This part one of an article looking at our acclaimed idea of financial independence, the generation of sufficient wealth to cater for all typical needs. Here we look at the principles and the desirability of self-reliance from both a personal and state welfare point of view, yet continually under threat from tax and benefit disincentives. We also make the case that as people are encouraged to save, they are able to build capital over a lifetime for the benefit of all the family, to give future generations a better chance to achieve that financial independence. In Part Two we examine the biggest threat to this, Inheritance Tax.
For the past thirty years the UK Treasury has been working to limit the State’s exposure to the liability for providing for the old age of a rapidly ageing population. To this end, state pension entitlements were quickly decoupled from average earnings and linked instead to the cost of living. This long term strategy successfully reduced the State’s financial commitment, but at a cost to the citizens? relative standard of living if they were dependent on the State for their retirement income.
The justification for State withdrawal was the desire to encourage individuals to make their own provision for retirement and for other welfare benefits, exemplified by the support given to private pension schemes, personal savings schemes such as ISAs, and tax relief in the area of private health insurance, an idea recently picked up and extended by the Conservative Party. The underlying purpose must have been to encourage as big a proportion of the population as possible to plan their lives to achieve financial independence.
Financial independence implies the building of a sufficiency of wealth to cater for all the typical needs. This starts with achieving a surplus of income over regular expenses, and extends to cover major additional outgoings, such as house purchase, retirement pension, purchase of larger assets such as a car, and major expense such as education. It also demands provision of comprehensive insurance cover against the risks that cannot be planned, such as ill-health, theft, fire loss etc.. The result will be the creation of a portfolio of assets, offset by various liabilities, which will have a large enough net value to enable an individual to manage the normal requirements of life without turning to the State for help.
Two points should be made here: desirable as the goal is, it is not easy for most people to build total financial independence, and it is nearly impossible to manage this on a whole life basis so that all the capital is exhausted at the moment of death. Common sense would suggest that families ought to be encouraged to accumulate wealth at least to the level where financial independence is available to all their members. To take capital away from individuals and families long before they have reached the goal of financial independence, and hence rob them of any chance of achieving it, would seem to fly in the face of the Treasury’s express purpose.
This, however, is what has been allowed to happen in recent years, progressively, and without regard for the consequences to the earlier goal to wean people off State support. The two major constituents of most people’s personal wealth have been attacked and the threat is increasing. The Treasury has removed colossal sums from the pension funds which manage personal pensions, and fiscal drag has been allowed to bring inheritance tax down to the level where most house-owners in the south east of England are now threatened by its 40% tax grab. The big fall in house prices in the current recession is only a blip and anyway creates more immediate obstacles financial independence. Increases in Stamp Duty and erosion of Capital Gains Tax allowances on selling your home have further impacted this goal and hit retirees particularly hard.
The biggest threat to personal financial independence, however, is Inheritance Tax. This is the subject of Part Two of our article on financial independence here on FinanCity.