Champagne corks are popping around the City as bankers and traders begin to rake in another year of generous bonuses. And with a return to healthy levels of merger and acquisition activity and a buoyant stock market, many are celebrating bumper payouts.
According the Centre of Economics and Business Research, the average bonus paid this year will be £23,000 – up 13 per cent on last year. But many financial advisers have been opening their doors to clients clutching multimillion pound cheques. Around 3,000 City workers are expected to bring home payouts of at least £1m in coming weeks and the total payout is expected to be £7.5bn.
Not all of this will be paid in cash. Bankers say that with the bigger bonuses, roughly a third is paid in cash and the remainder typically offered as deferred stock options, pay-able over two or three years.
Those in line for the biggest sums include commodities traders, who have benefited from soaring oil and gas prices, and those working on innovative derivatives products. Investment bankers are also set for hefty bonuses as both equity markets and M&A activity have surged.
Confidence in the job market is also high. Morgan McKinley, the financial recruitment company, says the number of ads for City jobs increased 52 per cent in the first two weeks of January compared with last year.
Financial advisers expect this job security will tempt recipients of large cash sums to splash out more than they save this year. Around half the bonus payments are expected to go into property, whether paying off a mortgage, moving up the property ladder or buying a second home.
Car dealers and wine merchants have already seen a sharp rise in orders. Pendragon, which operates car dealership franchises across the UK, said January was their busiest month ever, with the latest Ferraris, Bentleys and Rolls-Royces zooming off the forecourts.
Savvy investors may, however, wait to take advantage of the new pension rules being introduced in April which will offer greater freedom over how much they pay into pensions.
If you have yet to decide how to invest your payout, here are a few suggestions.
Financial advisers say reducing debt is a good place to start. Once any loans and credit cards have been cleared, you could pay off a chunk of any outstanding mortgage debt, provided you do not incur significant redemption penalties.
The mortgage website, www.charcolonline.com, says a lump sum repayment of £15,000 on a £200,000 mortgage would reduce the term on the loan by more than three years and save you £26,500 in interest.
With the new “A-Day” pensions regime around the corner, pension investment is expected to be a major pull for this year’s bonuses. Investors with funds in excess of or approaching the £1.5m “lifetime limit” being introduced on April 6 might be wise to mop up any unused pension allowances for this tax year. If they do this, they will be able to apply for protection from the proposed 55 per cent tax charge on funds above the £1.5m limit. Otherwise, advisers suggest stashing a chunk of your bonus away as cash until after A-Day, when you will be able to contribute up to £215,000 per tax year into a pension.
Nick Fletcher, managing director at Saunderson House, the independent financial adviser, says it would be worth checking whether your employer would be willing for you to sacrifice your bonus now and then pay it into your pension after A-Day, which could save you and your company National Insurance charges.
Property always provides a popular home for bonus money and this year estate agents are predicting a mini-boom in the London market. Savills, the estate agency, has seen a significant increase in demand for properties in areas such as Kensington, Hyde Park and Hampstead.
Many City workers are also using bonuses to snap up second properties abroad. Investors are flocking to countries with double-digit GDP growth – such as the Baltic States. Bulgarian Dreams, an overseas investment company based in the City, saw business increase threefold last month. But some City workers are more traditional. Assetz, the property investment specialist, saw a surge last month in sales of luxury ski chalets in the French Alps.
One of the biggest challenges employees face is how to keep their bonuses out of the taxman’s pockets. Make sure you have made use of both your own and your spouse’s annual allowances for individual savings accounts (Isas). You can invest up to £3,000 in a cash mini-Isa and up to £4,000 in a stocks and shares mini-Isa. In a maxi-Isa you can invest £7,000 in stocks and shares, of which up to £3,000 can be cash. You can hold one of each kind of mini-Isa or one maxi-Isa in any tax year.
Venture capital trusts (VCTs) – listed companies that invest exclusively in unquoted and Aim-listed stocks – also offer good tax breaks. VCT shares qualify for 40 per cent income tax relief if held for three years. They also offer investors exemption from tax on dividends and capital gains when they are sold. The tax rules surrounding VCTs may be reined in in this spring’s Budget so it could be worth snapping these up now.
Enterprise Investment Schemes (EIS), which allow individual companies and start-up ventures to raise capital from private investors, are similar to VCTs. They offer income tax relief of 20 per cent on investments up to £200,000 and allow investors to defer capital gains tax on gains made in the previous three years or in the next 12 months. Once an investor has owned EIS shares for more than two years, they are exempt from inheritance tax.
The Revenue has clamped down on tax avoidance schemes but there are still a few tricks to shelter your bonus.
Investors, whether movie-buffs or not, can go into film partnership schemes whereby they join a limited liability partnership to invest in film production. Any trading losses are written off against an individual’s income and investors get tax relief on losses from their investment in a partnership, plus gearing. You can also buy a completed film through a partnership and lease it back to the producer for a 15-year period and claim tax relief on the cost of production. A guide to film schemes is available from taxefficientreview.com
Forestry investments qualify for relief from inheritance tax after two years and no income or corporation tax is payable on timber sales. The average total return on investments in forestry in 2004 was 9.3 per cent, according to the Investment Property Databank. Fountains manages 750,000 acres of woodland in the US and UK. It says the highest returns come from the softwood species, Sitka spruce, used in packaging, construction and energy.
Advisers say that investors with high-risk jobs are typically risk averse. Mark Elliott, client group head at Coutts, the private bank, says investors looking for a fair amount of liquidity could leave some funds in cash or look to low-risk structured products, which are linked to asset classes such as currencies and commodities. These have fixed terms and provide capital guarantees as well as interest.
Investors should always look to build diversified portfolios. Funds of funds can provide a good one-stop shop for well-balanced equity investments.
The annual allowances for Child Trust Funds won’t make a huge dent in many people’s bonuses but they are still a good way to invest on behalf of your children. Each eligible child – those born after September 1, 2002 – can invest £1,200 annually in a CTF on top of their initial £250 nest-egg from the government. Trusts are also popular: the main types are life interest, discretionary and accumulation and maintenance trusts. Choosing the right trust can be complex so talk to an expert. The Society of Trust and Estate Practitioners (www.step.org ) can supply information on local practitioners.
Investing in fine wines can be profitable as long as you are patient and seek good advice. The Bordeaux Index says it is a very buoyant time for fine wine. It recently sold a case of Chateaux Petrus for £13,500 – £3,500 more than it had cost six months ago.
Berry Bros & Rudd says investors looking to buy now could go for the 2004 Burgundy en-primeur – meaning still in the barrel – or save their bonuses up for the Bordeaux en-primeur, which goes on sale in May.
Experts advise investors to buy into wine cautiously as selling scams are common and the industry is not regulated. The website www.investdrinks.org offers a directory of reputable wine merchants. Wine is usually bought by the case and held “in bond” at a merchant’s warehouse for a nominal annual fee, usually less than £10 per case. This means it is free of duty and Vat and is easier to sell. Wine is also seen as a “wasting asset” which means that profits from sales normally escape capital gains tax.
Gift payments provide good tax breaks for investors looking to put some of their pay cheques to worthy causes. The easiest way to do this is through Gift Aid, which allows UK taxpayers to increase the amount a charity will receive as it can claim 28p from the Inland Revenue for every pound given. Higher rate tax payers receive 18 per cent relief on donations. Coutts last year set up its own charitable division to advise clients.
