Newsletter – June 2018

The way savings are taxed is being reviewed by the Office of Tax Simplification (OTS).    

The OTS is looking at the way in which savings and investment income is taxed, which can be very complicated. According to its paper, published in May 2018, “the interactions between the [tax] rates and allowances is sufficiently complex at the margins that HMRC’s self-assessment computer software has sometimes failed to get it right”.

The complex marginal rules mean that, “many taxpayers continue to worry about the tax treatment of their savings income even when they do not in fact have anything further to pay, and there are also many specific complexities which taxpayers find difficult and confusing”.

To make matters worse, the OTS also found that 95% of people do not pay tax on savings income, thanks to a combination of the personal savings allowance (£1,000 for basic rate taxpayers and £500 for higher rate taxpayers) and the dividend allowance (£2,000).

The OTS paper makes a range of recommendations, including:

• Changing the personal savings allowance and dividend allowance into genuine allowances. They are currently misunderstood nil tax rate bands.
• Increasing the flexibility of ISAs by removing some of the rules about in-year subscriptions and transfers.
• Reviewing the early withdrawal penalty on Lifetime ISAs which have experienced “slower than predicted” uptake.
• Reviewing the use of emergency tax codes for lump sum pension withdrawals. The system generally results in an overpayment of tax and the need for a subsequent reclaim. Around £37 million of overpayments have been returned to date.
• Ending the differential tax rates for dividends (7.5% at basic rate, 32.5% at higher rate and 38.1% at additional rate), to bring them in line with other tax rates on savings.

We can expect to hear more, probably including the announcement of a formal Treasury consultation document, in the Autumn Budget. In anticipation of this, the OTS has already made the plea that, “it is important not to make piecemeal changes, which risk adding further layers of complexity”.

In the meantime, if the tax treatment of your own savings and investments is concerning you, do talk to us. Remember, even HMRC struggle to get it right.

For further information on ISA’s please contact one of our advisers on 01793 881602 or download our free Key Guide:

Investing tax-efficiently

Our full range of Key Guides can be found at:
www.polestarfa.co.uk/resources/key-guides

Tax treatment varies according to individual circumstances and is subject to change. 

The Financial Conduct Authority does not regulate tax advice.

A new report has proposed taxing the baby boomers to help resolve major issues around intergenerational fairness.    

The report, published by the Intergenerational Commission in May, offers ten policy recommendations which would represent a radical overhaul of the UK tax system.

Examples include replacing inheritance tax with “a lifetime receipts tax that is levied on recipients with fewer exemptions, a lower tax-free allowance (£125,000) and lower tax rates (20% and 30%)”, and replacing council tax with a “progressive property tax” levied on owners rather than occupants, with a marginal rate of 1.7% on property value over £600,000.

The Commission was set up by the Resolution Foundation to examine the issue of fairness between the generations, and has been examining whether the baby boomer generation (1946-1965) has left generation X (1966-1980) and the millennials (1981-2000) to pick up the bill.

Their report found the post-war generation has the advantage, based on a range of measures including home ownership, earnings progression, personal debt and pension wealth.

As with most think tank reports, this grand plan is unlikely to be put in place. However, some of the proposals could see the light of day, as ministers look for solutions to the problem.

One such example was an idea to generate extra funding for the NHS by extending national insurance contributions (NICs) to people working beyond state pension age. This was reported the day before the Commission’s report was published and Jeremy Hunt, the Health and Social Care Secretary, was quoted as favouring the idea. The Commission’s report went further, proposing that NICs also be charged on private pensions, at a reduced rate.

One point the report makes, which is supported by many other research bodies, is that the ageing population will require more government expenditure on health and social care. The Commission wants that cost to be borne by those who receive the benefit, but politicians may not agree. Either way, the message is that if you are hoping for tax cuts, they are unlikely to come from the government. Taking control of your own planning for your later years is a more sensible option.

Tax treatment varies according to individual circumstances and is subject to change. 

The Financial Conduct Authority does not regulate tax advice.

Life insurance can be the financial buffer that stops a painful bereavement also becoming a financial tragedy. A payout from a policy could help your family keep a roof over their heads and cover the household bills if you were no longer around. But it’s just one of the many types of policy that can protect families from life’s unexpected and unfortunate events.

How would your family manage financially if you were diagnosed with a critical, life-threatening illness? Figures from Macmillan and the British Heart Foundation show around a thousand people a day receive a diagnosis of cancer and nearly two hundred thousand suffer heart attacks every year in the UK.

How would you pay the bills if you were sick or injured and couldn’t work? If the unexpected were to happen, how would you and your family manage financially? Coping with a long-term illness or injury can be stressful enough without the added pressure of money worries. Taking out an income protection plan offers peace of mind and security for your family.

According to the Association of British Insurers¹, in 2017 there were 26.9m individual life insurance, critical illness and income protection policies in force. Insurers paid an average of £9.9m in life assurance, critical illness or income protection claims every day.

We can help you get the protection you need 

With hundreds of policies available on the market, the choice can seem confusing. We can help by analysing your needs and assessing the type of policy and the level of cover that’s right for you and your family circumstances.

1 Association of British Insurers, 2017

The Bank of England did not raise interest rates in May, despite earlier suggestions that it would.      

About four years ago a member of the Treasury Select Committee compared Mark Carney, the Governor of the Bank of England, to “an unreliable boyfriend”. The remark was prompted by Mr Carney’s record of talking about future interest rates increases that never became reality. The epithet came back to haunt the Governor last month.

The Bank had been hinting strongly that rates would rise in May, and by early April the money markets were effectively putting the odds on a May increase at 90%. However, a combination of surprisingly bad economic numbers – growth fell to just 0.1% in the first quarter – and downbeat business surveys prompted a rethink. By the time the Bank announced the rate would be held at 0.5% on 10 May, nobody was surprised.

The next opportunity for changes to the interest rate will come on 2 August 2018, when the Bank publishes its next Quarterly Inflation Report. The medium-term expectation is still that interest rates will rise, unless something disastrous happens to the UK economy. For its part, in May the Bank repeated its familiar mantra that, “any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent”.

If you have investments in fixed interest funds, now could be a good time to review those holdings. As the graph shows, the yield on 10-year government bonds is already around double the low hit in the wake of the Brexit vote. It could rise further – depressing bond prices – if the Governor becomes more reliable in his rate rise forecasts.

The value of your investment can go down as well as up and you may not get back the full amount you invested. 

Past performance is not a reliable indicator of future performance. 

Important changes affecting Chinese market indices took effect in June 2018, which could affect emerging market funds.  

On 1 June 2018, the index provider MSCI added 233 domestic Chinese stocks to its emerging market and global indices. MSCI has some of the most widely used indices for measuring the performance of emerging markets, with the MSCI Emerging Market index suite providing benchmarks for over $1,900 billion of assets. This popularity means that markets can move when any revisions are made to MSCI indexes.

Previously, MSCI’s indices had only included Chinese companies with share listings outside the Chinese mainland, e.g. in Hong Kong. Although the Chinese mainland stock market is the second largest in the world, MSCI previously considered the market to have too many drawbacks to merit inclusion. The Chinese authorities have worked on the issues that concerned MSCI, such as ownership restrictions and limited liquidity, resulting in MSCI’s change of heart.

The inclusion of the 233 Chinese shares will have little initial impact on the MSCI Emerging Market Index as their total weighting will be less than 1%. However, this is likely to grow as MSCI continues to monitor the market, include more Chinese companies and reweight its indices. In theory China could ultimately represent 40% of the Emerging Markets index.

However, before then it might be reclassified as a developed market. Such reclassifications do not happen often, but in September another index provider, FTSE Russell, will transfer Poland from the emerging to the developed category, the first such switch it has made in almost a decade.

These changes are a reminder that emerging markets funds are by no means static, even if they are merely index trackers.

The value of your investment can go down as well as up and you may not get back the full amount you invested. 

Past performance is not a reliable indicator of future performance. 

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

In response to the very low yield on bonds, some investors have been tempted to chase higher yielding bonds, in an attempt to squeeze some return out of what feels like an unproductive portfolio allocation. 

This is, unfortunately, an accident waiting to happen. The phrase ‘picking up pennies in front of a steamroller’ comes to mind.

Others are asking whether they should be holding cash as bond yields are ‘inevitably’ going to rise, denting bond returns, at least in the short term. Neither approach makes much sense.

We should be looking forward to yield rises

At some point in the future, yields are likely to rise back to higher levels. The problem is that no-one knows when, how quickly and with what magnitude it will happen. Investors should be looking forward to yield rises, because in the future their bonds will be delivering them with a higher yield, hopefully above the rate of inflation.

When yields do rise, bond prices will fall, creating temporary losses. At that point bonds now earn an investor more than they did before the rate rise and they reach a breakeven point where the new higher yield has fully compensated them for the temporary capital losses suffered. The time to break even is equivalent to the duration (similar to maturity) of an investor’s bond holdings. Short-dated bonds with a three year duration will breakeven after three years. Table 0-1 is a hypothetical example. Follow it through.

Holding cash deposits is not the solution

Imagine that an investor felt that rate rises were likely to occur, with a detrimental – albeit temporary – impact on bond returns in the near future. They decide to place a deposit for three years, receiving interest of 1.5% p.a., comparable to the current yield on three-year bonds. In three years’ time when their deposit matures, they end up with the same return as the bond portfolio (green-coloured cell in the table above). Why bother?

Long-term investors should stick with their bond holdings. At some point they will need them to protect against turmoil in the equity markets. Remember ‘You don’t need bonds until you need them!’.

The value of the investment and the income they produce can go down as well as up and you may not get back as much as you put in.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. 

Errors and omissions excepted.

This is a shortened version of an investment committee briefing note. If you would like the lengthier version please let us know.

Transfers out of private sector final salaries boomed in 2017.

There was a dramatic increase in the value and number of transfers out of defined benefit (usually final salary) pension schemes in 2017. A recent Freedom of Information (FoI) request to the Financial Conduct Authority (FCA) revealed that the £20,800 million was transferred last year, up from £7,900 million in 2016. There were 92,000 transfers, compared to 61,000 in 2016.

The increase in transfers stems from a variety of factors:

• A growing awareness of the planning opportunities introduced by pension flexibilities, which can make the traditional defined benefit scheme look outdated and rigid.
• The significant sums involved: the average transfer last year amounted to £226,000.
• Employers quietly welcoming transfers as a way of reducing their pension scheme liabilities, which have grown rapidly because of ultra-low interest rates and improving pensioner lifespans.
• The proportion of defined benefit schemes closing to existing employees steadily increasing, leaving more people with preserved pension benefits, even if they have not changed jobs.
• Since 2009, investment markets being generally benign or buoyant, helped by the same economic measures that have pushed, and held, down interest rates. The absence of any major market declines has reduced the visibility of one of the major transfer risks: exchanging a quasi-guaranteed benefit for one reliant on investment performance.

A transfer can be the right choice in certain circumstances, but there are sound reasons why the FCA continues to require advisers to start with the assumption that a defined benefit pension transfer will be unsuitable.

If you are considering transferring any of your existing pension arrangements, please make sure you talk to us before taking any action. A transfer out of a defined benefit scheme is nearly always a one-way ticket and you need to be sure you fully understand the pluses and minuses of the destination before the journey begins.

Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.

The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.