By Luke Brooks, Personal Financial Planning Specialist at Smith & Williamson
Although entrepreneurs are renowned for generating wealth through their vision and hard work, good financial planning in relation to non-entrepreneurial assets can significantly enhance their financial position over the long-term.
Here are some housekeeping rules and financial planning tips that should set entrepreneurs on the right path:
Stage 1 — Financial planning basics
Before committing to any long-term strategy it’s sensible to lay some strong foundations.
Tip — Build an emergency fund
Financial planning professionals recommend that the establishment of a cash reserve should be the first stage of any financial planning strategy and, generally, 6 to 12 months of living expenses is considered to be appropriate.
Tip — Protect yourself and your dependents
Entrepreneurs who do not have sufficient liquid capital to ‘self-insure’ against the consequences of death, disability and long-term sickness should consider putting in place the appropriate insurances.
Term assurance plans are often the cheapest way to cover known debts like a mortgage on death, while a family income benefit (FIB) can be a cost-effective solution for those looking to provide an income should they die while their family remain financially dependent upon them. Critical, or serious, illness cover can be used to provide a lump sum on the diagnosis and survival of one of a number of predetermined conditions whilst income protection, or permanent health insurance (PHI), policies provide long-term cover against disability or sickness.
Tip — Pay off personal debt
Consideration should be given to the efficiency of paying off personal debt before investing elsewhere; a top-rate taxpayer would need a gross return of over 10% to justify not first paying off a debt charging interest at 5% per annum.
If debt reduction appeals, remember to pay off expensive, unsecured lending like credit cards first.
Stage 2 — Enhance returns through tax allowances
Once the foundations have been laid, entrepreneurs should consider making use of the available tax allowances and exemptions to enhance returns on their invested wealth.
Tip — Utilise tax allowances
Higher and additional rate taxpayers with a lower or non-taxpaying spouse should consider utilising their personal allowance and basic rate tax band to enhance returns by transferring ownership of income producing assets. Deposit interest and rental income can be offset against the personal allowance, while no further tax is payable on dividends where total income does not exceed £42,475 in 2012/13.
Passing gain-laden assets between spouses to utilise the annual capital gains tax (CGT) exemption of £10,600 on sale is worth £2,968 for higher and additional rate taxpayers.
Tip — Maximise tax-free investments
Individual savings accounts (ISAs) offer tax-free returns on cash investments of up to £5,640 in 2012/13 and £11,280 for those willing to hold quoted stocks and shares as part of their portfolio.
Junior ISA investments of £3,600 per annum can be made for minors without a child trust fund, and the fact that the returns generated do not fall foul of the parental disposition rules makes them suitable for university fee planning.
Other tax-free options to consider include National Savings and Investments savings certificates, premium bonds and children’s bonus bonds.
Stage 3 — Tax relieved long-term strategies
Entrepreneurs willing to commit their personal capital for the longer-term can access attractive tax breaks in schemes that can complement their business interests.
Tip — Consider UK pensions
UK pensions are often overlooked by entrepreneurs as the lack of access and the manner in which retirement benefits must be taken can be considered unattractive. For those willing to tie up a proportion of their capital, however, UK pensions can complement and enhance their overall financial planning.
Self-Invested Pension Plans (SIPPs) can access a far wider range of investments than traditional pensions and strategies that might appeal to entrepreneurial investors include the ability to hold private company shares and to borrow up to 50% of the fund to invest in commercial property.
Such investment flexibility combined with tax relief of up to 60% on contributions, tax-advantaged growth within the fund, tax-free benefits on death before retirement and the ability to take 25% of the fund tax-free on retirement make pensions a tax deferral vehicle worthy of careful consideration.
Tip — Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EISs) and Seed EISs (SEISs)
HMRC continues to offer tax incentives to those willing to invest in smaller, unquoted businesses. VCTs, which invest in a portfolio of such companies, and EISs, which invest in a single company, are now an established part of the financial planning landscape for those looking to diversify from their own entrepreneurial activities.
Subject to a minimum holding period of five years, 30% income tax relief is granted on VCT investments of up to £200,000 in 2012/13 and the resultant dividends and capital gains are tax-free.
EIS, or ‘business angel’, investments of up to £1m qualify for 30% income tax relief provided they are held for three years and, although dividends remain taxable, the shares are exempt from CGT and will also qualify for an inheritance tax exemption under the business property relief (BPR) rules after two years. Notably, it is possible to ‘rollover’ gains made on other assets by investing into an EIS, deferring any capital gains until the sale of the EIS shares.
The Seed EIS is also now available for investments into start-up companies with gross assets of less than £200,000. Income tax relief is given at 50% on investments of up to £100,000 per individual per tax year and all gains are CGT-free, provided they are held for at least three years. The shares will qualify for BPR after two years.
In the 2012/13 tax year only, Seed EISs have a specific exemption from CGT for those reinvesting gains made on other assets, potentially boosting the initial tax relief to an attractive 78%.
Investments of this nature, while offering significant tax mitigation, can carry substantial capital risk. Advice should be sought to ensure that proposed investments are tax-efficient and structured in a manner that is appropriate to your overall financial planning.
... And finally
The lack of traditional bank finance available to small and medium-sized businesses (SMEs) in the last few years has seen the development of several alternatives which can help SMEs raise the development or working capital they need or better manage their cash flow. Such schemes are funded by private and institutional investors and can provide attractive returns for those seeking an alternative approach to investing their capital.
Examples include Funding Circle, an online peer-to-peer lending service which enables individuals to lend directly to SMEs in return for an attractive interest rate, and MarketInvoice, where SMEs can either raise short-term finance or improve cash flow by selling their invoices via a platform auction rather than waiting the traditional 30, 60 or 90 days for their customer to settle. Further information about these and other alternative finance platforms can be found at www.ngfc.org.uk
To discuss your personal financial planning, call Luke Brooks on 020 7131 4132 or email email@example.com.
By necessity this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Article correct at time of writing.
Smith & Williamson Personal Financial Planning
A division of Smith & Williamson Financial Services Limited which is authorised and regulated by the Financial Services Authority.