Back in my undergrad days, you would struggle to find a more depressing sight than that of accounting major lugging around the latest version of the Income Tax Act.
Suffice to say that one look at the 1,000+ page tome (part 1 of 2, no less) was enough to scare this finance major out of any tax-related courses.
The outcome I was trying to avoid
Others weren’t so easily deterred. My wife was one of those brave souls. She persevered, got through an absolute wringer of courses, some punishing exams – and ended up with an accounting designation.
Along the way, she had a chance to put her newly acquired knowledge to use as a tax intern with one of the Big 4 accountancy firms.
It was an interesting experience for her, if mostly in a Groundhog Day sense of the word. Every year, the same story would play out.
Crafty accountants screen rules to identify loopholes – and exploit them on behalf of clients. Watchful tax authorities audit and dispute filings.
Rulings are passed down, the tax code is amended – and the cat and mouse game begins anew the following year.
Who knew tax could be so exciting?
For Better Or Worse
Every country has its own approach to taxation.
Some, like the US or Canada, have a tax act that’s full of quirks and specific rules. The idea behind the approach is to provide targeted breaks to specific groups of people. Think of it as using a carving knife as opposed to a blunt axe.
Rental tax credits. Educational credits. Child tax credits. Disability credits. At a local level, each state piles in with its own set of rules, further complicating the issue.
The UK takes the opposite approach. Tax rules are pretty uniform. Very few tax breaks are in place and they are certainly not the preferred way to deliver economic benefits.
What you see is what you get – and you don’t even need to file a tax return unless you make over £100k, are self-employed, or otherwise find yourself in a very specific situation.
What has always bothered me about the US approach is the fact that there’s an entire industry that helps people like you and me file their annual tax returns – and maximize the tax refund.
The reality is that these tax professionals create very little incremental economic value. One set of folks (tax authorities) make up the rules. Another helps navigate them.
Instead of shuffling paper around, their efforts would be much better spent on building houses, writing cutting-edge software, or creating vaccines.
The other drawback of a US-type system is the tendency for special interest groups to lobby for specific rules that benefit a tiny sliver of people. But let’s not even go down that rabbit hole today.
However, the big advantage of the US approach is that people, in general, are much more aware of taxes as an expense item on their budgets. Nothing like the prospect of economic gain to make you get up to speed on a topic!
In the UK – not so much. The tax is what it is… or is it?
Don’t Evade, Avoid
A definition may be in order here.
Oftentimes, the concept of tax avoidance has a negative stigma to it. Put simply, it’s considered to be illegal.
Let’s make one thing clear – it’s not.
Tax evasion is the illegal bit. Things like not declaring your income. Making false statements on your tax return. Claiming tax breaks you aren’t entitled to.
Tax avoidance, on the other hand, has the word “legal” in its very definition:
“Tax avoidance is defined as the legal measures to use the tax regime to find ways to pay the lowest rate of tax.”
And as it turns out, those legal measures can make quite a difference.
After all, we are talking about one of the most meaningful expenses you will ever incur. Whether it’s 20%, 40%, or 45%, even small savings have massive compounding effects over time.
Tricks Of The Trade
The reality is that most people already use a tax avoidance strategy of one sort or another.
Whether it’s an ISA, a Lifetime ISA, a workplace pension, a SIPP, or yet another wealth-building tool – the general construct is the same.
The government gives you a tax break. In return, you postpone consumption. As a result, you are better placed to support yourself in old(er) age, lowering the strain on the public purse.
There are other ways to reduce your tax bill, including:
- Placing higher-return investments (i.e. equities) in tax-efficient vehicles and keeping lower-return investments (i.e. cash) in taxable accounts (like your bank account)
- If you have a partner, prioritizing workplace pension contributions of the partner in a higher tax bracket (though there are other factors to keep in mind here, such as employer matching)
- Participating in your employer’s Save As You Earn and Share Incentive Plans
- Claiming all allowable deductions (i.e. expenses related to running your side hustle or a bone fide business) against your income
- Should you be so inclined, using the enterprise investment schemes (EIS) and venture capital trusts (VCT) to make investments in UK businesses
- Perhaps even divorcing your spouse to get around a breach in the pension LTA (though this is so far out in the grey area that I certainly wouldn’t recommend it)
But that’s not where it ends.
One fundamental truth of tax planning is that the more money you make, the more options you have.
If you are keen to better understand the art of the possible, you can do worse than read two excellent posts by a fellow finance professional Finumus.
One is his writeup on getting an £80k annual ISA allowance.
The other is on the concept of using a family investment company structure to minimize your household tax bill.
I particularly like the second post as I have seen it used in the past and know it can be highly effective – provided you are working with the right amount of capital.
In addition, I found the comments on my most recent post on self invested personal pensions to be more than a little eye-opening.
A number of you have shared very interesting thoughts on leveraging SIPP vehicles to crystalize considerable tax benefits. I’ve got a feeling we are just scratching the surface there. Many more strategies exist (which you are of course very welcome to share in the comments!)
The reality is that some of the more advanced techniques will remain out of reach for the majority of people. But they are a helpful way of illustrating that notwithstanding the UK’s “blunt axe” tax system, it actually isn’t as blunt as it may seem.
Yes, taxes are boring as hell. But they are not set in stone. And over years and decades, the small reductions in your tax bill can snowball into very meaningful amounts.
For those willing to brave it – and do the (boring) work, there’s a meaningful prize at the end of the rainbow.
Happy (tax-efficient) investing!
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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3 thoughts on “The Really Boring (And Highly Effective) Way To Get Rich”
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Hi Banker on Fire,
Thanks for the blog, full of good UK centric detail. One aspect of the taxation system that never gets much coverage is the high income child benefit charge. It seems to me that most commentary out there is actually advising people to give up the benefit, whereas I take the view that this would be very silly, and leave me with a marginal tax rate of c.68% on income between £50-60K. I have 3 children, and the benefit is worth about £2.5k a year. I would be crazy to give this up. So I contribute sufficient money into my SIPP to reduce my taxable income down below £50k. The only place I have seen this explained clearly is this report from Prudential. Reduce the impact of the high income child benefit charge (pruadviser.co.uk). I would have thought this should be front and centre on major advice websites such as https://www.moneysavingexpert.com/family/child-benefit/ . They infer the work around, but really the article needs to be re-written to plainly and simply tell people how to avoid the charge, instructing them to open a SIPP if necessary.
I don’t think I have made a catastrophic mistake…and yet it seems very much on the low down. Perhaps you might do a post on it? It is surely central to any FI plan?
Thanks a lot Matt. I don’t have first hand experience with the child benefit but based on desktop research, what you are outlining above seems the right way to go about it.
As a matter of principle and intellectual honesty, I only write about things where I have first hand experience. That being said, I’d be a happy taker of a guest post on the above topic if you felt like giving it a shot?