Monthly Archives

December 2021

Timeline of years with piles of money alongside

Carry forward pension allowances

By | Pensions

For anyone approaching retirement, making the most of your pension annual allowance is a vital part of your pre-retirement planning. But you may be surprised to learn that individuals are allowed to take advantage of any unused pension allowances from the previous tax years. It’s called ‘carry forward’ and we think it’s a concept that more people need to be aware of.

But let’s take a step back. At FAS, we believe pensions are some of the most tax efficient investment vehicles available. For a start, payments made into a pension automatically qualify for income tax relief. In other words, the government pays you money to encourage you to put more into your pension! Income tax relief is paid at the basic rate of 20%, which means that for every £80 you put into your pension, the government will top this up with another £20. Higher and/or additional rate taxpayers can claim income tax relief at their marginal rate via their tax return, thus further increasing the value of pension planning.

But this generosity does have its limits. For example, pension rules state a person cannot pay more into their pension annually than they have earned. Additionally, to limit the amount of ‘free money’ the government gives to people paying into their pension, it has capped the annual amount an individual can pay in while still claiming income tax relief. For most people with a defined contribution pension, the ‘annual allowance’ places a limit of £40,000 (or 100% of earnings if lower) on the amount a person can place into a company pension (or self-invested personal pension – known as a SIPP) while still being able to claim tax relief. Any amount paid into the pension beyond this threshold is not eligible for relief.

What is the carry forward concept?

While the annual allowance means pension contributions eligible for income tax relief is capped at £40,000 in each tax year, the carry forward concept makes it possible for people to make use of any unused pension allowance not claimed in the previous three tax years. So, if you made pension contributions of £25,000 in each of the previous three tax years, you can carry forward the remaining £45,000 in unclaimed annual allowances (£15,000 x 3) on top of your current tax year allowance.

As you can imagine, this is a very valuable tax break, and one that appeals to individuals who may have sold a business, are close to retirement or hold large sums on deposit they would like to put into their pension. However, carry forward does come with a few conditions that must be met. For example:

  • Carry forward can only be used where pension input amounts exceed the standard annual allowance for the relevant tax year.
  • You must earn at least the amount you wish to pay into your pension in the tax year you are making the contribution for (so if you, for example, want to make total contributions of £100,000 you must earn at least £100,000 in that tax year). This doesn’t apply if your employer is making the contribution on your behalf.
  • You must have been a member of a UK-registered pension scheme (not including the state pension) in each of the tax years from which you wish to carry forward from.
  • You must use any unused annual allowance from the earliest year first (you can only go back three years) and can only use it once. This means carry forward cannot be used a second time.

Who fits the profile to use carry forward?

In our experience, carry forward is considered particularly useful for the self-employed, especially those whose earnings fluctuate from year to year, as well as individuals planning on making a large pension contribution before they reach retirement age. Here’s a theoretical example.

Case study: Meet Connor

Connor is self-employed and has been paying £2,000 a month into his personal pension for the last five years. Over the last 12 months, Connor has been working on a large contract. He expects to make a profit of £120,000 for the 2021/2022 tax year.

Connor knows that he can reduce his tax bill and increase his retirement pot by contributing more into his pension. On top of his monthly contributions, Connor wants to make a £40,000 lump sum payment into his pension.

As Connor is already making monthly contributions to a personal pension, the first step for him is to work out the total of these once tax relief has been applied. The easiest way to calculate this is to divide £2,000 by 20%, or £2,500. Connor’s gross annual pension contributions – including tax relief –  are therefore £30,000.

Connor wants to pay a further £40,000 lump sum payment into his pension. After applying basic rate tax relief (using the same principle shown above – £40,000 divided by 20%), Connor knows the total gross pension contribution is £50,000.

Given Connor’s annual allowance is £40,000, after deducting his total monthly pension contributions of £30,000, he has £10,000 available to use in the current tax year. Connor can use carry forward and use the unused allowances over each of the last three tax years (£10,000 x 3) on top of the £10,000 available in the current tax year, to pay his lump sum without exceeding the annual allowance and losing available tax relief.

How can we help?

The carry forward rules might seem complicated, and it’s important to understand their limitations. But here at FAS, we have considerable experience of helping individuals to make the best use of their available allowances, and help to get the full benefits from the carry forward rules. In the right circumstances, carry forward can really help to fund a pension before retirement.

If you are interested in discussing your defined contribution pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

Wooden blocks reading 2021 and 2022

2021- the year that was, and prospects for 2022

By | Investments

As 2021 draws to a close, investors can look back on a year that still presented challenges, despite conditions being much more benign than those experienced a year earlier. Following the very sharp recession seen at the start of the pandemic, we have witnessed a broad based economic recovery, fuelled by continued economic support from central banks and governments, which has continued to provide markets with the confidence to move forward.

At the time of writing, the S&P500 index of US shares stands 27% higher than at the start of the year, whereas the FTSE100 stands 12% higher. These increases have built on the strong returns seen during the latter part of 2020. Whilst most investment markets are higher than at the start of the year, there have been areas to avoid. Chinese markets, weighed down by concerns over the debt-laden property sector and government policy, have fallen throughout the year, despite a modest recovery seen over recent weeks. The safest government bonds have also seen disappointing returns, as inflationary pressures bite.

Compared to the wild swings in sentiment seen during 2020, this year has seen more stable conditions for investment markets. Apart from some volatility around the time that the Omicron variant was discovered, investment markets have sailed through much calmer waters than was the case a year ago.

As we progressed through the year, investor attention began to shift away from the pandemic, and the increasing rate of inflation being seen in Western economies became the primary concern. In the UK, the Consumer Price Index hit 5.1% in the 12 months to November 2021, the highest level for a decade. We are not alone in facing higher inflation, with the prevailing rate in the US standing just short of 7% per annum. A number of factors have contributed to the increase in inflation – demand for goods such as building materials and microchips has outstripped supplies, and the cost of shipping goods has also risen sharply. We have all felt the impact of higher gas and electricity prices, and food prices also continue to rise. Spare capacity in the labour market may also lead to modest levels of wage inflation, as certain sectors, such as hospitality and logistics, struggle to hire employees.

The heightened rate of inflation is unlikely to be welcome news for many. Whilst higher rates of inflation are helpful in eroding levels of debt, for households struggling with increasing energy costs, and for those individuals holding cash savings, these are painful times. Central banks would ordinarily be looking to increase interest rates at this point in the economic cycle, to combat the higher rates of inflation. However, they need to tread carefully to avoid damaging the fragile economic recovery. Taking away the support and raising rates too quickly could reverse the economic gains achieved since the height of the pandemic, whereas leaving rates on hold for too long could stoke inflationary pressure further.

The Bank of England was the first to jump, raising rates from 0.10% to 0.25% this month, and we expect most Western central banks to continue raising rates during the course of 2022. The pace of these rate increases is likely to be a key factor in determining how markets perform during the course of the year, and clear forward guidance – such as we are seeing now from the Federal Reserve – will be needed to avoid markets being spooked by unexpected changes in policy.

So where do markets go in 2022, and what is in store for the coming year? Firstly, the emergence of Omicron reminds us that sadly the pandemic is not over. Investors have faced continued uncertainty in the face of the virus since March 2020, and it is becoming clear that Covid-19, and the actions taken by governments to combat the spread, is once again going to dominate market sentiment as we head through into the New Year. As we have seen over recent weeks, governments around the world appear to be keen to avoid the kind of restrictions that could deal a substantial blow to the economic recovery, but they need to balance this with the need to protect public health.

The actions of central banks will also likely have an influence on market confidence. The rapid rise in inflation may well remain a headache for policymakers throughout next year, and tough decisions on removing key support that has been in place since the start of the pandemic could have negative consequences. Inflation may well start to moderate as we move through the next 12 months, although we suspect prevailing inflation rates will stay a little higher for longer, placing further pressure on central banks and savers.

We will be watching corporate earnings closely as we move through into 2022. By and large, profits have held up well and in some sectors have exceeded expectations this year. We do, however, need to be mindful that the valuations of some sectors of the economy are now looking a little expensive.

Finally, in contrast to the calm conditions we have seen through this year, we may well see a little more volatility return as a result of Omicron and the key interest rate policy decisions that will need to be taken. For this reason, 2022 could well be a year when paying careful attention to asset allocation, and maintaining good levels of diversification, are crucial to navigate the prevailing conditions successfully. Rest assured we are here to provide guidance and reassurance whenever needed.

If you are interested in discussing the above with one of the experienced financial planners at FAS, please get in touch here.

May we take this opportunity to wish you a peaceful, happy Christmas with good health and prosperity in 2022!

This content is for information purposes only. It does not constitute tax planning or financial advice.

Grandmother, mother, and grandchild sitting chatting

Intergenerational wealth planning explained

By | Tax Planning

According to probate and estate specialists an estimated £5.5 trillion will be changing hands – transferred between different generations – in the next three decades, either through inheritance or gifting. But with people living longer, and needing greater assistance with healthcare and daily living, the transition can be complicated. That’s why more people need to start thinking about how to cascade ‘intergenerational wealth’ down to children or grandchildren.

 

What is intergenerational wealth planning?

Intergenerational wealth planning is simply about taking steps to choose when and how you want to pass on your wealth to your children or grandchildren. Whether you are planning to leave behind a life-changing inheritance, or just enough to help your loved ones feel slightly better off, it’s important to understand the impact that inheritance tax (IHT) could have on the value of your estate. Every year, thousands of people pass away and leave behind an IHT bill for loved ones to deal with, drastically reducing the value of their inheritance. With the right planning in place, you can pass on more of your wealth, reduce or even eliminate any IHT due on your estate, and see your loved ones put the money to good use while you’re still alive.

 

What are the current inheritance tax thresholds?

As a reminder, everyone in the UK aged 18 or over has a personal IHT allowance known as the nil-rate band. This nil-rate band currently stands at £325,000. If the value of an estate (money, property, and possessions) when a person dies is below this amount, there is no IHT to pay. However, if the estate is valued above £325,000, the beneficiaries of the estate will be required to pay IHT at a rate of 40% on the amount over the threshold.

However, if you pass your home on to your children or grandchildren, your estate can also claim the residence nil-rate band, which is an additional IHT allowance that can increase the value of your estate excluded from IHT to £500,000. This allowance is only available provided you leave the home to your direct descendants, and the allowance is reduced if the total value of the estate is more than £2 million.

 

Making gifts

Making gifts out of your wealth before your death is an excellent way to reduce the inheritance tax on your estate, but it’s important to understand the rules around making gifts before you start giving it all away. HMRC gives everyone an annual gifting allowance of £3,000 – called the ‘annual exemption’. You can carry over the £3,000 annual exemption to the following year if you don’t use it, but only for one year.

You can also make small gifts (no more than £250) to as many different people as you wish, as long as you haven’t given them a gift as part of your £3,000 annual exemption. Wedding gifts are also IHT-exempt up to certain limits (up to £5,000 for your child, £2,500 for your grandchild or great-grandchild, and up to £1,000 for anyone else). Any gifts made between spouses or civil partners are completely IHT-free.

 

Potentially exempt transfers

Making gifts of larger amounts than £3,000 is permissible, but it does run the risk of triggering an IHT bill – particularly for people who are elderly or in poor health. This is because for a gift to become completely free of IHT, the individual making the gift must survive for at least seven years from the date the gift was made. Lifetime gifts of this type are known as ‘potentially exempt transfers’.

The IHT bill due on a potentially exempt transfer reduces on a sliding scale (also referred to as ‘taper relief’) for each full year the giver survives. So, if the giver dies within the first three years of the gift being made, the gift will be liable to the full 40% IHT charge – paid by the receiver of the gift. The IHT charge on a potentially exempt transfer falls by a further 8% for each year the giver survives (so charged at 32% if death occurs between years 3-4, charged at 24% if between 4-5 years, and so on), until seven years have passed, when the IHT bill reaches 0% and the gift becomes fully exempt.

 

Inter vivos policies

In cases where a large gift has been made, or could be made in the future, an inter vivos life insurance policy can protect against the possibility of a potentially exempt transfer failing, and falling back into an individual’s estate. Roughly translated, inter vivos means ‘between the living’, and it can be used to pay a lump sum in the event of a person’s death during a specific timeframe. The giver can arrange for the policy to have a fixed seven-year term, with the amount of cover it provides reducing to match the reduced IHT liability as taper relief starts to take effect. Although the cover reduces, the premium to pay for this type of insurance policy typically remains fixed for the whole seven years.

However, before choosing to set up a gift inter vivos policy, it is important to determine whether the available taper relief will apply in your own circumstances. This is because any lifetime gifts made will first be allocated against your nil-rate band when the gift is made. It is also worth noting that taper relief is applied to the rate of IHT to pay, not to the value of the gift. So, if a gift falls within the nil-rate band, the rate of tax is zero and therefore taper relief has no effect.

 

Summary

Over the course of this year, we’ve had more clients talking to us about estate planning and ways to reduce an IHT bill for their loved ones. Fortunately, there are lots of intergenerational wealth planning options available to clients looking to pass on more of their wealth to their children and grandchildren, and who would much prefer to see their wealth being enjoyed during their lifetime.

 

If you are interested in discussing IHT or your estate with one of the experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute tax planning or financial advice.

Egg timer running out with a stack of pound coins alongside

Tax-incentivised investments in growing companies

By | Investments

Over the years, governments have introduced, and then replaced, a variety of schemes to stimulate investment in new and small businesses. A key feature of all these schemes has been some type of tax incentive. The Treasury views these tax sweeteners as a necessary cost to attract ‘patient capital’ from private investors. The net result is that today the rules governing the three current schemes – venture capital trusts (VCT), enterprise investment schemes (EIS) and seed investment schemes (SEIS) – are highly complex. Before embarking on investment in any of this trio, it is crucial to understand the constraints that surround them, the inherent risks, as well as the potential rewards.

 

Relief on investment

All three schemes – VCT, EIS and SEIS – offer income tax relief on the initial investment into new shares, with VCT and EIS providing 30% relief, and SEIS offering 50% relief. These reliefs are subject to a number of conditions, primarily being the minimum holding periods. VCTs need to be held for at least five years and EIS and SEIS for at least three years, to avoid the relief given on investment being clawed back on disposal. In addition, it is important to note that income tax relief can only be obtained on income tax actually paid.

Over recent years, this income tax relief offered has become a key attraction for many high-income investors who find their scope for pension contributions has been constrained or eliminated completely by the reductions in the pension lifetime and annual allowances.

HM Treasury does not give tax relief without good reason. In the case of VCT, EIS and SEIS, that reason is the risk that the investor is expected to accept. This was underlined by a change to the legislation for all three schemes introduced by the Finance Act 2018. Broadly speaking, any underlying company in which investment is made must now satisfy a “risk to capital” requirement. For investments in companies that qualify for relief, the investment needs to demonstrate that the company has objectives to grow and develop over the long-term, and there needs to be a risk that there could be a loss of capital to the investor of an amount greater than the tax relief provided.

The aim of this test is to prevent low risk, growth-averse companies from being established solely for the purpose of accessing the tax reliefs available. It has had the desired effect, with VCT and EIS providers regularly reminding investors that the returns are likely to be more volatile than before the 2018 change.

 

Other tax incentives

In addition to the income tax relief on a qualifying investment, VCT dividends are tax-free and many VCTs focus on returning capital to shareholders through the payment of regular and special dividends. EIS and SEIS investments qualify for business relief after being held for 2 years’ ownership. This grants the shares in EIS and SEIS exemption from inheritance tax, as long as the shares are held until death. EIS also offers investors the ability to defer capital gains tax charges for gains made between 3 years before to 1 year after investment.

 

Risk to capital

It is important to acknowledge that investment in any of these schemes involves holding shares in very small and fledgling companies. These companies are seeking capital to help them grow, and whilst there are substantial success stories where exceptional returns have been achieved, the risk that these companies fail to deliver is also considerable. By way of example, companies that qualify for VCT funding need to hold assets of less than £15m at the time of investment and have fewer than 250 full-time employees (or 500 for so-called “knowledge-intensive” companies). SEIS qualifying companies are much smaller still, with the company needing to hold gross assets of less than £200,000 and have fewer than 25 full-time employees.

An additional risk is the fact that these investments can be hard to sell once the minimum holding period has elapsed. VCTs are listed on the London Stock Exchange (LSE), but trading in smaller issues can be thin, partly because of the tax relief clawback rules. That being said, VCTs normally offer a buyback route, where the shares are re-purchased by the company at regular intervals, at a discount to the underlying asset value. EIS and SEIS investments are not quoted on the LSE, and disposing of these unquoted investments relies on finding a buyer for the shares, which can take some time.

 

The importance of advice

It’s necessary to point out that VCT, EIS, and in particular SEIS investments involve a higher level of investment risk when compared to the likes of other equities, bonds and cash. The potential returns, of course, can be higher than those provided by more traditional asset classes, and the various tax incentives are attractive.

Selection of the appropriate investment is vitally important, as there can be vast differences in performance between individual VCT and EIS funds. Different investment approaches are also taken, with some focused on a specific area or field, and others being more generalist in nature. For this reason, you should always discuss this with one of our experienced financial planners first to ensure that any VCT or EIS investment sit appropriately within your investment risk profile, time horizon, and your other assets and investments.

 

If you are interested in discussing your VCT, EIS or SEIS investments with one of our experienced financial planners at FAS, please do get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.