Tax hikes are coming, for investors and savers alike, with deposit interest retention tax (Dirt) set to rise in January. But as the new year rapidly approaches, should you take action now to avoid giving another cut of your income to the State’s coffers?
From January 1st, the rate of Dirt on deposits will jump by almost a quarter from its current rate of 33 per cent, up to 41 per cent.
For investors, the move is not as significant, but is still hefty. Any gains they make on investment funds and life assurance policies will have tax levied at a rate of 41 per cent also, a hike of almost 14 per cent on its current 36 per cent.
So what should you do if you have holdings in investment funds?
Brian Weber, head of wealth manager Quilter's Dublin office, is urging clients to consider doing a "B&B", given the strong performance of equity markets in recent years.
“We believe it is prudent for clients to examine all of their holdings of domestic and international unit trusts, OIECs [open-ended investment companies], Sicavs [société d’investissement à capital variable, a type of OIEC], unit-linked funds and ETFs [exchange-traded fund], with a view to crystallising the gains in the current year,” he says.
This means that an investor should take their gains now, by selling the fund to crystallise the gain and pay tax at the lower rate of 36 per cent – and then buy back the same investment with their funds.
If you put €100,000 into an equity fund in the recent past, you may have seen this double in the intervening period. If it is worth €200,000 now, paying tax at 36 per cent – rather than 41 per cent from January – will save you €5,000.
For Weber, such a move is particularly relevant to investors who have enjoyed considerable gains.
On the other hand, Brendan Barr, head of marketing with Standard Life, says that, while deciding what to do is "dependent on each individual' s circumstances", a number of scenarios the investment company have assessed show that it might be best to hold tough.
Pointing to additional charges such as the 1 per cent levy that applies to life assurance policies, as well as exit and entry charges that might apply, he argues that it may not actually save an investor very much.
One of the reasons is that, because investment funds are allowed grow on a gross roll-up basis, gains are allowed to build up untaxed until the eighth anniversary. Breaking the policy ahead of this date in order to pay tax might reduce the overall value of the fund.
Indeed, if your gains have been more modest, if may make sense not to move. Take the example of our €100,000 investment which has instead achieved a gain of 40 per cent. Exiting now will incur taxes of €14,400 (at 36 per cent), leaving €125,600 to be reinvested.
If this achieves further growth of 20 per cent over the next three years, the additional gain will be €25,120, meaning a tax bill of €10,299 (assuming the new 41 per cent rate does not rise further) and a net value of €140,421.
If the investor hadn’t done anything, their gain at the end of the period would have been just €301 less.
The argument may be more straightforward if you're approaching the eighth anniversary of a policy. On this date, Revenue enforces a deemed disposal and any tax on any gain is deducted from the policy. So, a policy taken out in January 2006, for example, will have such a disposal in January 2014. Exiting the policy now, rather than waiting until January may offer greater rewards.
Exit-tax rebate
Barr warns, however, that if the policy drops in value and is surrendered at a lower value in year 10, an exit-tax rebate kicks in, which compensates the investor for tax paid already. If the policy was surrendered already voluntarily, however, this clawback of tax wouldn’t apply.
If you want to do a B&B on a fund, Barr says, there is plenty of time left to do it. With Standard Life for example, you can sell out of the fund right up to December 31st, and then buy back in thereafter.
Another option is to consider selling out of funds and re-investing the funds directly into a portfolio of shares, given the discrepancy that now exists between Dirt and capital gains tax (CGT, which is levied on gains in direct shareholding value), which is levied at just 33 per cent.
“CGT has remained the same so direct holdings of shares are more attractive from a tax perspective,” says Weber, adding that he has clients who are selling out of ETF funds and converting them into direct holdings because the CGT liability is more attractive. This is particularly true if you are carrying forward CGT losses, which can be used to offset any taxable gains you may make on your share portfolio.
If you’re a bond investor, the move in tax rates shouldn’t affect you. Despite the jump to 41 per cent exit tax on bond funds, they remain more attractive then holding the bonds directly and paying income tax at your marginal rate (which could be upwards of 52 per cent) on bond income.
While the above advice is not related to investment strategy, if you are stuck in risk-averse investments, it may also make sense to re-adjust your risk profile at the same time if you are selling out of investments.
“It’s a very good time to assess where you are on the risk metric. We’re seeing people increasingly being forced out of deposits because they’re not earning enough, who are very unsure where to go,” Weber says, adding that his view is that the bull market still has further to run. “We think it will pay you to up your risk.”
Barr agrees that people are increasingly looking to get a better return on their money by taking on more risk. Money going into investment funds has tripled since 2012, with “most of the money coming off deposits”, he says, and the money is generally going into low to medium risk investment funds.
So, what can savers do?
Bottom of the pile in terms of tax efficiency lie deposit accounts. With Dirt of 41 per cent – plus a possible PRSI charge of 4 per cent depending on whether your unearned income is over €3,174 – and rates on the decline, deposits are quickly losing their lustre.
Interest upfront accounts
However, if you have been considering locking away money for some time, you may find that it’s too late to avail of interest upfront accounts.
Although some banks now offer you the possibility of paying you interest you’ll earn over the term of the account upfront, which means that if you had locked in before now, you would have had your gains taxed at 33 per cent, rather than 41 per cent from January, it’s now too late to open such an account for the purposes of paying a lower rate of Dirt.
KBC Bank for example, pays an AER of 2.35 per cent on amounts of between €3,000 and €1.5 million over a 12-month fixed term on its interest upfront account. According to the bank, business has been brisk on this account.
However, to meet the end-of-year deadline, you would have had to open such an account by December 5th.
Similarly, Permanent TSB offers a selection of interest-first accounts, with terms ranging from six months to 26 months. Again, however, its deadline for availing of a lower rate of Dirt was Friday last, December 6th.
If you think another rate cut might be on the way next year, you could still consider opening such an account. Its best rate is an AER of 2.5 per cent on amounts over €10,000 locked away for 18 months, and no maximum amount applies.
However, a minimum deposit of €5,000 is required. While you can make a further lodgment to the account, any withdrawals will incur a charge.
And some savers may find that, even if they have deposited their funds this year, they will still incur the higher rate of Dirt.
Customers of Ulster Bank’s Loyalty Saver account, for example, are discovering that while they may have opened their accounts this year, or even earlier, the way the account is structured means that interest is paid on January 2nd – so interest for 2013 will be paid on this date in 2014.
Of course, this means that savers will have to stomach the higher rate of tax. According to the bank, it arises because of the “terms and conditions” associated with the account, which can’t be changed.
Holders of certain long-term credit union savings accounts have also discovered that they will be liable for the new higher Dirt rate even though they made their investment some years ago.
Remember that Dirt exemptions still apply for certain people, so the above advice may be unnecessary. If, for example, you are over 65 and your income is less than €18,000 for a single person, or €36,000 for a married couple, or if you are permanently incapacitated, you will be exempt from Dirt.
Also, everyone aged 66 and over is exempt from paying PRSI.
