Reply to: Investing company assets in OEICs/Unit Trusts

[dude69]

This article is based on the same principle:

http://www.telegraph.co.uk/money/mai...3/cmfees13.xml

They are arguing that the cost of a mortgage, at say 5% interest, is less than the return from a pension, which is 7-8%, tax-free, and with tax relief as well, it actually makes sense to borrow money now (increase your mortgage), and defer paying it off until 55, at which point the tax-relief from the pension contributions in the form of the 25% lump sum will pay it off.

The problem with this strategy is it is predicated on the lump sum still being available at that point - while I, age 25, can borrow money at ~5%, fixed for 25/30 years, there is no guarantee that the government will still let me get my money out of my pension at that point.

The idea is not to borrow to invest, but to borrow to spend, which might reduce your income as well.

[Lewis]

I agree entirely. I certainly wasn't advocating taking more dividend in order to have money to pay capital off the mortgage.

Yep I agree completely as well.

One concern at the back of my mind about keeping large reserves in the company bank account is legislation such as IR35 and MSC, where if it's in the company HMRC may demand it. A bird in the hand and all that. But I think as long as one is sure they are IR35 and MSC safe they shouldn't worry about that.

[ASB]

True, but it's not really sensible to be a higher rate tax payer, which is voluntary for most of us, unless you need the money.

I agree entirely. I certainly wasn't advocating taking more dividend in order to have money to pay capital off the mortgage.

[dude69]

It's not really a question of where the money comes from anyway. The comparison is:-

Pay 1000 of mortgage, save 60 quid in interest. Implicit return = 6%. Save 1000 get return of 10% (i.e. 100 quid) only actually receive 60 quid.

True, but it's not really sensible to be a higher rate tax payer, which is voluntary for most of us, unless you need the money.

So it's not so much a choice between saving the money at 3.6% net or putting in mortgage at 6%, as not paying the dividend at all. It's not which is better, but whether you should have the money at all (because you are taxed at 25% on it).

[Lewis]

So in terms of ISA versus mortgage, if both have the same rate, then for a basic rate tax payer, the return is identical. BUT, you can always pay off your mortgage in the future, whereas your ISA is gone forever, and with identical returns, the use-it-or-lose-it ISA tax shelter is more valuable.

The problem is I think a Cash ISA is unlikely to ever outperform or even match the offset mortgage interest, which means you are worse off having a Cash ISA. I can see how a shares ISA can outperform but the person should always be aware that they are borrowing money from their mortgage to speculate on the stock market, which is an individual investors decision.

There is a large benefit to offsetting if you intend to pay off more than £7K of your mortgage each year or have significant savings already, but I can appreciate having an ISA if it is performing well. I certainly am not saying don't have one. I personally just haven't found one that makes it worth it yet (I don't want to speculate on stock market).

For a higher rate tax payer, you are correct that 8% will beat any ISA, but that is a catch-22, because the REASON you are a higher rate tax payer is that you have CHOSEN to pay out dividends in access of your basic rate allowance. So you are CHOOSING, voluntarily, to pay 25% tax on capital today, to save POSSIBLY having to take dividends taxed at 25% in the future.

Not so, you can declare dividends up to the higher rate bracket paying no higher rate tax and STILL benefit from the tax saving of an offset mortgage. Because if you weren't offsetting the gains on your money would push you INTO the higher rate bracket.

But at the end of the day, I appreciate this is a side-track as you seem most concerned about what to do with large reserves in the company and how to get them out without paying higher rate tax.

I think we are in agreement re: the offset mortgage / ISA trade off.

[ASB]

If you are a basic rate tax payer, than a £6 interest costs you £6 of income out of your company.

If you are a higher rate tax payer, than £6 of income is earned from an £8 dividend.

It's not really a question of where the money comes from anyway. The comparison is:-

Pay 1000 of mortgage, save 60 quid in interest. Implicit return = 6%. Save 1000 get return of 10% (i.e. 100 quid) only actually receive 60 quid.

If one is able to invest in a tax free wrapper then that changes things of course. But whatever happens you are still leveraged will an implicit hurdle rate of either:-

The mortgage interest rate - if able to invest tax free
The rate * 1.25 - if standard rate payer
The rate * 1.66 - if higher rate payer

You are effectively borrowing at 6%, 8% or 10% depending on circumstances to purchase the investment asset - whatever it is.

I am not saying people shouldn't do this, just that they should be aware of it.

[dude69]

I don't follow your 6%, 8% argument, what does dividend tax relief have to do with it?

Everything?

As per your previous post, assuming your mortgage rate is 6%, then for each £100 of capital outstanding, you pay £6 interest.

Where do you get that from, as a Company Director?

The answer is your company, as a dividend.

If you are a basic rate tax payer, than a £6 interest costs you £6 of income out of your company.

If you are a higher rate tax payer, than £6 of income is earned from an £8 dividend.

That is because you cannot get tax relief on dividends. Under the old scheme, if you received £8k dividends, then it was deemed (using current 20% income tax), that you had £10k income, and £2k tax had already been paid on it. If you were not a tax payer, you could RECLAIM that £2k, which had not been paid by you, but by the company, in the form of Corporation Tax (at a higher rate, incidentally). So £6 of interest actually GENUINELY costs you £7.50 income.

But you can no longer get tax back on dividends.

So £6 interest costs you exactly £6, if you are a basic rate tax payer, and £8 if you are higher rate.

The relief is not nearly as good as claimed - it turns 6% into 8% for dividend-earning higher rate tax payers, not 10% as for income-earning higher-rate tax payers

So in terms of ISA versus mortgage, if both have the same rate, then for a basic rate tax payer, the return is identical. BUT, you can always pay off your mortgage in the future, whereas your ISA is gone forever, and with identical returns, the use-it-or-lose-it ISA tax shelter is more valuable.

For a higher rate tax payer, you are correct that 8% will beat any ISA, but that is a catch-22, because the REASON you are a higher rate tax payer is that you have CHOSEN to pay out dividends in access of your basic rate allowance. So you are CHOOSING, voluntarily, to pay 25% tax on capital today, to save POSSIBLY having to take dividends taxed at 25% in the future.

Which is clearly nonsense.

While it is true that spare existing capital is very effectively employed if you are a higher rate tax payer to earn effective 8% (based on 6% mortgage rate), by reducing the amount of higher rate dividends you pay, you certainly should not pay MORE tax to do so, and if you do not need to pay higher rate tax (i.e. £40k/year plus your spouse's income if applicable is enough income), there is no point whatsoever in paying off the mortgage (unless NET rates (not grossed up) make it worth while).

[quote]
The point is that once your money is out of your company (i.e. you have taken a dividend) an offset mortgage is an extremely good place to put it, as opposed to an ISA or other form of savings, even if you are not a higher rate tax payer. I have yet to find a cash ISA to beat my offset mortgage

It depends how you accumulate money. If there is substantial capital left in the company, which seems quite likely with only ~£40k withdrawable, it would seem you would not have that much cash to deposit onto the mortgage.

As a basic rate dividend-earning tax payer, the offset mortgage only pays as well as its rate, which admittedly might be extortionate.

and a shares ISA is certainly not going to beat it in this economic climate.

http://www.h-l.co.uk/fund_research/f...dol/B11V7T6.hl

HTH

I haven't looked at the figures of investing directly from the ltd company as I have no interest in doing that, is that the comparison you are making to get 6% and 8%?

No, see above. Dividend tax is maximum 25% of received, not 40% as for regular income.

[glashIFA@Paramount]

So your financial advice is hide the money off shore, create a loss and bring the capital back. But you don't know how to do this.....



Remind me to give you a call when I have £50,000 sitting around doing nothing...

Hey - i was just helping someone with an enquiry about investing company monies ok. "Invest" not hide the money offshore so that you can benefit from gross rollup. CT is payable when it comes back onshore, assuming it does, but as i said earlier its still better than paying it on an ongoing basis. Some companies are able to show a trading loss which would be a good time to bring the monies back, have a word with your suppliers or your accountant - but if this can't be done then you pay the tax. And let me save you the price of a phone call - if you've got £50k sitting around doing nothing - give someone else a call.

[Lewis]

Wrong, for contractors using Ltd/dividend structure: there's no basic rate tax relief on dividends. So it's actually 6% for basic rate payers, 8% for higher. But to be a higher rate tax payer it implies you are taking unnecessary dividends. There's no point at all in taking out extra dividends to pay beyond the minimum payment on a mortgage. If you have spare cash/savings that isn't taxed at higher rate, then go ahead, especially if it means you can keep within basic rate for future years.

That was the whole thing with the scrapping of ACT and Gordon Broon raiding all those charities and old people to pay for his evil plans.

I don't follow your 6%, 8% argument, what does dividend tax relief have to do with it?

The point is that once your money is out of your company (i.e. you have taken a dividend) an offset mortgage is an extremely good place to put it, as opposed to an ISA or other form of savings, even if you are not a higher rate tax payer. I have yet to find a cash ISA to beat my offset mortgage and a shares ISA is certainly not going to beat it in this economic climate.

I haven't looked at the figures of investing directly from the ltd company as I have no interest in doing that, is that the comparison you are making to get 6% and 8%?

I think most homeowners forget that they are essentially borrowing to save by not paying off their mortgage first.

[Lewis]

Don't forget, that for us contractors, offset mortgages are not nearly as good as for salaried people - we can only paying 25% tax, normal people can avoid 40%.

I disagree, I think they are particularly suited to contractors, who often need flexibility due to breaks in work etc. There are many benefits to an offset mortgage, the main ones are:

(1) Your savings (including a positive current account balance) are offset against you mortgage, which has the effect of making them tax free. e.g. for a higher rate tax payer, a mortgage rate of 6% means you would have to get 10% on savings elsewhere. Unless you put them into tax free savings (e.g. ISA) and in which case you would need to get the same rate as your mortgage. But the advantage of the offset mortgage is the money is always there and there is no limit on what you can offset per year, unlike an ISA.

(2) You can arrange a borrowing limit which is in excess of what you need so you can have instant access to emmergency cash with no hassle and an excellent rate of interest (compared to a personal loan). Plus nothing to pay if you don't use it.

(3) You can easily make overpayments or take payment holidays or increase you mortgage or switch to interest only without asking for any authorisation, you just transfer money from one account to another. Great for contracting where you usually need extra flexibility.

I think it is hard to beat having an offset against mortgage. The only thing to watch out for is the interest rate, which can be more than elsewhere, but you can get excellent offset mortgage rates now.

[dude69]

If you are a higher rate taxpayer then paying off mortgage effectively gives you a guaranteed return of 10%. A base rate taxpayer a guaranteed return of about 8% - assuming a mortgage rate of 6%.

Wrong, for contractors using Ltd/dividend structure: there's no basic rate tax relief on dividends. So it's actually 6% for basic rate payers, 8% for higher. But to be a higher rate tax payer it implies you are taking unnecessary dividends. There's no point at all in taking out extra dividends to pay beyond the minimum payment on a mortgage. If you have spare cash/savings that isn't taxed at higher rate, then go ahead, especially if it means you can keep within basic rate for future years.

That was the whole thing with the scrapping of ACT and Gordon Broon raiding all those charities and old people to pay for his evil plans.

[ASB]

So paying down mortgage debt or leaving it in cash is preferable at the moment.

If you are a higher rate taxpayer then paying off mortgage effectively gives you a guaranteed return of 10%. A base rate taxpayer a guaranteed return of about 8% - assuming a mortgage rate of 6%.

If you have a mortgage and are also actively investing then you are effectively borrowing money at a net 6% in order to make a gross x%. Paying off the mortgage is probably a better use of the money.

[GreenerGrass]

Don't forget, that for us contractors, offset mortgages are not nearly as good as for salaried people - we can only paying 25% tax, normal people can avoid 40%.

The thing is, if you want to pay your mortgage off early by making overpayments, especially in the south east, then you're going to have to draw over the higher rate tax limit.

At the moment I'm trying to have a foot in all camps, use up full ISA allowance, match 10k salary in pension contributions, make mortgage over payments to the maximum available, and leave what's left after living expenses in the company.
I guess the alternative is to leave more in the company and then every 3 or 4 years close it down, and pay off a big chunk of mortgage at that point.
Probably end up doing that anyway if the HMRC persecution continues.

I wouldn't want to invest anymore in OEICS/unit trusts than the above, we could be in a bear market that lasts 2 or 3 years, so paying down mortgage debt or leaving it in cash is preferrable at the moment.

[dude69]

I think most 'normal' people would disagree with that.

What do you think the median wage is?

tim

about £20k?

for the purposes of people considering offset mortgages, paying 40% tax is normal.

[Ardesco]

Don't know the answer to that one, I'm afraid. I know that its not always possible for this to be done although its a lot easier for some companies / businesses than others.

So your financial advice is hide the money off shore, create a loss and bring the capital back. But you don't know how to do this.....



Remind me to give you a call when I have £50,000 sitting around doing nothing...