On the Money: Don’t let the tax tail wag the investment dog

On the Money: Don’t let the tax tail wag the investment dog

Expert advice from Leitrim financial adviser

What research should you do before making an investment decision?
Many potential investors will often spend significant time comparing the past performance of one fund against another, researching the asset mix etc but most will overlook one of the most important factors, ‘what is the tax treatment of any investment growth?’
Selecting a tax efficient investment can often have the greatest bearing on your overall return. What is meant by a tax-efficient investment is often quite difficult to define, what is viewed as being tax-efficient for one individual may in fact be quite inefficient for another.

Are you considering an investment?

For anyone considering making an investment there are a number of key tax related issues to consider:
- What is the exit tax at the end of the investment?
- Am I better to have the return taxed as income or capital gains?
- What rate of tax do I pay on my returns?
- Should I invest as an individual or through a company structure?
The tax treatment of investment returns can vary from 33% capital gains tax, 35% DIRT, 41% exit tax and up to 52% income tax.
You cannot adopt a one-size-fits-all approach as everyone has differing personal circumstances.
Let’s take for example a client who has suffered capital losses in recent years (this applies to many people who suffered losses on property or shares during the recession), this type of client ideally wants to generate a return liable to capital gains tax so that their existing losses can be fully offset against future gains.
This offset couldn’t be achieved if they invested in a managed fund which is liable to exit tax or in a deposit which is liable to DIRT. Furthermore this same client could avail of an annual CGT allowance of €1,270 (or €2,540 if it’s a joint investment), are you utilising this exemption?
Given the poor returns currently available from cash deposits, it might be viewed as foolish to leave your savings sitting in a deposit account. Although the DIRT rate has fallen from 41% in 2017 to 35% today and due to fall again to 33% by 2020 this is not enough to offset the likelihood of poor returns.

Life Insurance

It’s also worth noting that DIRT is payable on the very first cent of deposit income which is earned while capital gains tax investments come with an annual exemption of up to €2,540 as mentioned above.
Despite intensive lobbying by the life insurance industry the government have refused to reduce the rate of exit tax (41%) which currently applies to managed funds.
The life insurance industry were requesting that the rate be reduced to 33% to bring it in line with DIRT. The government working group found no inconsistencies in the current two-tier tax system even though the two tax rates had been broadly the same for the previous two decades (not to mention the fact that this tax generates €200m a year for the exchequer).
This penal exit tax rate along with the 1% life insurance levy on new business combine to make investments in managed funds a very unattractive option for personal investors.
Another issue to consider is whether an investment should be made by an individual directly, or whether they might consider setting up an investment company to make the investments. For individual investors the investment income may be subject to a maximum rate of income tax of up to 52%, compared with a corporate entity that will pay tax on investment income at 25% plus potentially close company surcharge which will bring the effective rate of tax to 40%. While the tax rate paid by the company is lower than an individual, you are then faced with the issue of getting the money out of the company in a tax efficient manner. For Irish dividend income, the corporate entity would be exempt from corporation tax so that the only exposure to tax would be the close company surcharge at 20%.
One of the most tax efficient investments many people will make is contributing to their pension, you may not like to hear it but it make sense. All investment growth within a pension fund is completely tax free, and the compounding effect of tax-free growth over time is very powerful.
In addition, if you are a higher-rate taxpayer, you also get 40% tax relief on any contributions paid into a pension, subject to certain limits.
Needless to say, tax is just one box that needs to be ticked when considering whether or not to invest in a particular product, and always remember, don’t let the tax tail wag the investment dog.

Barry Kerr CFP® is Managing Director of Wealthwise Financial Planning who have offices in Carrick on Shannon & Galway, www.wealthwise.ie All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use. Wealthwise Financial Ltd T/A Wealthwise Financial Planning is Regulated by the central Bank of Ireland #CI66141

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