Tax Free Savings?

eddie_fb

I have 15k to save, and need it to be tax free as I already pay 40% tax.

Looking at NS & I they do a 2 year at 3.5% Fixed rate, or a 3 year 1.25% Fixed rate + inflation. Either would suit, I am just wondering which you think would perform better?

Or, alternatively, do you know of any other tax free systems worth considering?

FYI: I am single, no children, 40% tax payer, no pension (but undecided if I want one), not very bright when it comes to money.

DiggingOut

Have you used your cash ISA allowance this year? If not, you can put £3K in an Abbey Postal ISA, currently at 5.1%, for starters.

eddie_fb

Yeah, sorry forgot to mention that I have already used my ISA allowance already for this year.

dunstonh

Pension contributions are very tax efficient for higher rate tax payers.

For example,

£3600 contribution. You write a cheque for £2808. Thats £792 gain straight away for everyone regardless of being higher, basic, lower or non tax payer. However, as a higher rate tax payer you can claim an additional amount on your tax return. The difference between the basic rate tax relief and the higher rate tax relief. A futher £648 on current tax rates.

So, that £3600 has only really cost you £2160.

There are some rules to prevent you over contributing but it is certainly worth investigating. HOWEVER, the way you get your money out has to be under consideration. Presently, you can only get access to 25% of the investment tax free with the rest being used to purchase an annuity. However, depending on the size of your fund, it is possible to get more out than that. You can also only take the benefits between age 55-75 (currently 50 but going upto to 55 in 2 years).

So, pensions could be an answer for the funds.

As for the NS&I, some of the investments pay the returns gross but you have to tax on them if you are a tax payer. This means paying ALL the tax on them via your tax return which in turn affects your tax code which in turn means your monthly take home pay will go down. However, those ones you mentioned are tax free but the rates are pants.

Other considerations, depending on your attitude to risk are low yield unit trusts/OEICs (open ended investment companies - replacing unit trusts). You pay tax on the income created within these but chosing one with no or low yields would be suitable.

Or, investment bonds. These are taxable at source and upon encashment or other "chargeable" events you would pay further tax if you were still a higher rate tax payer. However, if held on until a time that you are no longer a higher rate tax payer, you can avoid paying any additional tax. Some bonds have better reduction in yields than equity ISAs. Mostly due to no up front charges and increased initial allocations. (reduction in yield is the effect of charges on the rate of return).

There are others which may be suitable for you but they are a start.

MJSW

However, those ones you mentioned are tax free but the rates are pants.

Please explain why you consider the NS&I rates are 'pants'. For higher rate taxpayers, the 2 year bond is equivilent to 5.83%, which makes it one of the highest rates in the market. The 5 year bond is equivilent to 6.08%, which is the highest rate in the market.

At current rates of inflation, the 3 year index linked bonds are currently equivilent to 6.75% and the 5 year bonds are equivilent to 6.92%, making them easily the best rates currently available, although of course these rates depend on future inflation levels.

To answer the original question, whether the fixed or index linked bonds will work out better depends on what you expect inflation to be. For example the 5 year bonds pay 3.65%, and the index linked pay 1.35% + inflation. So you need RPI inflation of at least 2.3% for the index linked to work out better (it is currently 2.8%). Personally, I'd go for the index-linked. If inflation unexpectedly drops, then you can always withdraw early without 'penalty' at any time after the first year (although the interest rate paid reduces, for example with the 3 years bonds you only get 1%+inflation during the first year instead of 1.25%+inflation if they are held for the full term).

dunstonh

We are in a period of increasing interest rates and with fixed rates, you run the risk of being left behind as the rates increase. Chelsea b/s and Halifax both have fixed rate bonds at 6.25% (3yr Chelsea, 5yr Halifax) which net beats NS&I gross.

The problem here is that you cannot give a definitive answer as there is no indication of purpose, timescales, attitude to risk, accessability etc. So when looking as to whether you consider the NS&I pants or not is very dependent on knowing those. The lower the risk you are willing to take, the more attractive they look, the higher the risk you are willing to take, the less attractive they look.

MJSW

We are in a period of increasing interest rates and with fixed rates, you run the risk of being left behind as the rates increase.

Fair enough. But that's not at all the same thing as saying NS&I's rates are 'pants', I think what you actually appear to mean is 'fixed rates are pants'. You can of course withdraw from NS&I's bonds without notice if you wish to (although this will reduce the interest rate).

The index linked bonds also include a partial hedge against rate rises, because when interest rates go up it increases the RPI as well. The effect of rises in interest rates has increased RPI inflation by 0.5% over the last year, compared to base rate increases of 0.75% over a comparable period. But grossing up the 0.5% increase actually results in an effective increase of 0.83% to the gross rate, so interest increases have in fact slightly benefited index linked holders.

Chelsea b/s and Halifax both have fixed rate bonds at 6.25% (3yr Chelsea, 5yr Halifax) which net beats NS&I gross.

Really? According to Chelsea's website their 3 year fixed rate bond pays 5.6%. And according to Halifax's website its 5 year bond pays 5.5%. In Chelsea's case you can only get 6.25% (although it actually went up to 6.5% 10 days ago) on a maximum of 30% of your investment, and at least 70% has to be invested in a Norwich Union Portfolio bond, so it's hardly a like-for-like comparision!

dunstonh

It would be fair to say that I was referring more in general to fixed rates at this time rather than one provider.

I didnt check the specifics of the deals, I just reported what came out top. There were 11 products that showed a headline rate of 6% or higher at the time of the research. How they achieve the terms or what criteria is something i dont have time to do at present. As we discussed on another thread, research is out of date the minute its done. Deals get pulled so quickly and are replaced with alternatives. I think you posted one the other day that was withdrawn inside 3 days?

The research list was asked for deposit based term accounts so I have to question why Chelsea have chosen to supply their details under that section. They should have quoted their lower rate without the NU bond tie in. However, one assumes they did that for marketing reasons.