March 2020

Mar 27

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Where Should the State Pension Sit in Your Retirement Plan?

By FAS | Pensions | No Comments

The State Pension is unlikely to provide you with a comfortable retirement on its own, but it shouldn’t be overlooked.

The State Pension for 2020-21 is £9,110.40 per year. This assumes that you reach State Pension age after 2016 and have enough National Insurance credits. Some people may even receive more than this if they built up some additional pension before the rules changed in 2016.

This may well be enough to pay the bills, while your private pension can be directed towards other things.

It’s easy to fall into the trap of either ignoring the State Pension, or avoiding retirement planning altogether on the assumption that the State Pension will be enough.

Our belief is that the State Pension is important, and that you should build up maximum National Insurance credits if you can. However, this is just one part of a retirement plan, and where possible should complement a well-funded private pension.

How Much is a State Pension Worth?

The average salary in the UK is around £30,000 per year. This salary would incur National Insurance contributions of £2,460. This buys one year’s credit. You need to accrue credits for 35 years to build up a full State Pension, although you can start to earn a proportional State Pension with only 10 years’ worth of credits.

If you were to invest £2,460 per year into a private pension for 35 years, and achieved investment growth of 5% per year, you could build up a fund of £233,297.35.

You could probably safely withdraw 3% of the fund value every year and increase your withdrawals annually in line with inflation. This could give you over £7,000 per year. Not only is this less than the State Pension, it is not guaranteed, as it would be dependent on investment growth.

Of course, some people earn much more than £30,000, but many people earn significantly less, and are still able to accrue the same State Pension.

To be able to buy an income equivalent to the State Pension, you would need a fund of just under £300,000.

Clearly, the State Pension is a more valuable benefit than many people believe.

When Would You Like to Retire?

Depending on your age and gender, the State Pension is payable between age 65 and 68.

One of the main financial goals that clients tell us about is the desire to retire early. Clearly, relying on the State Pension does not allow for this.

You may wish to build up a fund to allow you to retire at age 55. But think carefully about your spending patterns. Most people spend more in the early years of retirement while they are still fit and well. Does it make sense for your income to suddenly increase (and to rise with inflation) at age 68?

A good financial plan will account for these irregularities. Perhaps you will have a personal pension, or even an ISA to fund your expenditure from age 55, with a cash reserve to cover any ad hoc costs. Your withdrawals can then be reduced alongside the State Pension, not only to preserve the fund, but also to make the best use of your tax allowances.

Filling in the Gaps

If you are not employed, there are other ways of building up a State Pension. For example:

Receiving Child Benefit for a child under the age of 12
Claiming unemployment benefits
Claiming disability benefits

If you are not working, and not receiving any of the above benefits, you can still accumulate a State Pension by making voluntary National Insurance contributions. In 2019-20, this amounted to £15 per week.

This is overlooked by many people who are not in work but think about what you receive in return. A year’s contribution of £780 buys 1/35th of a full State Pension – approximately £250 per year. No other pension or investment provides this level of return on your money.

Company directors have an added advantage, as they can draw a basic salary from their business (between £6,144 and £8,628 per year as of 2019/2020) and take their remaining income as dividends. At this level of salary, no National Insurance contributions are actually payable but are credited nonetheless.

You can check your State Pension Forecast at:

https://www.gov.uk/check-state-pension

The Disadvantages

If you are a salaried employee, paying National Insurance is not optional. For high earners, there is a chance that you will pay more in National Insurance contributions than you receive in return.

Of course, the other side of this point is that many people do not have the opportunity to build up much, if any pension provision, and the current system provides a safety net.

We also cannot ignore the government’s role. Pensions are an area of continual tweaking, with retirement ages rising, and many people questioning if they will receive any State Pension at all.

It used to be possible to pass some of your State Pension on to a spouse on death, if they didn’t have a full State Pension in their own right. This was quietly removed in 2016.

Again, a sound financial plan is the answer, as changes can be made in plenty of time to account for legislative developments. It is unlikely that the State Pension will be removed entirely.

While the State Pension is not perfect, it provides a solid foundation from which to build your retirement income.

If you would like to discuss retirement planning in more detail, please do get in touch. We can help you plan for the future.

Mar 20

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Tips When Using Trusts for Inheritance Tax Planning

By FAS | Tax Planning | No Comments

Inheritance Tax is still a concern for many families, despite the new Main Residence Nil Rate Band adding up to £350,000 to the standard IHT threshold.

Making gifts or using Trusts usually take seven years to become completely free from Inheritance Tax (IHT). But an investment in a Business Property Relief (BPR) qualifying company can be passed down to beneficiaries free of IHT on the death of the shareholder, provided it has been held for at least two years at that time.

At FAS, we are strong advocates of using Trusts as well as BPR investments to mitigate a potential IHT liability and always give full consideration to both options when discussing Inheritance Tax Planning with our clients.

Don’t Give Away More Than You Can Afford

Trusts are a specialist planning tool that may not be suitable for everyone. We have prepared this guide to address some common questions, concerns and pitfalls that can arise when considering Trusts.

Remember, a Trust is a completely separate legal entity. Once you have gifted an asset into a Trust, it is no longer yours. In most cases, you cannot receive any benefit from the asset.

If you are thinking about gifting money into Trust, think about how much you would be prepared to give away without the Trust structure.

The main benefit of a Trust is that it gives you some control over how and when the gift is distributed. So, if you’re sure that you want to set aside £100,000 for your grandchildren, but don’t want them to receive it as a single lump sum when they turn 18, a Trust could be the answer.

But if there is a chance you will need the £100,000 to pay care home fees, a straightforward Trust won’t help with this.

There are certain Trusts which allow you to retain some access to the capital or to draw an income. These are known as Gift and Loan Trusts and Discounted Gift Trusts. However, these carry some restrictions, and may not be as effective for IHT purposes as a full Trust.

Trustee investments should be considered as part of your wider financial plan. A simple cashflow projection can help you decide how much you can afford (and are prepared) to give away.

It’s Not Just for Gifts

A Trust can be set up even if you don’t have any money to gift.

The simplest way to use Trusts in IHT planning is to ensure that your life insurance is payable into a Trust. This offers the following advantages:

No IHT when the benefits are paid out
No IHT on second death, as with the benefits in trust, the surviving spouse’s Estate has not increased in value
Benefits are paid out more quickly, bypassing probate procedures
Life policies can be set up for family protection, or specifically to cover an IHT liability.
Pension death benefits and employer death in service plans can also be paid into trust.

Absolute or Discretionary?

An Absolute Trust (or Bare Trust) works in the same way as a gift. The asset is earmarked absolutely for one or more beneficiaries under the terms of the Trust. There is no scope for the Trustees to apply their discretion.

This means that once the Trust is in place, you no longer have any control. However, the gift will drop out of your Estate after 7 years. The investment is taxed as if it belongs to the beneficiary.

A Discretionary Trust, as the name implies, allows more control over the investment. The Trustees can decide how and when to distribute the money. The beneficiaries can also be changed or selected from a particular group.

However, a Discretionary Trust offers certain disadvantages:

If the gift is over £325,000, IHT of 20% applies immediately. A further 20% is then due if you die within 7 years.
Further IHT charges apply every 10 years. This is broadly 6% of the value over £325,000, with adjustments made for any withdrawals taken.
Exit charges may also apply when money is distributed from the Trust.

These points can mostly be mitigated with proper planning. But considering that larger Trusts in particular may incur additional fees in respect of legal and tax advice, a Trust can prove very expensive.

IHT is Not the Only Tax

Discretionary Trusts are subject to higher rates of tax than individuals.

Income is taxed at 20% on the first £1,000 only. Thereafter, income is taxed at 45% – an individual would need to earn £150,000 before paying this rate of tax.

If the Trust realises a capital gain, the first £6,000 is exempt from tax. This is half of the allowance available to an individual investor. Any gains over this amount are taxed at 20%, the same rate payable by a higher rate taxpayer.

Detailed planning is required to make sure that the strategy works, taking all taxes and costs into account.

The Investment Strategy Matters

The portfolio selected for a Trust investment may be different from an individual’s own funds.

It could be appropriate to use a higher risk portfolio on a Trust, to maximise the growth potential so that the money can last for several generations. Alternatively, the money might be required in the short term to provide an income, in which case a lower risk strategy would be suitable.

Taxation is an important factor. Using an Investment Bond as a wrapper for the investments can be effective, as there are no tax implications unless money is actually withdrawn. This means that funds can be switched within the bond without worrying about Capital Gains Tax. Similarly, interest and dividends produced within the funds are not only free of tax, but do not need to be declared on a tax return.

Bond withdrawals can result in unintended tax consequences, so it is always best to speak to one of our Financial Planners before proceeding.

A Trust can be an effective way of mitigating an Inheritance Tax liability, but you should always take financial (and sometimes legal) advice to ensure it is the right course of action.

Please do not hesitate to contact a member of the team if you would like to find out more about Inheritance Tax Planning.

Mar 13

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Is It Better to Use an Active Fund Manager?

By FAS | Investments | No Comments

For many investors, an active investment strategy appears to be a good idea. It can be reassuring to know that there is someone in the background, making informed decisions about how to invest your money. And more importantly, where not to invest it, since they will be more than familiar with the pitfalls of risky investments.

But recent years have seen an increase in the appetite for passive investment solutions. So what is the difference, and is it worth pursuing an active investment strategy?

The Argument for Active

Most of the traditional investment companies offer mainly active strategies. This means that a fund manager has responsibility for choosing the underlying investments, making switches and altering the proportions as necessary.

Now, there are many variations to this. Some managers actively choose stocks and trade frequently. Others prefer to buy and hold, adding new stocks as opportunities arise. Some aim for consistent asset allocation while others will shift proportions depending on what is happening in the market. In any case, a ‘bespoke’ service, including an element of expert judgement can be very appealing, particularly in this era of uncertainty.

But reliance on human judgement is fading, with most active managers now operating robust processes or complex algorithms to decide what they should include in their portfolios. With today’s technology and access to information, the talented fund managers of the past are being phased out in favour of teams of analysts and clever software.

While consistency and technology reduce the risk of human error, another question arises. If everyone has access to the same information at the same time, does any active manager genuinely have insight that the others don’t? And will that insight consistently lead to higher returns? By consistently, we are not talking about the last 6 months, or even the last 5 years. A 5 years performance history is not that significant when considering a 30 years retirement plan.

The Passive Position

Some may argue that active fund management is like trying to get ahead on a busy motorway. You can switch lanes, weave in and out of traffic and take shortcuts. You might gain a small advantage, but it is equally possible that your efforts will be counterproductive. Ultimately you will end up in the same place, and will probably have used more petrol.

A passive investment strategy does not attempt to perform ahead of the market, simply to participate in the growth. Passive investors generally accept the following to be true:

The market is efficient. There is no point in trying to time investment decisions based on economic news or world events, as by the time you hear about it, it has already been priced into the market.
Asset allocation contributes more to your performance than the individual stocks chosen.
Diversification is vital, as the various asset types behave differently. When one goes up, others may go down.
Diversification can lead to steadier long term growth.
Charges are a certainty, while performance is unpredictable. It therefore makes sense to keep charges as low as possible.

A quick snapshot of the Mixed Investment 40% – 85% index (which is broadly comparable with a typical balanced portfolio) indicates that of the 170 funds within the sector, 71 outperformed the index over 5 years. 99, or 58% of the funds, did not.

In the UK All Companies sector, 85 out of 251 funds outperformed the FTSE All Share. This means that 66% of funds in the sector underperformed when compared to the average of the UK share market.

While it is simple enough to point out an actively managed fund that has outperformed its benchmark, the odds of choosing the right fund at outset and maintaining the outperformance over a lifetime of investing are extremely slim.

Of course, in certain areas, there is little doubt that an active manager can add value. Investing in certain sectors or economies requires specialist knowledge that a typical investor does not have. But this type of investment can be risky, and should form only part of a well-diversified portfolio.

What to Consider

There is a place for both active and passive funds in a diverse portfolio. These are our top tips for choosing between active and passive funds in the same sector:

Look at the charges. If the active option charges 1% more than the passive equivalent, that’s 1% in extra performance needed every single year to be in the same position. Is it worth it?
Has the active fund genuinely outperformed? Compare it to the passive equivalent as well as the benchmark. Measure the longest possible period – one year’s good performance is not statistically significant. Look at discrete figures as well as cumulative.
How do the funds stack up when the market falls? Does one appear to provide better capital protection, even if the upside is lower?
What do the funds invest in? For a straightforward equity fund, a passive investment may meet your needs best. Active funds may be more suitable if you want to invest in specialist areas.
What are the trends in the sector? In some sectors, it is very difficult for active managers to outperform passives, while in others, passive funds lag behind.

At FAS, we can agree on an investment strategy with you, one that you understand and feel comfortable with, designed to meet your long term objectives that can help you face the future with confidence.

Please do not hesitate to contact a member of our team if you would like to find out more about your investment options.