Newsletter – November 2016

The new addition to the Individual Savings Account range (ISA), the Lifetime ISA (LISA) looks set to help millions of self-employed people make provision for their retirement when it launches in April 2017.

Research by insurer Royal London¹ refers to the UK’s 4.4m self-employed business people as the ‘Forgotten Army,’ concluding that when it comes to pension provision, this group needs a substantial nudge to encourage them to save more.

The LISA could provide a welcome incentive for long-term savings. Designed to provide a deposit for a first home or to be held until age 60, it offers a valuable bonus incentive. It will be available to those aged 18 to 40 who want to save up to £4,000 each year. The government bonus means that for every £4 saved, the government will add a further £1, meaning that anyone contributing the maximum will receive a further £1,000 at the end of the tax year.

A LISA can be held until age 60 (although bonuses are only paid up to the saver’s 50th birthday). After 60, all money saved can be taken tax-free. Penalties will apply if the money is withdrawn before 60; the bonus will be forfeited and there will also be a 5% charge.

Whilst making regular contributions into a pension plan could ultimately represent a better, more tax-efficient way of providing for retirement, a LISA is a welcome addition to the savings range.

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

1 Royal London, Britain’s “Forgotten Army”, 2016.

When will you reach your peak earning potential? Many people assume it will be towards the end of their careers, perhaps at some point in their 50s, giving them more time to plan their finances before they approach their retirement years.

However, figures from the Office for National Statistics¹ show that in actual fact workers can expect to reach their peak earning powers between the ages of 40 and 49.

From then on, incomes start to fall. This can come as a wake-up call to those who have yet to make adequate provision for their financial future.

Family protection is paramount

Most people in their 40s have a lot of calls on their time and money. It can be hard to cope with all the financial pressures of raising a growing family, like mortgages and the cost of education. That’s why every family needs a back-up plan that includes an emergency cash fund, and adequate life insurance to cover the mortgage and protect their income.

When it comes to pension planning, it’s worth bearing in mind that pension contributions attract valuable tax relief, and due to the beneficial effect of compound interest and reinvestment of dividends, even small sums saved now can make a difference to the level of pension you will enjoy when you retire.

Working with your adviser you can make the most of your earnings, whatever your age, and ensure you have the right plans in place to protect your future.

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

1 Office for National Statistics, 2014

Yet more evidence has emerged underlining the role played by the Bank of Mum and Dad in helping the younger generation move into the property market.

Recent research shows that in 2016, the Bank of Mum and Dad looks set to lend £5 billion. It will be instrumental in facilitating 25% of all the UK’s property purchases, providing deposits for over 300,000 mortgages on homes worth £77 billion. This prodigious amount of lending will rank the home-grown bank amongst the top ten UK mortgage lenders.

Gifts and loans for deposits

The survey, carried out by Legal & General¹, illustrates how unaffordable property has become for many first-time buyers. The amount provided by parents and grandparents averages £17,500, or around 7% of the average price of the property purchased.

Of these contributions, 18% are in the form of interest-free loans, 57% are outright gifts, with only 5% made as loans repayable with interest.

Not once but twice

Parental contribution doesn’t end with that first all-important step onto the housing ladder. Research from Lloyds Bank² estimates that almost one in five ‘second steppers’ need to receive a further cash injection from the Bank of Mum and Dad in order to move further up the housing ladder, this time needing around £22,000 in order to complete their purchase.

Pressure on young and old

In some quarters fears have been expressed that if prices continue to rise at the current rate, the Bank of Mum and Dad could face its own funding crisis. Whilst parents are eager to offer much needed support, they need to ensure that they retain enough cash for their later years.

1 Legal & General, May 2016
2 Lloyds, Second steppers still need ‘Bank of Mum and Dad’, October 2015.

It’s over a year since the Chancellor’s pension revolution began. There’s now more choice available than ever before to those approaching retirement and this brings with it the added responsibility of planning wisely to ensure that funds are available throughout later years. 

Whilst there had been concerns that people would raid their pension pots and blow the lot on fast cars and luxury holidays, good sense prevailed, not least because of the massive tax bill that would have resulted had they done so. Those who have accessed their pension pots have used some of their money to pay off debts, make home improvements, or pass on funds to the next generation to pay for education or a deposit on a home.

The role of annuities 

There was much media attention focused on the fact that under the changes no-one would be forced to buy an annuity. Sales of annuities fell initially, but have picked up latterly as the volatility of stock markets convinced some retirees that the certainty of income an annuity provides can be a good way to cover basic living costs.

How the cash was taken 

Not everyone opted for tax-free lump sums. One of the new methods of accessing cash from pension savings is called uncrystallised funds pension lump sum (UFPLS). This was the choice of 34% of people, allowing them to access their money in instalments while leaving the rest of the fund invested and sheltered from tax. 40% used the drawdown facility to take an income.

The way ahead 

In response to the changes, many more new products are coming onto the market, some combining income drawdown facilities with a type of annuity contract to give a balance between access to funds and a degree of financial certainty.

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

ACTION POINTS

There is more choice than ever before…

• Give careful consideration to your requirements and income needs in retirement
• Think about the time scale
• Plan wisely as early as possible
• Consider all of the options
• Take advice

Since Britain voted to leave the European Union, the pound has slumped to a five-year low against the euro and a 30-year low against the US dollar. Currencies have historically been volatile and unpredictable, but this unpredictability need not cause concern to investors with global assets.

It is hard to quantify the complex effect of currency movements. For example, a weaker pound may be advantageous for UK exporters but bad for foreign companies selling goods in the UK. All else being equal, sterling investors with unhedged assets overseas are likely to have gained, while European investors with UK unhedged assets may have lost out.

Academic evidence suggests that currency movements are difficult to predict in the short- to medium-term in a manner that is relevant for making investment decisions.  Currencies differ from shares and bonds because they do not produce interest or profits; therefore, they do not have an expected long-term positive return. It is possible to profit from currency trading, but trying to do so is highly speculative and, on average, returns are close to zero.

We do not attempt to predict currency movements, but, because we value the benefits of diversification and increased opportunity that global bonds and shares offer, we pay close attention to the way currencies affect the performance and characteristics of your portfolio.

Some investors seek to reduce volatility by hedging their currency exposure—like when the bureau de change offers to buy back your unused currency at the same rate it sold that currency to you.

We think that hedging depends on the asset class and the aim of the strategy. In global equities, hedging foreign currencies tends not to reduce return volatility by a significant amount. Equities are more volatile than currencies, so the volatility of an unhedged global equity portfolio is, on average, dominated by the volatility of the underlying equities, not the currency movements.

In global fixed income, hedging currencies is an effective way to reduce return volatility because currency returns are more volatile than investment-grade fixed income returns. If the currency exposure is unhedged, the currency will be mostly responsible for the volatility in a fixed income portfolio.

We generally hedge the currency exposure of our global fixed income strategies with the goal of reducing volatility. But we do not see the same volatility reduction benefit for our multicountry equity strategies, and in most cases, do not hedge currency exposure in these strategies.

For example, see the following:
Meese, Richard A. and Kenneth Rogoff. 1983. “Empirical Exchange Rate Models of the Seventies: Do They Fit Out of Sample?” Journal of International Economics 14 (1): 3-24.
Lustig, Hanno, Nikolai Roussanov, and Adrien Verdelhan. 2011. “Common Risk Factors in Currency Markets.” The Review of Financial Studies 24 (11): 3731-3777.
Rogoff, Kenneth and Vania Stavrakeva. 2008. “The Continuing Puzzle of Short Horizon Exchange Rate Forecasting.” NBER Working Paper no. 14071.
Lacaze, Nathan and Philipp Meyer-Brauns. 2015. “Strategy in Practice – Currency Hedging” Dimensional Fund Advisors.