The Importance Of Financial Education

A couple of weeks ago, I attended the latest Personal Finance Society (PFS) Regional Conference, and as the Professional Qualifications Officer for Kent, I presented some slides to other financial professionals on the initiative by the PFS for members to provide pro bono financial education sessions within local secondary schools.

The content is in the form of a board game and looks to provide students with tips on understanding investment risk and financial budgeting, but for me the most important objective is helping young people to avoid financial scams. It reminded me of an article that I’d read on the BBC website a couple of days earlier about London Capital & Finance which went into administration after taking £236 million from investors.

Their marketing campaign targeted first-time investors with promises of fixed interest returns of 8% from secure ISA’s and would spread investment risk over hundreds of companies. The reality was that 25% of the investments made were paid as commission to the marketing agent, and then funds were lent to a total of 12 companies – four of which had never filed accounts and nine were less than three years old!

The financial crisis of 2008 showed that even well-known and reputable financial firms are not immune from the perils of administration, but in the current low interest rate environment, a guaranteed investment offering a return of four times the best Cash ISA rate on the market would be treated with scepticism by the majority of experienced investors.

The government have introduced incentives such as Junior ISA’s and automatic enrolment to encourage younger people to start saving earlier in life, but it is important that we educate them on managing money responsibly. For those children fortunate enough to have parents and/or grandparents funding Junior ISA contributions, they will take over sole responsibility for the management of the account on their 18thbirthday. What’s to stop them investing in the scheme they saw on social media promising double digit returns, and looks so much more interesting than their existing investment?

I’ve done a number of surgeries to talk to people about the pension benefits offered by their employer, and some of the people I speak to are just out of school or university. For the majority this is probably the first conversation they have ever had about pension provision, and while there are those who are lucky enough to have parents who they can turn to for help, I’ve met young people who struggle to understand how deductions from payroll such as Income Tax and National Insurance operate.

Matt wrote a blog a couple of months ago about our intention to host workshops to provide the tools the next generation needs to be successful financially, and while the goal of any investment is to make some money, it is probably more important to teach the lesson of how not to lose it all.

The New Property IHT Allowance

One of the more predictable elements of the summer Budget was the introduction of a new ‘Property Nil Rate Band’, which will mean that eventually individuals can pass on a further £175,000 tax free to their direct dependents, in addition to the current £325,000 nil rate band that exists at present.

As with all new legislation however, there are some things to be aware of.

First of all, the new allowance will be introduced in tranches as follows:

  • 2017/18 – £100,000
  • 2018/19 – £125,000
  • 2019/20 – £150,000
  • 2020/21 – £175,000

These amounts are given with reference to the date of death of the deceased.

In addition, the new Nil Rate Band will only apply to a family home (i.e your main residence), passed onto direct descendants, which in the legislation are taken to mean children and grandchildren. There is some further consultation on where the property could be left to certain types of trust.

As with all new legislation, it is important to review you current plans to make sure you get the full benefit. Any older will that include gifts into trust, may not be eligible to claim the new nil rate band, and this could also be true for those who do not own a home, or who choose to leave their home to people not considered to be direct descendants.

We will be covering the new changes in detail during our updated Estate Planning Seminars, running from September onwards. You find out more information here.

Summer Budget Summary

The Summer Budget contained little in the way of surprises (nice ones anyway), however the rate of change seems to be building, creating a more dynamic and fluid financial planning world. There are already hundreds of budget summaries online, so I will cover here some of the key points that might impact on Buckingham Gate Clients:

 

1. Dividend Tax Changes

From 2016, dividends will no longer come with their 10% tax credit, which used to satisfy the basic rate tax liability for those in the 20% tax band. From 6th April 2016 dividend income will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers, once income from dividends exceeds a £5000 tax free allowance. This news will be unwelcome for business owners who receive large amounts of dividends as part of their remuneration and those with large share portfolios outside of a tax wrapper such as an ISA.

Business owners especially, may wish to review how they are remunerated from their companies.

 

2. New IHT Property Nil Rate Band

I have written a more detailed article about this change here.

 

3. Removal of Higher Rate Tax Relief on Buy to Let Investment

I have written before about the potential pitfalls of using pension assets to fund buy to let purchases, however the case has just become even less compelling. The Chancellor has announced that over the coming years, tax relief on buy to let mortgages will be restricted to just 20%. This will have the effect of reducing the net returns from buy to let investments for higher rate taxpayers. While buy to let property is undoubtedly a success story for many, there are risks and pitfalls.

Beware Of Temptation

A majority of pensioners who were asked if they would sell their annuity – a reform the government is currently consulting on – said they would not sell, reported the Financial Times. Almost half said they thought they would get a poor deal. But almost one in five said they would sell either to pass on an inheritance or to fund healthcare costs in old age.

The sale of existing annuities is likely to be tricky and even if the government does go ahead with its proposals, many annuitants can only expect to get back a much smaller sum than they paid originally.

What needs to be remembered here, is that it is likely to be the same insurance companies who offer the annuities that will be offering to buy them back, and the cynic inside me says that they will want to take some profit along the way.

What Does The Conservative Election Victory Mean For You?

With the Conservatives surprising just about every pollster, media outlet and individual in the country with their majority election win, people may now start to wonder what might change from a financial planning point of view. Here we summarise some of the key Conservative manifesto pledges (a word of warning – these changes are yet to be implemented in law yet):

The conservatives have pledged to increase the tax free personal allowance to £12,500, while at the same time raising the higher rate tax threshold to £50,000.

Introduction of a new help-to-buy ISA, which will offer a bonus from the government for those who are saving for their first home.

The addition of a new Inheritance Tax allowance that can be used to pass on the family home. The proposal here is to give each individual a further £175,000 allowance to use for a family property, on top of the current £325,000 allowance.

Protecting various pensioner benefits such as the free bus pass and winter fuel payments.

Reduce tax relief on pensions for those earning over £150,000.

The key thing to remember here is that these are currently just manifesto pledges. These changes have not become law, nor has draft legislation been published. As with many things the devil will be in the detail so we will have to wait and see just how many of these proposals will become a reality.

Freedom Comes With a Health Warning

With all of the excitement and media comment surrounding the new pension freedoms, the 6th April itself seemed to pass without incident. While some providers have reported an increase in call volumes, it would appear that for the moment, there has not been a gold rush on the nations pension pots.

All of this new freedom and flexibility is fantastic for those who wish to use their pension pots to fund a lump sum purchase, a holiday or even a Lamborghini. However for those of us who still wish to generate an income for life with our pension funds, we have a tough choice to make. Do you purchase an annuity with the guarantee of an income for life, but with loss of your capital sum, or, do you opt for a drawdown pension and draw an income out of your invested lump sum.

While the latter option will be appealing to many, especially given the ability to pass on any unused funds to a beneficiary, it does come with a health warning.

You see the problem with this approach is that none us knows exactly how long we are going to live and therefore, how long this pot will need to last for. The main risk here is what we would call ‘sequence of return’ risk. That is to say, in what order do the returns on your fund occur. We all know that over the long term asset backed investments tend to out-perform cash, but they are volatile. The impact on your retirement of a 10% fall in your fund value during the first year will be very different to a 10% fall in year 10. It is very important to diversify and smooth the returns of the market as far as possible in order to protect your fund from sudden falls, especially in the early years.

This article from the Telegraph sums this up fairly well and is worth a read if you are considering taking a drawdown pension. While I am certainly in favour of the new flexibility rules, it is important that we consider all of the risks involved before taking the leap!

Our 2014 Investment Action Plan – Part 7 – Auto Enrolment

The end of 2012 saw the introduction of the government’s flagship Auto Enrolment pension legislation. The aim of Auto Enrolment is to require employers to set up a pension scheme for their employees and for them to make a specified minimum level of contributions. The government hopes that this will start to create a turnaround in the seemingly ever- decreasing levels of pension saving in the UK.

Auto Enrolment requires all “eligible jobholders” to be enrolled into a qualifying pension scheme either on
or before a company’s “staging date”. The staging date is the deadline for complying with the new legislation and will vary depending on the amount 
of employees in the business and in some cases that employers PAYE reference number. Larger employers (who have over 500 employees) had staging dates towards the end of 2012 and throughout 2013. These larger employers generally have specialist HR and pensions departments to help them qualify with the rules and in many cases they will have had a suitable pension scheme in place anyway.

2014 is the year in which small and medium size business will begin to be affected by Auto Enrolment. In January employers with between 499 and 350 employees will have to comply and by October, those with as few as 60 employees.

In many cases these smaller businesses will have much more work to do than some of their larger counterparts. For starters, many smaller employers do not currently have a formal pension scheme in place. Although previous legislation has required all employers to designate a stakeholder pension scheme, the absence of employer contributions means that in many cases these are nothing more than an empty shell. Auto Enrolment will therefore see many employers dealing with the implementation of a pension scheme for the first time.

Smaller businesses will also need to get to grips with the categorisation of workers, making sure that their payroll software is suitable and also ensuring that they maintain compliance on an on-going basis. Add in the communication requirements, the categorisation of part time workers, sometimes on a monthly basis and the need to ensure that the scheme offers suitable investments and it is clear that Auto Enrolment can be a very time consuming and costly exercise.

The penalties for non-compliance are severe, and in some cases are up to £10,000 per day. Suffice to say, most smaller employers can ill afford these types of fines.

If you are an employer or business owner, it is recommended that you begin to plan for Auto Enrolment at least 6 months before your staging date. A planning window of a year or more would be ideal. A Chartered Financial Planner or Employee Benefits Specialist will be able to help your business comply with the legislation and will also free up your time to focus on your business.

While some employers will simply want to comply with the legislation with the minimum cost and hassle, others will see Auto Enrolment as an opportunity to engage with their employees, and use the newly formed pension scheme as part of a wider employee benefits package to increase employee retention and job satisfaction.

Our 2014 Investment Action Plan – Part 4 – Beware of Pension Tax Changes

As the current tax year draws to a close many individuals will be looking to take advantage of the generous tax relief available on pension contributions. While this is an effective form of planning for many clients, care needs
to be taken to ensure that pension contributions and overall savings remain within the permitted limits.

Pensions tax allowances have been an easy target for the government in recent years and 2014 is no different. Both
the Annual and Lifetime Allowance are set to be reduced once again.

The Annual Allowance is the amount of tax advantaged pension saving that an individual can make in a single “pension input period”, not to be confused with the tax year itself. A pension input period is normally 12 months and the actual dates are decided by the pension scheme. Each pension input period relates to a specific tax year. The annual allowance has been on the chopping block for a number of years now, looking something like this over the past few tax years:

10/11 – £255,000

11/12 – £50,000

12/13 – £50,000

13/14 – £50,000

14/15 – £40,000

You are able to carry forward any unused allowance from the previous 3 tax years, although there are special rules relating to this facility for the 10/11 tax year.

People who are members of a final salary pension scheme are particularly vulnerable to the annual allowance.
An increase in salary or a pensionable bonus could easily cause a breach of the allowance and the subsequent tax charge. A series of complex calculations are required to work out the deemed contributions for a final salary pension scheme member. The input amount is not simply based on the payments made by the member, as many people wrongly assume.

Individuals with personal pension schemes will have an easier time making the required calculations, but could
still find themselves over the annual allowance without proper planning.

The Lifetime Allowance is the lifetime limit on pension savings that an individual can accumulate. The allowance was previously £1.8m. This reduced to £1.5m on 6th April 2012 and will fall again to £1.25m this year.

The penalties on any excess pension savings over the lifetime allowance are particularly severe, with the maximum tax charge currently standing at 55%. Once again, members of final salary or career average pension schemes should check carefully where they stand. An annual pension entitlement of £40,000 is an indication that further planning may be required.

There is a range of different protection schemes available which can reduce the impact of the changing lifetime allowance. Care should be taken however, because these protections usually come with some rather restrictive caveats.

Professional advice should be taken to establish your position against the annual and lifetime allowance and to ensure that you take advantage of all of the protections available to you. It can take some time to accumulate all of the information required to provide comprehensive advice in this area so clients should act without delay. 

Our 7 Step Investment Action Plan – Part 2 – Tax Allowances

 

The new year brings many resolutions of prudent financial management and plans to save and invest for our futures. Central to any of these plans should be the considered use of the available tax allowances and reliefs available to you on or before 5th April each tax year.

Many people leave the use of these allowances to the last minute which means that any decisions are usually rushed and ill thought out. It usually follows that the investments chosen are an afterthought and
do not get the attention or due diligence they deserve. Furthermore, investments made in haste often lack sufficient diversification and carry a far higher degree of risk than would normally be taken on by most clients.

By making early use of your tax allowances, not only will you benefit from a whole year of tax advantaged fund growth, you will also have sufficient time to really consider what your objectives are and how the various allowances can help you to achieve them. The result is the right tax wrapper for the right objective with the right investments, meaning you are far more likely to achieve your goals.

 

From Pensions To Property

Following on from my post last week about taking the benefits from your pension plan as cash, I would also like to touch on the growing number of media outlets that are suggesting that people use their pension pot to purchase a buy to let property.

In the same format as last week, I have run a couple of very simple examples to show the tax implications of drawing money out of a pension in order to fund property purchase. For simplicity I am assuming that our subject has £100,000 in a pension pot and is considering purchasing a buy to let property that would have a 5% rental yield after expenses. We will also assume that the pension fund could generate a 5% return after fees. We will assume our subject has £20,000 per annum of other lifetime income.

 

Option 1 – Take all of the pension pot as cash and purchase a buy to let property

£100,000 pension pot could be taken as:

£25,000 Tax free

£75,000 will be subject to income tax as follows

£21,865 @ 20% = £4373 tax

£53,135 @ 40% = £21,254 tax

The client would receive £74,373 in cash and pay £25,627 in tax

£74,373 is then invested in a buy to let property and a 5% income is drawn from the property.

The income would be £3719 per annum ( this would reduce to £2975 after tax)

 

Option 2 – Leave the money invested and draw an income from the pension

£25,000 could still be drawn from the pension tax free (however this money is no longer needed to purchase a property and can be used as income)

£25,000 will provide income for 8.4 years based on £2975 per annum (as the property would produce above)

£75,000 remains invested and earns 5% per annum return on average for the 8.4 years mentioned above.

The £75,000 is now worth £111,793 (approximately).

5% income on this amount is £5589 per annum which would be £4471 after tax.

The client could also choose to draw larger amounts from the capital as well if required.

 

While property can form an important part of a retirement portfolio it would be wise to consider the tax consequences before taking the plunge!