Earlier last week, I went to talk to children at a secondary school as part of the Speakers for Schools programme. Before I went, I thought about what it was that I really wanted the young to understand about money before they enter a world where their lives will be dominated by how much of it they have.
I’ve done this several times before, and I generally use the same format. I know I want them to understand what money is, how it is made, and where it comes from. And I want them to understand how it grows.
I always tell the legend of the chess-loving Indian king who promised a sage any reward he liked should he win their match. The sage, as all those interested in the power of exponential growth will know, asked for something pretty modest-sounding: that the king place a grain of rice on the first square of the chess board, double it on every square after and give the sage the lot. Two grains were to go on the second square, four on the third, eight on the fourth and so on for the full 64.
The king agreed. Bad choice.
By the 21st square he had to find space for over one million grains. By the last square it was about 9,200,000,000,000,000,000, and the total was enough to cover all of India in a layer of rice and, of course, to bankrupt the king.
It’s a fabulous way to start explaining how numbers aren’t always intuitive, and then move on another not immediately obvious miracle — compounding. From there it’s a short step to demonise the negative compounding nastiness of unaffordable debt, and to promote the brilliant long-term effects of starting saving early. If you want to get rich, stay rich and retire in style, I say, avoid taking on too much debt; save early and often; put the money away in cheap tax-efficient investment products, and let maths do the work for you.
But the more often I say this to the young, the more I think to myself that it isn’t a message for the modern world, filled as it is with distorting financial incentives. Working and saving hard might be one way to have a go at creating a reasonable retirement. But, perhaps what I should really be saying to my students is that a much better route to wealth is to work 16 hours a week, borrow money to buy a house on the side, and to devote the rest of your time to being really nice to your relatives in the hope that they will favour you in their wills.
The 16 hours bit is because that is the number of hours our system insists that you work in order to claim in-work benefits, something that has nasty implications for UK productivity (that’s another column), but also means that about 3.5 million part-time workers in the country end up taking home more than the median wage. Go for 16 hours (as many do — since 2012 the average number of hours worked part-time has averaged 16.1), and, while you won’t exactly be spending much time in the Maldives, your living costs should be taken care of.
The housing bit is obvious. The lack of capital gains tax on housing, the tax relief on interest payments on buy-to-let and the tsunami of policy aimed at keeping house prices high has made buying houses a good way to get rich in the UK.
The being nice to relatives bit is all because this government’s policies are remarkably inheritance-friendly. Couples can already leave £650,000 between them inheritance-tax free. And in their manifesto, the Conservatives promised to add another £350,000 per couple to that for the “family home”. So if you are from a reasonably well-off family — or just one with any old thing in London — and the July budget follows through on the plan, there’s a million in the bag for starters.
For the real money from the oldies in your family, however, turn to their pensions. Until very recently there wasn’t much for an heir to get excited about here. All annuities died with their owners, and pension assets held in drawdown were liable for a 55% tax on the death of their owner. But that’s changed. Under the new regulations, anyone who dies before they are 75 can leave everything in their pension up to their lifetime allowance (LTA) to their heirs 100% tax-free.
Yup, if you have £3m in your pension fund and a protected LTA (which those working in high earning careers sometimes do — see www.gov.uk for the trying detail on all of this — today’s LTA is only £1.25m), and you keel over two days before your 75th birthday, the whole lot passes down tax-free. The system takes no account of the fact that the money was originally saved income tax-free in the expectation that it would be spent, and hence, taxed later. It just hands it over, no questions asked.
If you die past 75, the deal is also pretty amazing (although why the pre-75 and post-75 deals are different in the first place remains a mystery to me). The money stays inside its pension wrapper where it can roll up income and capital gains tax-free indefinitely. It effectively becomes a long-term family trust for the lucky heir, one that gets to utilise the holy grail of investing (tax-free compounding) for as long as he or she fancies. The only tax payable comes when you withdraw cash from the fund — then you pay your marginal rate of income tax on it.
So be lucky enough to be the child of parents with large pensions, or have the time to find a relative who has one and likes you, and you could find yourself the happy owner of millions of pounds worth of tax-free cash. A recent study from Nest Pensions showed that 30% of households in the 55-64 age range have more than £600,000 in wealth, as do 23% of the over 65s. No shortage of happy hunting grounds there.
My point here is really about incentives. If you tax income from inheritance less than you tax income earned from productive work, you begin to skew the perception of the value of work. If you incentivise people to work part-time, you get a lot of part-time workers with unsatisfactory careers (and low productivity). And if you use the tax system to show that you favour housing above all else, you get very expensive houses and, as a knock on, possibly lower levels of productive investment than you would like.
I tell the students I meet to behave in a very different way than they might if they followed the logic of the tax system. Perhaps it’s time for me to be a little straighter with them. Or perhaps it’s time for the government to have a think about the signals UK tax policy sends to the potentially productive young.