Make your commission income work for the long-term, and your future self will thank you for it.
If your income is made up of a mix of salary and commission, it’s all too easy to fall prey to ‘lifestyle creep’. This is particularly the case in industries like IT sales, where commission is often as much, if not more than your base salary.
It’s not that you’ve been particularly extravagant, but, when you’re on a high level of commission, juggling lifestyle costs and waiting long periods of time for bonus payments, is it ever possible to make your finances work for you, both in the now and in the longer term?
After meals out, a few nice holidays and a couple of new cars, suddenly you can find yourself 10 years down the line with very little to show for it. In fact, you’ve still got a hefty mortgage, you’re not sure how to pay for the kids’ school fees, and your pension provision is nothing to write home about. And you certainly haven’t built up the private wealth you’d hoped you would.
However, with a little careful life and financial planning, it is possible to make commission or bonus income work for you over the long term. In this post, we’re going to explain the basics of what you need to do and consider in order to create a financial plan that meets both your current and your future needs.
The Starting Point of Your Financial Plan
Financial planning is about much more than just investing. It’s about life planning, a little budgeting, and making sure you have the essentials in place. It’s also about safeguarding the short term while making provisions for the long term.
We’ll have a look at a specific example towards the end of this post, but for now let’s take a look at the basic steps that you need to take in order to both ensure that your financial security and make sure that any spare cash from your salary and bonuses gets put to good use.
To start, you need to be absolutely clear about your employment status. It’s becoming much rarer to be self-employed at executive level (thanks to anti-tax avoidance legislation or IR35), but it will make a big difference to your tax obligations (amongst other things) if you are.
Once you’re clear on your employment status, it’s also important to clarify what your employee benefits look like. These include:
- Life Insurance
- Accident and sick pay
- Holiday entitlement
Then there are wider considerations to start thinking about, such as whether you have or are planning to have children, and whether you have a mortgage. If you work with us, we’ll also consider your career plan, including where you are now in your career and what your career risks and opportunities are. In particular, are your skills up to date? You don’t want to find yourself in a situation where your skills are so niche that there’s just no demand for them.
Finally, whatever age you are now, it’s never too early to start thinking much longer term. What do you want your retirement to look like and what, if any, legacy do you want to leave? Are you likely to receive an inheritance, have you written a Will and put in place a Lasting Power of Attorney, and have you made sufficient provision for your loved ones in the event of your unexpected death?
Your Immediate Financial Plan
You may not be ready to think about pensions, but that shouldn’t stop you planning your immediate future.
Whilst the idea of budgeting may not seem like much fun, it remains important. Without it, bonuses, commission and wealth quickly getting swallowed up by everyday expenses and life’s little luxuries.
Start by identifying the expenses to which you are committed as well as those to which you’re not, in order to determine your level of financial flexibility. Using this information, we can work out what you can afford to save each year.
With that knowledge, and the information you have provided as part of your answers to the life choices questions above, we can use cash flow modelling software to identify your financial goals. We can calculate both what you need to save in order to achieve the future you want and how much wealth you could accumulate by putting a financial plan in place now. It’s a powerful motivator.
Want to know how we do it? Find out more about our process here.
2. Life Insurance
Once you have a budget in place, one of the most immediate issues you need to address is whether you have sufficient life insurance and whether it’s tax efficient. There is a risk, depending on how your employer life insurance is structured, that it could be within the same master trust as your pension.
If it is, then a pay out on death could be treated as being the same as a pension pay out. That means that if the total amount paid out by way of pension and life assurance is above your Lifetime Allowance (£1,055,000 for the tax year 2019-20), it will be taxed at 55%.
If this is the case, there are steps you can take to mitigate this, such as setting up a personal policy by a way of a trust to ensure the pay out falls outside of your estate, but you will need professional advice.
Need some help? Click here to book a consultation now, at our cost and a time that suits you.
3. Safeguarding your Commission
A lot of IT execs we meet have commission paid via restricted stock units, and often these will vest at varying percentages over a number of years. If this is the case, we normally recommend that as part of your financial planning you sell your shares as soon as they vest. There’s always a risk associated with shares, because the value attributed to them is fixed at the date they are awarded to you, which will not usually be the same date at which they vest in you. Therefore, whilst of course the value may have gone up, it equally may have gone down and could continue to go down.
If you don’t sell, you also risk all your wealth being tied to your employer. This in turn can result in concentration risk as well as foreign exchange risk (e.g. if your shares are in dollars, but you’re based in the UK).
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Best Investment Options
Now that you have a budget in place and have safeguarded your position, it’s time to look at tax efficient investing. We recommend that you approach your initial investing in the following order to ensure that you minimise risk and maximise gains.
Your annual pension allowance is the amount that you can contribute to your pension each year and is currently £40,000 (2019/20). However, once you earn more than £150,000 (based on adjusted income), your annual allowance is ‘tapered’. ‘Adjusted income’ includes salary, dividends, rental income, savings interest and employer contributions.
For adjusted income between £150,000 and £210,000, you lose £1 of annual allowance (starting at £40,000) for every £2 of adjusted income. Once your income reaches £210,000, you’ll be left with an annual allowance of £10,000.
However, subject to the above, we’d recommend you start your financial plan by paying any spare bonus or commission into your pension fund, up to your allowance, as this remains one of the most tax efficient strategies open to you. However, it is prudent to take professional advice at this stage to ensure you don’t inadvertently go over your allowance.
ISAs are tax-free accounts for your savings or investments and your ISA allowance is £20,000 per year (2019/20).
If you’re aged between 18 and 40, you can open a Lifetime ISA with which you can save to buy your first home or save for later life. You can put in up to £4,000 each year until you’re 50 and the government will add a 25% bonus to your savings, up to a maximum of £1,000 per year. The £4,000 contribution counts towards your total £20,000 ISA allowance.
Once you’ve exhausted your Lifetime ISA, we recommend any remaining ISA allowance (which could be up to £16,000) is invested in a stocks and shares ISA. For details of how much you could save this way, see our case study below.
Investment bonds are life insurance policies where you invest a lump sum. Some investment bonds run for a fixed term; others have no set term. When you cash in investment bonds, how much you get back depends on how well the investment has done.
Investment bonds are a sensible consideration if it is likely that in the future you may have less taxable income. All gains and income earned within an investment bond are taxed at 20% and paid directly out of the investment bond.
You can withdraw up to 5% each year without incurring an additional tax charge. Or, you can roll your allowance over, for example you could choose to cash in 15% at the end of the 3rd year (provided you haven’t previously cashed any in) or cash in the whole lot at the end.
If you’re a higher rate or additional rate taxpayer (i.e. you’re paying 40% or 45% tax on income in the current tax year), an investment bond can minimise your income tax bill because the tax due is deferred and any additional tax due will be payable at the time you cash in the bond, or when it matures.
When the bond matures, if you divide your profit (including any previous withdrawals) by the number of years of the bond, and the resulting figure when added to your other income for the tax year is below the higher-rate tax threshold, there is no extra tax to pay.
A note of caution, however. If the amount calculated on maturity pushes you over the higher rate tax threshold for the year, then additional tax must be paid on the entire gain.
Venture Capital Trusts (VCTs)
When you invest in VCTs you are investing in a basket of investments, so although they are higher risk than ISAs and Investment Bonds, they still have an element of diversification.
VCTs are tax reducers, so in other words, they give you credit against your tax liability. For example, if your tax liability is £50,000 and you invest £100,000 in VCTs, you’ll get a tax credit of 30% of your investment (i.e. a tax credit of £30,000) thereby reducing your tax liability to £20,000.
You do have to hold VCTs for 5 years, but the dividends are tax free.
Enterprise Investment Schemes (EISs)
There are different types of EISs but it’s important to stick within the spirit of the governing rules to ensure that they remain within the scope of what is permitted by HMRC. Much like private equity, the investment is longer term and dependent on a single investment, so they’re higher risk and a more appropriate option for those seeking capital gains rather than tax free dividends.
Lyfe Wealth can help with all kinds of investments. We offer an initial consultation at our cost, so you can talk to us about what could work best for you. Click here to book.
Now that we’ve looked at the basics of how to start putting a financial plan in place, let’s look at a more specific example.
Meet Alice. She’s 32 and works for Google. She’s got a mortgage but no children yet. Alice has specialist skills within the IT sector and is on a successful career trajectory.
Her base salary is £100,000 and she is also on a bonus scheme which amounts to £100,000 annually. She has a mortgage of £350,000. From her net base salary of £60,000, she takes home £5,000 a month from which she pays £1,600 on mortgage payments and £2,000 on living, leaving £1,400 to put aside by way of savings.
From her salary, Alice’s best option is to start by making regular contributions to an ISA, starting with £333 per month (£4,000 per year) to a Lifetime ISA. That leaves £1,067 per month that she could pay into a normal ISA. Together, this takes up nearly all her annual ISA allowance.
By investing her excess salary of £1,400 in an ISA (and assuming a growth rate of 5%), Alice could potentially have savings worth almost £109,000 in 5 years’ time and £248,000 in 10 years’ time.
Another consideration for Alice would be to calculate her tapered pension allowance and make a contribution from her excess salary accordingly.
Let’s assume that Alice already has an emergency fund in place. Thereafter, we’d advise Alice to start by putting any extra cash from her bonuses towards paying down her mortgage, at the rate of 10% per year of the mortgage (if she can without triggering early redemption charges). Paying down her mortgage gives Alice more financial flexibility later down the line.
Long-term Financial Planning
With an immediate financial plan in place, it’s time to look at Alice’s long term plans. The process includes consideration of her career plans, retirement plans and broader life plans.
With her specialist skills, Alice is likely to continue to do well for the next 10 years. However, she may want to start a family and send her children to private school. She may receive an inheritance, and she may want to leave a legacy. Once we have a clearer picture, we can use cash flow planning to identify her financial goals and put a plan in place to ensure she achieves them.
Don’t let Lifestyle Creep Erode your Future
What the above illustrates is that being on a mixed salary / commission income doesn’t have to mean famine and feast, and that you can still make provision for your future, whatever that may look like.
Financial planning is often perceived as being all about investments, but it’s much more than that. It’s about making the right adjustments and early investments now, and putting in place the basics to ensure that you still enjoy the here and now but aren’t left short in the future.
If you’d like any help with your financial planning, protection and investments, simply book an initial consultation with Lyfe Wealth. It’s at our cost, and you can book any time that suits you. We look forward to meeting you!
Book your no obligation Lyfe consultation
Lyfe Wealth offers a no obligation consultation, at your convenience and at our cost.