23rd September 2018
Charles Dickens’ novel about Dr. Manette, his 18 year incarceration in Paris and subsequent relocation to London to spend time with his daughter Lucie, and all the messing that apparently ensued is meant to be quite a read. I haven’t managed it myself but am reliably informed that I should. Some day I will, as soon as I have read every investment and retirement planning book in existence! A Tale of 2 Cities was set against the back-drop of the run-up to the French Revolution and one could potentially say that there may be a revolution ahead in terms of investing in Ireland, there is a groundswell building around the inconsistencies in how investments are taxed and the access to various investment options. This week we explore the tax implications of investing in 2 different vehicles in Ireland, what tax an investor will pay, and the net impact that that means over the term of an investment. It’s an investment tale of 2 cities as such……I know, a very tenuous link indeed!
Welcome to Ireland’s only dedicated Financial Planning Blog & Podcast, on a mission to make a positive difference in how people like you & I manage their finances and make decisions. Your input and feedback are of real importance to us so would be delighted if you were to drop us a mail with any such ideas or feedback you have here.
City 1 – Deemed Disposal
For most of us when it comes to investing a lump sum we will have 2 options of city destination! City 1 will be an investment in a traditional insurance-based product, typically proposed for a minimum of 5 years. These types of plans will be offered by a broker or by a bank and will carry a 1% Government Levy on the way in. So if you invest €100,000 the insurance company are obliged to deduct 1% of that (€1,000) and pay it to Revenue, and so €99,000 of your investment will get invested (assuming no other charges/fees are applied!). With this type of plan you will also be obliged to pay ‘exit tax’ when you cash in your chips, or withdaw funds, but only if your cash-in value is higher than your initial investment on day 1.
What is deemed disposal?
If you do not encash your investment by the 8th anniversary the insurance company will be obliged to take 41% of the difference between the price on that date and the initial investment. This means you pay exit tax every 8th anniversary irrespective of the fact that you do not encash it. Many deem this ‘deemed disposal’ tax as an unfair and punitive tax on investors who wish to leave their investments for the long term, and I concur!
If you do end up paying tax via deemed disposal on 8th anniversary, and you cash-in the following years when the value fell below the rate on which that tax was calculated you can then seek a refund from Revenue for tax that you essentially over-paid……scary thing is that many people never think to do that, and their advisor may have missed it too, so worth considering if you may have done something like that in the past, and if there may be a refund in scope for you!
City 2 – Capital Gains Tax
As opposed to Exit Tax at 41% an investment in a Capital Gains Tax vehicle, such as Direct Shares or a Discretionary Investment/Segregated account is liable to Capital Gains Tax at 33% on any gains achieved. Already this may seem like a more favourable rate of tax, and there is no doubt that it is.
CGT option also carries another benefit or two worth noting. First of these is the fact that when we invest in CGT route an investor is allowed earn €1,270 in CGT gains totally tax free. What’s more, if you are investing as a joint investment, the allowance is double, which is not to be sniffed at!
Second, is the fact that an investor can offset losses on disposal of other assets against the gains on a CGT investment, proivided a gain on the disposal of that other asset would have been subject to CGT (if I have explained that OK!?). This can be a major benefit to people if they have losses from sale of shares or property in the past (no limit on when that loss was realised, provided the revenue are notified of the loss when it’s made).
Thirdly, if an investment in a CGT route happens to be in ‘gain’ territory when the beneficial owner dies, the total fund on date of death passes to the estate (assuming that is where it was to go on death!). There is not tax on gains payable, total fund hits the estate. Our understanding is that if it were an ‘Exit Tax’ option the tax of 41% is payable on death on any gains at time of death which could amount to a lot of cash.
Having said all that most of us are mainly only interested in the euro and cents of it all so lets have a look at a scenario or two.
In scenario 1 we will assume that each investment is done in 1 person’s name only. We will assume that the return achieved is the same on each fund and that each fund achieves an average return of 6% over the term of 8 years, and each has a fee/reduction on yield of 1%. In reality the fee would typically be north of that in an insurance-based product, as it would on a Segregated Investment account.[table “2” not found /]
In that scenario you can see a reasonable difference in the net returns of each option, I guess the question is, which result would you rather??
In scenario 2 we have made the assumption that each investment runs for 12 years instead of the 8 in Scenario 1. As a result of this the insurance Company are obliged to take 41% of the growth on the 8th anniversary and pay it to Revenue. The remaining balance remains invested and continues to achieve the 5% Net Return.
We have assumed that in this case each investment is done in joint names.[table “3” not found /]
Yikes! Now in this scenario we can see the pretty significant difference that the CGT Allowance and the lower rate of tax has on the net return to an investor in this scenario. It is worth noting that if you are investing a considerably larger amount of funds that the difference becomes proportionately less as the relative impact of the annual allowance diminishes as invested sums increase.
In the above scenarios we have assumed a straight-forward investment, and a straight-forward and linear return rate. This things seldom exist so in reality the maths will rarely pan-out exactly like this. Having said that it is clear for us all to see that the CGT route carries some very handsome benefits if there is a reasonable rate of return achieved over time. The aspect of the CGT being payable into one’s estate with no tax payable is a benefit that many may benefit from (or at least their kids/estate may benefit!). We did not simulate that but in essence it is the same outcome as Scenario 2 where the allowance absorbed tax payable on maturity…the entire fund passes to the beneficiaries.
If Scenario 1 is London, and Scenario 2 is Paris, are you going to opt for the City of The Gerkin or the City Of Lights……Fiona and I had our honeymoon in the latter, that’d be my shout!!
Thanks for reading, be delighted to hear from you, or indeed if you told a friend about our wee site here!
QFA | RPA | APA | Qualified Coach
If you would like to get in touch to see how Paddy can help, please complete the form below and we will be in touch.