby. "Remember, you need to hold these products to maturity or you do not receive the full rate of return," he added.

* If you're feeling adventurous, you might be tempted to put some money into spread betting, where you essentially bet on the movement of shares. You don't pay any CGT on winnings from spread betting. Neither do you pay any stamp duty or betting duty, according to a spokeswoman for the Revenue Commissioners. Spread betting is very risky however – and by no means should you ever consider putting too much money into it.

Only bet money that you can afford to lose.

'Cheaper' energy plans can start you off on higher bills

If you're considering switching to a cheaper gas or electricity provider, it's important that you understand what you're signing up to.

To get some of the best discounts out there, you may have to sign up to a monthly budgeting plan, where you pay a set amount for your gas and electricity every month, regardless of the time of year.

However, your bills could initially be slightly higher than average under such plans.

Under the Bord Gais 'Level Pay' plan, for example, your set monthly payments are based on your most recent energy usage and how much you used over the last year.

According to the terms and conditions of Bord Gais Level Pay, "an initial tolerance, typically 20 per cent, is added for variations in your usage".

This means the first few bills you receive could be about a fifth higher than average – although your monthly payments can be changed later on to reflect any higher or lower energy usage.

"At the end of the first year and annually thereafter, any balance of over or under payment will normally be allocated to the next year's monthly payments except if the amount is judged by Bord Gais Energy to be excessive," state the conditions of the plan.

"If this is the case, then Bord Gais Energy will require payment of the balance or reimburse the balance prior to continuing the facility in the following year."

If you find that the monthly payments initially set for you under a budget plan are too high, you should ring the energy company, advise them of your average bill – and agree a new payment.

Cosmetics thrive in spite of selfie craze

So far, the "no make-up selfie" craze doesn't seem to have impacted make-up sales.

Make-up certainly didn't lose its appeal to consumers over the last year, according to a new study of the value of cosmetics brands.

The total brand value of the world's top 50 cosmetic companies rose by almost 5pc over the last year, according to the study by the brand valuation consultancy, Brand Finance.

Brand value is a measure of the strength and potential of a brand. So if we take this study as an indication of the make-up brands we spend our money on, what brands are most popular?

The world's most powerful cosmetics brand is L'Oreal, followed by Avon, and both of the companies saw their brand value increase by 24pc over the last year.

Estee Lauder and Lancome also feature amongst the 10 most powerful cosmetics brands in the world, while Elizabeth Arden and Yves Saint Laurent are less popular.

American and French brands dominate the list of Top 50 cosmetics.

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