On holiday in Sicily, we saw a demonstration of Pizzú, How the Mafia collected a “tax” on wheat to pay for its protection. A barrel of wheat was stacked to the top, with the pointed mound — or pizzu, Sicilian for “peak” — on top. The top of the barrel was then carefully scraped off with a flat stick to remove the payment.
I instantly thought: this is what happens to our money if it’s not kept in a tax wrapper.
I mentioned this to my family: and the pizza they take away could be much more than a mouthful of wheat, because investments are potentially subject to capital gains tax in the case of growth and income tax in the case of dividends. The teenagers rolled their eyes, but I hope the message was absorbed anyway.
A friend got caught buying Tesla shares that soared during the pandemic. Because he held them in a general investment account, not an ISA or pension tax wrapper, he ended up paying a big Capital Gains bill. His pizzu was a 20 per cent growth – only the £12,300 tax allowance softened the blow.
That allocation has since been halved and then halved again, while the dividend allowance has also been cut twice. Many investors, including my friend, opened ISAs as soon as they could – investment platforms reported a surge in “bed and ISA” activity at the end of the 2023 tax year, where investors transfer assets into the tax wrapper to protect future growth and dividends.
New government figures this week show that 12.5 million adult ISAs were signed up that year, up from 11.8 million the year before, although the number of stocks and shares ISAs fell, perhaps due to cost of living concerns.
71%According to Hargreaves Lansdown, the number of customers contributing the maximum £60,000 to their Sipps is increasing this year.
Still, in anticipation of the “painful” decision of the Labor Party, Budget Next month, investors will be rushing to make the most of tax relief on their ISA and pension accounts, according to the UK’s largest platform, Hargreaves Lansdown. According to the platform, the number of clients who have contributed the maximum £60,000 to their self-invested personal pension plan (SIPP) has risen by 71% so far this year compared with the previous year. Maximum contributions to stocks and shares ISAs (£20,000) have risen by 31%, while Junior ISA reliefs (£9,000) have increased by 40%.
According to Hargreaves Lansdown, investors are responding to growing speculation that personal income tax rates could be aligned with income tax, resulting in gains being taxed at up to 45 per cent for higher earners. If this happens, additional rate taxpayers could face a tax liability of £21,150 on a £50,000 capital gain made on an investment made outside a tax wrapper, according to Interactive Investor. This would be £11,750 more than the current tax liability under the current personal income tax regime (£9,400). Nick Nesbitt, partner at financial advice firm Forvis Mazars, believes savers are looking to maximise pension and ISA contributions in case they are cut on 30 October.
But is maximizing your allocations always the best strategy?
At first glance, it seems sensible to fill out paper tax forms; I still suspect that too many investments have been left outside ISAs for too long: the number of taxpayers paying dividends has doubled in the past three years (HMRC expects to collect £18bn in dividend tax this year).
But there are many reasons why it may not be best to “fill to the maximum.”
For example, if you are topping up your pension allowance, that money is locked in – perhaps for longer than you think – as the private pension age rises to 57. And if the state pension age rises again or rises faster than previously scheduled, the private pension age may rise at the same time.
You may also have more than you need in a pension or know that you will have to pay a high level of tax to withdraw it in retirement. Therefore, it would be rational to favour other options such as ISAs, government bonds and other tax-efficient investments.
For example, someone with a final pension of £20,000 (with an initial lump sum of £60,000) and £1m in their pension pot will have maxed out their single pension allowance. And with £20,000 in pension income plus £11,500 in state pension, they will have little scope to access their pension pots within the basic tax band. “People often start to turn away from pension pots once they get close to these limits,” says Nesbitt.
Another consideration is the timing of pension contributions to maximise the rate of tax relief. “Carryover facility” is the ability to use this year’s unused pension allowance next year. Some people may choose not to make contributions each year and instead concentrate more of their contribution potential in years when their income or tax liability is higher.
In the case of individual savings plans for young people, advisers often describe as “crazy” those who prioritise filling these plans over their own for adults. Lack of control over money is the key problem: at 18, the child receives everything and has to manage the money themselves. Nesbitt says one exception is clients who have sufficient pension funds but want to make sure they have a certain amount saved specifically for their children in their early adult years (for expenses such as weddings or house deposits).
Then there are cash fixed-term deposits. In the first six months of the year, analysis by Paragon Bank found that savers invested an extra £42bn. At the end of June, there were £351.6bn in adult cash fixed-term deposits, compared with £309.3bn at the end of December 2023.
But if you have at least five years to put your money away, the advice generally is that you should invest it in stocks and securities, not cash, unless you’re predicting a major stock market crash.
Interest rates on one-year fixed rate savings accounts have also fallen from a year ago. According to Moneyfactscompare.co.uk, the most expensive one-year fixed rate savings account pays 5%, compared with 4.67% for the most expensive one-year fixed rate savings account.
Advisers say that where there are better rates available on deposits and bonds than on cash ISAs, unless you are a higher rate taxpayer, it may be rational to avoid cash ISAs.
The right strategy will depend on your individual tax rate, your family circumstances and your goals. So if you have the funds and are feeling the pressure to cover allowances before the Budget, bear in mind that there may be better ways to reduce your “pizzu”.
Moira O’Neill is a freelance finance and investment writer. moira o’neill@ft.com, UNKNOWN: @MoiraONeillInstagram @MoiraOnMoney