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Although there is little we can do to avoid paying at least minimal taxes, if we are lucky our passing from this physical realty we call our material world will be swift and without event, and we will have made provisions to ensure those individuals closest to us receive that which we would like them to receive upon our passing. We may alternatively have a very slow and perhaps even painful demise, and quite often when this is the case, we will need the resources we have saved during our years of relatively good health to see us through those periods of ill health.

Reasons why a person would need to save can easily be explained by looking at three generations of one family:-

Edgar Porter was born in 1906 before there was ever even such a concept of social security, which was not introduced to the United States until 1935 when Franklin D Roosevelt signed it into law (Wikipedia, 2007). Because there was no form of social security as we know it today, Edgar Porter knew that he was solely responsible for making his own way in this world and his success or failure laid purely on his shoulders, so he behaved accordingly. He married, raised four children, and worked in manual labour jobs his entire life. During his working life, he invested his savings in property in Arkansas, USA and built a farm, which enabled him to produce his own livestock, fruits and vegetables. Thanks to his lifestyle of working hard in manual labour jobs during the day and then working on his farm on evenings and weekends, he was in good health and peak physical condition throughout his entire life, rarely suffering from those ailments that plague people as they mature. One day when Edgar was working on his farm, he went into the house that he built with his own hands and told his wife that he was going to lay down because he did not feel well. It was when he lay down that he suffered a heart attack and died without incident at the age of 72. All of his property and other assets were divided amongst his surviving wife and four children, and although they were of course sad to lose him, they were also secure in the knowledge that they had been provided for by their benefactor.

Matthew Porter, born in 1934, was Edgar Porter’s son. He inherited a portion of Edgar Porter’s estate where his farm had been built on. Matthew had a completely different attitude to life and regard to his responsibilities, and as a result his views about saving were completely different. During his life he had been married and divorced three times and had two common law wives in addition to that. He also had three children from his first marriage that he failed to support, preferring instead to spend his money on the golf course and cigarettes, among other things. He was also a welder by trade and his occupation combined with the fact that he had been a heavy smoker for most of his life affected his respiratory tract to the extent that he was diagnosed with emphysema and then lung cancer in his late 60’s. Although he was able to work part time when he retired, once he was diagnosed with lung cancer he had to stop working because the chemotherapy and then radiotherapy was too much of a drain on his already failing health. Although Matthew Porter did not have many assets, the little that he did have had to go towards paying the medical expenses that his insurance did not cover. When he died, just two months after his 70th birthday, the remainder of his assets were distributed to his children and grandchildren.

Renee Porter, born in 1961, was is the granddaughter of Edgar Porter and the daughter of Matthew Porter, lacked the stable family background that her own father and grandfather had been fortunate enough to have, and as a result developed a completely different attitude to life. She joined the armed forces and, being provided free accommodation by the United States government, had little incentive to invest in property, so she didn’t. She only would have been given a military pension if she had stayed in the United States Air Force for 20 years, and choosing to leave and move to England when she had only served 15 years, she gave up that entitlement as well. Because she was too old to invest in a British pension, and property in the UK is too expensive on her modest income, the only viable way she can save money is through high interest savings accounts and low risk investments.

The above paragraphs show how three generations of the same family can adopt different strategies of saving their money based upon their own particular experiences and lifestyles. Edgar Porter chose to invest his money in property, Matthew Porter chose to invest his money in an Individual Retirement Account, which is a type of pension, and Renee Porter chose to invest her money in tax-free equities and bonds.

An individual’s propensity to save is to a large extent determined by his income. If he is on a modest income then it is highly unlikely that he will be in a position to save vast amounts of money.

It should be noted that the English government does not encourage people on modest incomes to maintain funds in excess of £16,000 as at 2006. If an individual, through no fault of his own becomes unemployed, he will be expected to live on his savings until he has less than £16,000 in the bank before he will be able to claim any benefit other than job seeker’s allowance from the English government. Because of the strict criteria that the English government places on people before they are allowed to claim benefits, some dishonest individuals will claim benefits whilst keeping their money in off shore banking accounts. Other deceptive individuals will open savings accounts in their middle names, hoping to claim government benefits while at the same time retaining their savings. Of course, the two examples cited above are highly illegal, but they illustrate the lengths that some people will go to in order to defraud the English government.

Although any person depending on the social security system for his income knows very well the maximum amount of money he is allowed to save before those benefits he needs are withdrawn, it is refreshing to know that there have been empirical studies in the finance sector that confirm what the common man has known all along: that the distortionary effect that the public sector social security scheme, including pensions, will result in a decrease in savings. Through taxation, the government saves on behalf of individuals by making provision for retirement and incapacity. The Harvard economist Martin Feldstein used data from a cross section of the population to confirm the existence of the displacement effect, finding there is a negative relationship between social security spending and savings. In other words, the more people rely on the government for their social security the less inclined they are to save (University of Leicester, 2001). This analogy can be illustrated below as:-

Another determinant of an individual’s ability to save is to a large extent governed by their income and consumption, which is algebraically expressed as:-

Y = Income

C = Consumption (University of Leicester, 2001).

Therefore, if an individual has an income of £1,200 a month and spends £800 a month then he will have the ability to save £400 a month. Over a period of a year, therefore, he will have saved £4,800.

There are four main assets that an individual can invest in, which are cash, bonds, property and equity.

Cash investments are secure investments that include bank or building society accounts, National Savings Accounts, and other interest paying accounts. These types of investments are easily accessible and generally give lower medium to long-term returns than riskier investments (Scottish Widows, 2006).

Bonds, also known as fixed interest and index-linked securities, are essentially loans to the organization that has issued them. Bonds issued by the UK government are called gilts, and are used to finance improvements to the country’s infrastructure. Gilts are considered to be a very low risk because the UK government can always raise taxes if it has difficulty repaying its borrowings. Corporate bonds are bonds issued by companies for a variety of purposes, such as expansion or research and development. These types of bonds, unfortunately, have a higher risk than gilts (Scottish Widows, 2006).

Investment in property via our own homes, for many of us, will be the biggest investment we will ever make and will quite likely be our largest financial asset. Investing in property is considered riskier than investing in bonds for several reasons to include maintenance, purchase costs, and the possibility that the housing market could collapse, leaving the property with negative equity. The benefits of investing in property are the fact the buyer can live in the property while it is investing in value and he can also generate income through acquiring rental payments through tenants (Scottish Widows, 2006).

Equities, also known as stocks and shares, are perhaps the riskiest investment an individual can make because the prices of the shares can fluctuate, sometimes decreasing in value. Although they are risky ventures, some people like to invest in them because they can receive income in the form of dividends and they become part owners of the company without having to become involved in the day to day running of the business (Scottish Widows, 2006).

As previously stated in the beginning paragraphs of this paper, there are only two things that we in this life can be certain of – death and taxes. With that in mind, it should come as no surprise to the reader that the British government will endeavour to tax any interest earned on savings, with a few exceptions, and any capital gains earned through the disposal of assets, also with a few exceptions.

The British government levies a tax on savings interest of 20% before the saver receives any interest payments at all. Some savers must pay a higher rate of 40%, and they will be required to pay tax on the difference. Some savers who are on a low income may be able to claim the tax back. The rate at which an individual is taxed depends upon his income. Savings income below £2,230 is taxed at 10%. Savings income more than £2,230 and below £34,600 is taxed at 20%. All savings income above £34,600 is taxed at 40% (direct.gov, 2007).

Although the British government taxes interest earned on savings, there are a few exceptions to this rule, so there are some savings and investments that will provide a tax-free return. Individual savings accounts, or ISA’s, are tax-free savings and investment accounts. They are used to save cash or to invest in stocks and shares. The maximum amount that an individual can put into an ISA is £7,000 each year (direct.gov, 2007).

The British government also taxed UK dividends, which are income received from UK company shares, unit trusts, and open-ended investment companies. Dividend income in relation to the basic rate tax band applied after personal allowances and any blind person’s allowance of less than £34,600 is taxed at a rate of 10%. Dividend income above £34,600 is taxed at a rate of 32.5% (direct.gov, 2007).

Although shareholders like to receive dividends, there are disadvantages to receiving dividends because those dividends are essentially taxed twice. Corporation tax as currently 20%, and any dividends paid liable to corporation tax before they are paid to the shareholder (qck.com, 2007). For example, if a huge company makes £100 million profit after interest payments and other deductions, it would be liable to pay 30% corporation tax, which is £30 million. The profit after corporation tax therefore would be £70 million. If that same company decided to pay out the entire £70 million as dividends to its shareholders, the least amount of tax they would be liable for is £7 million and the greatest amount of tax would be £22.75 million. Therefore, the tax payable to the British government can be illustrated as:-

	                                10% tax                   32.5% tax

                                      £ million	             £ million
Profit after interest deductions.	       100                       100
Corporation tax	                        (30)                      (30)
Profit for the financial year	             70	                      70
Shareholder’s tax	                        (7)                      (22.75)
Shareholder’s remaining funds	             63	                     47.25

The above example illustrates that, theoretically speaking, from £100 million profit, the shareholders may only see £47.25 million of it after the company has paid corporation tax and the shareholders have paid their personal tax.

In the UK, pensions are a type of investment that individuals make in an effort to plan for their retirement. They are particularly attractive because they are not normally tax deductible. There is no other type of investment that enables an individual to gain tax relief when he pays money into it, enjoy the benefits of the fund and pay no tax on its income and gains, and take a part of the fund as a tax-free lump sum. Paying money into a pension allows a person to effectively convert taxable income into a tax-free capital sum (Foreman and Mowles, 2004).

As attractive as pensions are, however, they are not appropriate options for everyone. Some people who are on modest incomes have difficulty making the necessary payments into a pension fund, and they are left with no other alternative but to rely on the state pension instead of building up a private pension. There are other individuals, such as Renee Porter, who was cited at the beginning of this paper, are too old to invest in a private pension. The reason why it would be impractical for her to invest in a pension at this stage in her life is because any money she invested in a pension would not give her a high enough return to live above the poverty level upon her retirement. The British government, therefore, would be forced to top up her meager income with a tax credit to bring her standard of living up to the poverty level.

It is precisely because some people have, through possibly no fault of their own, have failed to make adequate provision for retirement, and it is for that reason that the British government has been forced to step in and pay out state pensions to those individuals. Such pensions are funded through National Insurance contributions. The British government, therefore, is saving for a person’s retirement by making provision for him, and this has the effect of displacing private sector savings (University of Leicester, 2001).

Many people decide to invest in property as a way to make their money grow. The last several years in particular have seen an enormous property boom, with the value of house prices going up about £50 a day (O’Grady, 2007). Because the interest rate has been raised to 5.75% in an attempt to bring inflation down, this has caused housing prices to slow and they are predicted to continue to slow down in the near future. In addition to the high interest rates, first time buyers are paying an average of £1,458 in tax, or stamp duty, to get on the property ladder. At a price of £125,000 stamp duty is 1%, at a price of £250,000 it is charged at 3%, and at £500,000 it is 4% (O’Grady, 2007).

Unfortunately, because housing prices have become so perilously high, with the average cost of a home reaching £211,056 in May 2007, combined with an interest rate of 5.75% that is expected to go up to 6% before the end of 2007, and adding the costs of buying the property, such s stamp duty, legal costs, rates, surveyor fees, mortgage fees, interest on the mortgage, and any renovation costs, leads to a very unfortunate situation for the average homeowner. It has been reported that in the first six months of 2007 half a million homeowners have missed their mortgage payments. Borrowers with a £200,000 mortgage are paying £160.24 more a month in July 2007 than in August 2006 when the interest rates were 4.75%. Because homeowners are having difficulties paying their mortgages, it is feared that many properties will be repossessed and the property market will crash. The last time the property market crashed in the UK was 1991-1992, and at its peak there were 75,000 repossessions (O’Grady, 2007).

Capital gains tax is a tax that is charged on the profit realized on the sale of an asset that was originally purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals, and property. In the UK, all individuals are exempt from paying capital gains tax on up to £9,200 as at 21 March 2007. Individuals are also exempt from paying capital gains tax on their principal private residence and holdings in individual’s savings accounts or gilts. After exemptions and personal allowances, people must pay capital gains tax at their highest rate of marginal income, which could be up to 40% if the individual earns more than £38,000 a year (Wikipedia, 2007).

At the beginning of this paper an example of three generations of one family was presented to the reader in an attempt to illustrate the different ways an individual can choose to save and invest his money. Although those three individuals came from the same gene pool, they had completely different philosophies of life and ideas of how to spend and invest their money. No one investment was right or wrong, but was intended to suit what the individual needed in order to help him to achieve his life goals.

To conclude this paper, no one can be sure of anything in this life. We all make decisions to live our lives in a certain way, and those decisions are all based upon a risk assessment that we have made. We can choose to invest in our future by various means, either by putting our money in a high interest savings account, a pension, stocks, bonds or property. Some people may even choose to marry, hoping such an arrangement will provide them with security for life. No matter what we do to ensure a safe future for ourselves, there are no certainties in this life that we have chosen for ourselves.

If we invest our money in a savings account, there is no guarantee that inflation will not erode our investment or the financial institution will not collapse. If we choose to invest our money in a pension, there is no guarantee that the fund manager will make wise decisions and we will receive any pension at all. If we decide to invest in securities, there is no guarantee that the organization we have invested in will not cease to operate or the value of the shares will plummet. Finally, if we decide to invest in property, there is no guarantee that the housing market will not collapse or a natural disaster will not destroy our property.

Any investment, therefore, contains an element of risk, which we must always take into consideration before parting with our hard earned cash. When investing money, the only thing that we can truly be certain of is that the government will endeavour to gain income by taxing any interest earned or capital gains incurred through the disposal of our assets, with certain exceptions.

There truly are only two things that we can be certain of in this life, therefore, and they are death and taxes.

References

Direct.gov (2007)
URL: www.direct.gov.uk/en/taxandbenefits/taxes/taxonsavingsandinvestments/index.htm
[2 July 2007]

Foreman, A. and Mowles, G. (2004). Zurich Tax Handbook 2004-05, Pearson Education Limited: Harlow, UK

Lowe, J. (2002). Be Your Own Financial Advisor, Which? Books: London, England

Qck.com (2007)
URL: http://www.qck.com/budget-2007.html
[2 July 2007]

O’Grady, S. (9 July 2007). 500,00 can’t pay mortgage bills, The Daily Express, page 2.

O’Grady, S. (17 July 2007). Value of Houses is Going Up £50 a Day, The Daily Express, page 1-2.

Oldfraser.lexi.net
URL: http://oldfraser.lexi.net/publications/forum/1998/february/terminology.html
[2 July 2007]

Scottish Widows Plc (2006). Investing With Confidence: Investment Guide 2006/2007, Edinburgh

University of Leicester (2001). MSc in Finance: 2505 Public Finance, Learning Resources, Cheltenham.

Wikipedia (2006)
URL://http//www.wikipedia.org
[2 July 2007]