Orienting one’s portfolio behavior based on tax benefits by targeting those tax-advantaged products seems a good move to manage one’s savings better. But this is not necessarily the case: taxation is only one of the elements that determine the final performance of a product
What, on the other hand, is the most rational approach to dealing with the selection? We talked about this with independent financial advisor Luca Lixi, co-founder of Aegis Scf
Pay less tax. It is a phrase that comes melodiously to the ears of any saver. When investing, it is often possible to do so: as we often write in detail in this newspaper, investments are not all taxed equally. Orienting one’s portfolio behavior based on tax benefits by targeting those tax-advantaged products seems an excellent move to manage one’s savings better. But this is not necessarily the case. Taxation is only one of the elements that determine the final return of a product; moreover, it cannot alone decide whether or not an investment is suitable for our personal needs (perhaps because it is too risky or because, instead, it offers meager returns).
A brief review of the leading examples of tax-advantaged investments.
- Government bonds (not just Italian): are exempt from inheritance tax, and returns tax is at 12.5 percent instead of 26 percent
- Life insurance policies: are exempt from inheritance tax
- Pension funds: have multiple advantages both in the accumulation phase (such as deduction) and in the performance phase (details here).
- Individual savings plans (Pir): which, under certain conditions, are exempt from the 26% tax on capital gains
Calculating whether a tax benefit brings substantial benefits is not always a straightforward exercise: the risk is that a single, simple certainty prevails in the decision: that, with the tax-advantaged option, you will pay less tax. What, on the other hand, is the most rational approach to dealing with the selection? We discussed this with independent financial advisor Luca Lixi, co-founder of Aegis Scf and popularizer for LixiInvest. “Proper financial planning, in this case, understood as a match between the client’s needs (protection needs and investment objectives) and the right financial products to fulfill them, should not start from the tax benefit,” said Lixi, “this is a possible plus that characterizes some products, but it should never be the only driver of choice of a financial product.
In your experience as a consultant, how decisive, or at least influential, is the tax benefit on client choices?
Tax benefits in a country with a very high overall tax burden are something to pay attention to. Savers are very likely to value anything that involves tax savings because they feel the burden of the IRS on their skin every day. Unfortunately, this has an apparent side effect: there is too much emphasis when selling financial products and services on anything that allows tax savings.
The sales negotiation of financial products (which unfortunately still predominates over unbiased and independent advice) thus emphasizes this “pro” of tax savings while going on to omit the various “cons” of the products.
I mention, for example, the very long time constraints concerning pension funds, the high deductibles for inheritance that make a large proportion of life insurance policies sold for this purpose superfluous, the poor diversification, and the home bias of products such as PILs [i.e., the intense concentration on the Italian market alone Ed.] As well as, as always, the high costs that can burden these investment instruments.
Is it possible to simplify the complex exercise in which we try to understand how much a tax benefit can positively affect the ultimate returns on investment?
It depends on which tax benefit we are talking about.
Concerning pension funds, a good advisor or good insurer can estimate the positive effect of tax savings (but without omitting the costs and other expenses that burden the product or service).
Consider life insurance policies taken out for inheritance purposes (the product is not part of the estate, so there is no paid inheritance tax). In this case, an accountant or notary (as well as a financial advisor) could also help in understanding what inheritance tax the heirs would save (remembering that the deductibles, i.e., the amounts inherited below which nothing is paid, are relatively high).
Still different is the case of the tax benefit on Pir, which manifests itself in the exemption of capital gains tax (26 percent). In this case, there would be no difference between gross profit and net profit, but before worrying about any capital gain tax, it would be better to worry about getting a capital gain. Therefore, it would be wise to understand where the individual savings plan (Pir) invests, its risk, whether it is adequately diversified, and what its costs are, and then consider its tax advantage.
Are there investments for which the tax benefit is a vital component in the choice (and others for which it is less so)?
Indeed, one should consider the various tax benefits of pension funds: not only the deductibility of the payment up to the traditional 5,164.57 euros (which would undoubtedly be appropriate to increase up to 10,000 euros annually, to give more incentive), as well as the preferential taxation then during the performance. And also what is not its tax benefit, such as the additional contributions the employer must pay in some instances.
In the case of the life insurance policy, you need specific advice to see if you fall under the inheritance tax cases (check the applicable deductibles) and act accordingly. In comparison, the tax benefit of offsetting all capital gains and losses is impossible to calculate ex-ante, partly because no one knows what capital losses and gains will occur.
Honestly, on the other hand, I am much more skeptical about the tax benefit of Pir because one risks disrupting one’s portfolio, increasing risk, and reducing diversification.
Contrary to what you may read online or hear from those who promote them, wealth management schemes are one of the most tax-inefficient products. The 22 percent VAT to be added to the cost of the service and the capital gain to be paid every year (and not just when disinvesting), thus locking in compound interest, make the product very inefficient, beyond the possibility of offsetting gains and losses of the underlying products.
A tax benefit, in theory, exists to encourage virtuous collective behavior. Are there cases where you believe the tax benefit exists to further objectives that quickly turn out to be at odds with the interests of savers persuaded by the relief?
For example, in the case of Pir, the expectation is to favor unlisted Italian SMEs.
Unfortunately, we often get beguiled by a tax benefit, forgetting what matters most in the long run. I give a crude example: it makes no sense to go and save 4 percent inheritance tax (a one-time tax that heirs will pay) by taking out a life insurance policy that costs 4 percent per year. So, I fully understand that the legislature has its general goals (to finance the local business fabric, to support the underwriting of the public debt, to prevent all pension provisions from falling on the Inps.). However, it is appropriate for the saver to pursue their individual goals in the first instance. They do not always go through underwriting a “subsidized” product. If these goals coincide with general taxation, so be it.
But I don’t think the saver should bear this burden, not least because savings are, by definition, unconsumed income taxed during its formation
