Transcription
What if I told you that there are some things about the UK tax system that HMRC would prefer that you didn't know? One of those is that owning assets and using leverage to your advantage is a powerful tax avoidance strategy. I'm a chartered accountant with over a decade of experience working for some of the UK's leading tax practices. And in this video, I am going to share an important tax strategy that you need to understand.
The first part is why owning assets is more important than earning a high salary. The second part is how to use leverage to pay less tax. And the third part is how to tie all of this together properly to keep more wealth in your family.
I want to clear something up. First of all, there is a very well-known strategy used by Americans called buy, borrow, die. And wealthy families across the pond use this strategy to keep more wealth in their family and pay less tax. But here's the thing, that strategy does not work in the UK. And I'm going to explain why later on in the video.
What does work is a variation of that strategy that I call buy, borrow, sell, gift, die. It's a bit of a mouthful, but I'm going to explain how it works as this video goes on. But the fundamental thing that I want you to know is that the UK tax system is designed to tax earned income, that's basically your salary, more heavily than assets. So if you are an employee, you will get hammered by high tax rates up to 45% and there's very little that you can do to avoid that tax. But when you own assets, everything changes. When you sell your asset, the highest tax rate that will be applicable is 24%. Not to mention that there are a number of reliefs that you can use and you can borrow against those assets which is even more tax efficient.
So let's get straight into this UK strategy. And part one is buying more assets. Most people rely on salary as their main source of income, but that's the worst place to be for tax purposes because you pay income tax and national insurance automatically. You've got no control over how much tax you're paying. And if you earn between 100 and 125k, your marginal tax rate will be as high as 60%. So if you want to build serious wealth and pay less away in taxes, you have to focus on asset ownership. That could be your own business. It could be shares in other businesses, so investing in the stock market, or it could be investing in property. And that's where the tax efficiency really starts. And it's true that you have to have money in the first place to be able to invest in those assets. But by knowing how the UK tax system works, you know which general direction you need to be heading in in order to pay less tax.
Once you own assets, you've got more options. You could choose to sell your assets in order to generate an income. And remember that capital gains are taxed at lower rates than income. So you'll pay a maximum of 24% which is a lot more generous than how income is taxed at the higher rates. Plus, you could decide to borrow against the assets, which I'm going to talk about next, and that's to borrow until you die or at least for a long time.
So, once you own your appreciating assets, that's important for two main reasons. First of all, your assets are growing in value and you're not paying any tax because assets are only taxable once you sell them even though your net worth is increasing. And secondly, because assets do generally increase in value over time, it means that you can borrow against them. But debt is not a taxable income stream. So you're not going to pay any tax when you take out a loan against your assets.
So let me show you how this works with a very simple example. Let's say that you buy a property for £200,000, but you only put down 20K and you borrow the rest from the bank. And in 20 years time, that property will be worth £1 million. That's a gain of £800,000 in terms of the value of the property, but your wealth is £1 million and you don't have to pay any tax on it because you've not sold anything and you've not triggered a taxable event. So that's an example of leverage. You have used debt to increase the return on your investment being the value of the property over time.
Now you need some liquidity and you need to realize some cash, but you don't need to sell the property. Instead, you can borrow against it. Meaning that you could refinance and take out say 600k. And because that's not income, there's no income tax to pay. And because you've not sold anything, there's no capital gains tax to pay. That £600,000 is debt. And it's tax-free. it will reach your bank account ready for you to either reinvest it or to spend and use to fund your lifestyle. Importantly, you do need to make sure that you can service the debt, meaning that you can afford to pay any interest payments on that debt. But that's how leverage works and that's exactly how business owners can also borrow against their shares. So somebody like Elon Musk takes out a very small salary and all of his wealth is actually tied up in his shares, but he doesn't want to sell his shares because that's a taxable event and he could end up losing control of his company. So instead he borrows billions against his stock.
Now the next part of the strategy is where I see a lot of online content exaggerating. There is something called buy, borrow, die, which is a very tax-efficient strategy that can be used in the US to pass on wealth tax-free to the next generation. So in the US, a rich person can buy assets and borrow against them just like we can do in the UK and like I've described in this video. But then in the US when that person dies they can pass on their assets completely free of capital gains tax and that's because in the US they have something called estate tax and the recent one big beautiful bill act increased the estate tax allowance to $15 million per person meaning that somebody can pass on $15 million of assets tax-free on their death in the US. That is incredibly generous and it's why the richest families in the US can stay rich for generations.
If we compare that to the UK, we have inheritance tax, not estate tax. And in the UK, we have a tax-free allowance of £325,000 on death, increasing to half a million if you're passing on your main home. Compare that to $15 million and you can see why it's not possible to pass on wealth tax-free on death in the UK. So that's why buy, borrow, die doesn't hold up in the UK because you can buy assets, you can borrow against them, but then if you hold them when you die, you're not getting rid of the tax bill. You are just deferring it to the next generation. And if you exceed 325K or half a million and you've not planned to give away those assets before you die, then your descendants could be hit with a 40% tax bill, which is incredibly high.
But it's not all doom and gloom. There are things that you can do in the UK, but it's not buy, borrow, die. Instead, it's buy, borrow, which we've already covered, and then it's sell gift before you die. So in the UK the strategy that works is buy, borrow, sell, gift, die. So you buy assets, you borrow against them, but then you sell them in your lifetime. And that's because the capital gains tax rates are lower than the inheritance tax rate of 40%, which would apply if you held the assets until you died. Your descendants would have to deal with that 40% inheritance tax rate on your death. But if you sell those assets whilst you're still alive, you are dealing with a known capital gains tax rate, which is always going to be lower than the 40%. And then what you would do is you would gift the cash that you'd made on the sale of those assets, or you could gift the assets themselves. And as long as you live for at least 7 years after making the gift, there'll be no inheritance tax to pay. So that 40% will be completely bypassed because you've taken the asset outside of your estate for inheritance tax purposes. And that's why it's really important to understand why buy, borrow, die in the US doesn't work in the UK. You can do the first two parts of the strategy, which is to buy and to borrow, but then you have to be willing to sell your assets or to give them away well in advance of your death.
Now, borrowing against assets is not for everybody. First of all, remember that you still need to service the debt, meaning that you need to meet the interest payments. Secondly, the value of your assets can fall as well as rise. And thirdly, the rules around these things can always change.
But in terms of how to take advantage of this tax strategy, the first thing you can do is to focus on building your assets. So that could be in the form of property. It could be your own house. It could be a buy-to-let or a commercial property because that will allow you to hold an asset and use leverage later down the line to go and buy another productive asset. But in its most simplest form, it could simply mean investing money through a stocks and shares ISA or a pension because that way you are able to buy shares in other companies which are again an asset in a very tax-efficient way because remember that pensions and ISAs are tax wrappers.
Secondly, remember to use leverage to your advantage. So the option to refinance and to use leverage is always there on property, but make sure that you use that debt to buy another productive asset rather than refinancing and then blowing all the money because that doesn't help you to build your wealth and it's probably not very responsible. But also know that borrowing against shares, which is a securities backed line of credit, is generally quite complicated and expensive. So that might not be the way that you want to use leverage.
Thirdly, you want to plan well in advance. The worst thing you can do is to buy assets, borrow against them, and then do nothing and still be holding those assets personally when you die. So far better than that is to sell those assets or to gift those assets well in advance of your death so that you can avoid that 40% inheritance tax rate and your family get to keep more of your estate.
By only earning income, you are playing the hardest version of the wealth-building game. So remember that you need to own assets to unlock flexibility. Hit the subscribe button if you haven't already because it means a lot to me and it helps the channel to grow. Remember that this is purely educational. It is not advice. Thanks for watching and I'll see you next.