After pensions, the UK’s most popular tax shelter is the ISA (Individual Savings Account). Each tax year, around 15m adults save or invest inside Cash ISAs or Stocks and Shares ISAs.
Using ISAs avoids extra taxes on capital gains (from selling assets at a profit) and income (such as savings interest, share dividends, or bond coupons). They are a no-brainer for over-18s (over-16s for Junior ISAs).
Taxing times
Even ISAs cannot stop British high-earners from paying some of the world’s heftiest tax rates. This is because the UK tax system is horrendously complex.
Indeed, Tolley’s Tax Guide — the definitive manual for UK taxation — now stretches across 45 chapters and around 1,050 pages. After decades of fiddling by successive governments, today’s tax system resembles Frankenstein’s monster. It’s a horrible mish-mash of different tax rates, exemptions, allowances, and loopholes.
For example, income tax on earned income in England and Northern Ireland has three rates: basic (20%), higher (40%), and additional (45%). Another tax — employees’ Class 1 National Insurance contributions (NICs) — has a standard rate of 8% and an upper-earnings rate of 2%.
Thus, middle earners often face combined tax rates nearing 50%. Furthermore, the withdrawal of the annual personal tax allowance of £12,570 creates a crazy ‘cliff edge’ (no pun intended!) for those earning £100k+ a year.
Above this level, workers face a marginal tax rate of 62% a year, consisting of 40% income tax, 2% NICs, and an effective 20% tax charge from withdrawing the tax-free allowance. Above £125,140, this rate drops to 47%.
To me, this is bonkers, because earning more can actually leave workers worse off as childcare support is lost. Therefore, many senior workers (including NHS doctors) choose to work four days a week, leaving them better off than working a five-day week. This damaging and daft tax nightmare affects hundreds of thousands of British workers.
Dodging 62% tax
Many professionals I know detest this 62% marginal tax rate. However, some don’t pay it. They use two legal ways to keep their incomes below £100k: salary sacrifice (which HMRC is already reining in) and pension contributions.
A few put every penny above £100k into their pensions, dragging their taxable incomes back below six figures. This is no easy task, plus it’s also limited by maximum pension contributions of £60,000 per tax year.
One worker investing large sums into pensions asked me which globally diversified fund I prefer. My wife and I invest in the Vanguard FTSE All-World UCITS Accumulating ETF (LSE: VWRP). This exchange-traded fund (ETF) — also a London-listed share — is widely held by UK investors.
This fund passively owns almost 3,800 stocks worldwide, including the biggest global and tech businesses. Launched in July 2019, it has total assets of $36.3bn. Vanguard — my favourite low-cost investment manager — recently reduced the ongoing charge to 0.19% a year.
For my family portfolio, this ETF offers massive diversification with low fees. Up 18.2% over one year and 64.8% over five years, it’s now our biggest shareholding. Of course, when stock markets slump (as happened last month), down goes the VWRP share price. Also, if the US-Iran war drags on, then I expect this fund to suffer further falls.
That said, my aim is for this core ETF to become the financial foundation for our happy retirement!
