Is ‘loan’ still a dirty word for HNWI finances?March 16, 2020 | Categorised in: Inheritance Loan, Executor, Family
Marcus Holburn, Finance Director @ Ampla Finance
Historically, the word ‘loan’ would send shivers up the spine of many steady, solvent people, conjuring images of red-letters and bailiffs at the door. But whilst the steady-eddies of the world were living within their means, others were leveraging their assets, using available finance to take advantage of investment opportunities and accumulating wealth as a result.
Increasingly, niche lenders are making it possible to use capital assets as security, to unlock new opportunities or de-risk investment decisions, a prime example being funding for legal expenses, particularly in divorce and litigation.
You might say, if you’re a private investor or High Net Worth Individual, why would you need funding for something like legal fees, surely there’s plenty of available capital to pay the costs outright? But this may not be the most financially savvy option and there is an increasing realisation that a low-interest loan from a specialist lender could prove a better investment decision in the long run than drawing down on other asset pots.
For those seeking to claim a share of wealth owed to them but, as a result of their circumstances, don’t have access to ready cash, this sort of lending is proving a vital lifeline.
When facing unforeseen costs, such as legal fees, there are a few considerations to make, particularly regarding maximising profit and minimising loss from investments.
Firstly, beware the hidden costs – you may need more than you think. Divorce is notorious for cutting into the finances of High Net Worth Individuals and the more complex the case, the more the costs are likely to mount. Try to avoid adding complexity or unnecessary acrimony to the proceedings, as this will only serve to increase the fees incurred.
It’s also critical to make sure the balance sheet adds up. Remember that “hard” debts (bank loans, mortgages and litigation loans) are considered as joint liabilities during the division of assets and divided between the parties accordingly.
In comparison, liquidated investments used to pay for legal fees generally aren’t considered on the balance sheet as the costs are already incurred. Likewise, “soft” loans from family and friends are generally considered non-repayable, so may not be accounted for in the overall calculation. Also be aware that liquidated investments may be easier to value than invested assets, so think smart about how the assets and liabilities stack up when listed out side-by-side.
Understanding the costs of cashing in investments
Bricks and mortar are often considered the stalwart of prudent investment. An Englishman’s home is his castle after all; but those who have invested in property, especially over the last few, politically tumultuous, years know all-too-well that there are few short-term gains to be made. If property makes up a large part of your asset base, then you understand the losses possible if forced to sell when the market is weak, just to cover immediate legal costs.
And that’s not to mention the tax implications. If you’re a higher or additional rate taxpayer, you’ll pay 28% on gains from residential property that is not your home, including buy-to-let (investment properties), business premises and land.
Assuming your property portfolio is generating income through being rented for either residential or commercial purposes, you may also need to consider potential financial and legal penalties for breaking contracts with tenants, not to mention the time and hassle of doing so.
Stocks, shares & ISAs
Depending on the structure of your investment portfolio, the asset classes and risk appetite applied, cashing in your investments may come with a range of penalties, complexities and implications for achieving a return on investment. Two main costs to consider are:
In the UK, you may have to pay Capital Gains Tax if you make a profit when you sell shares or other investments. This excludes shares in an ISA or PEP, but can include equity shares, units in a unit trust and certain bonds. As with property, as a higher rate taxpayer, the 28% rate applies in this case.
- Opportunity cost
If your investment portfolio was set up for the long-term, then cashing in early can certainly hurt. Common belief dictates that you only want to play the stock market when investing for a time horizon of 10 years or longer. In that horizon, you can weather the market ups and downs and still make a profit. Suddenly cashing in your shares to fund an unexpected cost may end up costing you dearly in unrealised opportunity cost.
It’s also not uncommon in managed funds to have investment minimums or withdrawal restrictions and penalties. All these factors will have a significant impact on the ultimate return on your investment, so simply selling up may not be the most effective way of releasing capital when you need it.
It may be tempting to cash in a pension to release funds for unforeseen costs now, however this Is not only risky for your future, but may also incur significant cost, levied by HMRC. If you were to release the whole of your pension pot in one go, you would pay income tax on 75% of the whole amount. If you’re a higher rate taxpayer, this could mean paying 40% or even 45% on your pension, which is certainly something that requires careful consideration. Not only that, releasing your pension early could also affect your entitlement to benefits later in life.
Specialist lending could be the answer.
It may not seem obvious but staying in the market, using your investments to leverage your position and borrow for unforeseen costs, could well be the way to answer your immediate cash requirement, whilst seeing through the long-term investment opportunities.
In fact, in the case of a divorce, the balance of a loan used to pay legal costs can be wrapped into joint liabilities with your partner, splitting the debt after separation of finances.
There are many niche lenders who offer bespoke loans, tailored to specific needs and situation, so considering the right option for you in the circumstances may be the best investment decision you ever make.