Monthly Archives

May 2022

Piles of coins and receipts alongside the word tax

Why is tax efficiency so important?

By | Tax Planning

As the old financial adage suggests, you should “never let the tax tail wag the dog”. The rather bizarre phrase is used to remind investors that conventional wisdom dictates that investment returns should be the primary objective of an investment strategy (i.e. “the dog”) with tax considerations being a secondary importance (i.e. “the tail”).

Whilst we wouldn’t argue with the general premise that investment performance is the main driver of investment returns, tax efficiency can often play a larger role in effective planning than many give it credit for. This can be particularly important during periods when investment returns are lower. Let us explain.

 

The effect of income tax on investment income

Equities dividends and bond and savings interest are all subject to income tax. Dividends are taxed at 8.75% for a basic rate taxpayer, increasing to 33.75% for a higher rate taxpayer and 39.35% for an additional rate taxpayer. Interest is taxed at the individual’s marginal rate of tax (i.e. the tax rate that applies to additional income earned over and above salary or pension income).

If you are investing for income, tax considerations become vitally important. Take the example of an individual who pays higher rate tax overall and holds £10,000 in an equities fund which pays a dividend of 4%, and £10,000 in a fixed interest fund, which pays 4% interest. The gross position is that £800 of income is generated (£400 of dividend and £400 of interest); however, the dividend income is subject to 33.75% tax and the interest is subject to 40% tax, leaving a net income payment (once tax due has been settled) of just £505.

Of course, tax breaks exist to shelter some or all of this income, in the form of individual savings accounts (ISAs), the dividend and personal savings allowances and the starting band for savings. As the above example demonstrates, using these allowances to their fullest extent is vital to maximising income earned.

 

Don’t waste annual allowances

Capital gains tax (CGT) is charged on the disposal of assets, at a rate of 10% or 20% on investment gains, depending on whether an individual is a basic or higher rate taxpayer. An annual CGT allowance of £12,300 per individual is available, but only within the tax year in question – if you don’t fully use the allowance, you lose it.

We often see clients with portfolios that have been held in the same investments for many years, without changes being made. Whilst we fully support the notion of long-term investment, by making regular changes to the portfolio to use the annual CGT allowances available, you can avoid the gains building up which creates a bigger problem when the investment is eventually sold. Married couples can also rearrange assets so that both allowances are used, which can yield a tax advantage when selling down positions that have been held for many years. Alternatively, ISAs provide exemption from capital gains tax in addition to income tax.

 

Effective retirement planning

When saving for retirement, tax relief on pension contributions can have a significant impact on the overall investment return achieved. For a basic rate taxpayer, relief on qualifying contributions attracts relief at 20%, whereas higher rate taxpayers can obtain an additional relief of 20% via a self-assessment tax return.

In other words, every £100 invested in a pension will only cost a basic rate taxpayer £80 and a higher rate taxpayer £60. This is a significant immediate return on the contribution, which is the equivalent of many years’ investment growth on the net amount contributed.

Of course, this simple example ignores the fact that only tax free cash is paid out from a pension without any tax deducted, and any income generated by the pension over and above the tax free cash is subject to income tax. However, even considering the net position of tax relief versus tax deducted on pension income payment, using a pension can yield a significant tax advantage.

 

Venture beyond

Pensions are not the only source of upfront tax relief available. Venture capital trusts (VCT) and enterprise investment schemes (EIS) are two types of investment where income tax relief of 30% is provided on qualifying investments. This is a generous relief, but is only granted on the premise that the underlying investments in smaller and unquoted companies are high risk, and the tax relief granted at least matches the potential for loss on the investment. These investments also need to be held for minimum qualifying periods. For example a VCT needs to be held for a minimum of 5 years to retain the tax relief provided on investment.

Whilst not suitable for all investors, individuals with significant assets, sufficient income, and the necessary tolerance to investment risk, may feel VCTs are worth considering, as a small part of a larger and more diversified investment portfolio.

 

Planning is key

At FAS, our experienced financial advisers will always consider tax efficiency as a key component in the financial planning process. Whilst investment strategy and selection will be the main drivers of returns achieved over the long term, considering the tax efficiency of investments plays an important role. Why not speak to one of our advisers to gauge how tax efficient your portfolio is, and where improvements can possibly be made.

 

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Cryptocurrency coins in soil symbolising cryptocurrency mining

Cryptocurrencies – a stark reminder of the risks

By | Investments

Whenever clients talk about cryptocurrencies, our response has always been the same – the investments are unregulated and carry significant risk of total loss of the investment. Recent price action in cryptocurrencies, together with warnings issued by leading crypto exchange Coinbase, have only reinforced our view.

 

Making headline news

Cryptocurrencies have made headline news over recent days as a severe bout of turbulence has knocked the value of the largest coins available, including Bitcoin and Ethereum. The catalyst has been the collapse of the Terra Luna currency, which is supposedly pegged to the US Dollar as a so-called “stablecoin”. The Terra currency lost its peg to the Dollar last week, apparently due to issues in the algorithm that links the price of the digital currency to the US Dollar. The peg was not backed by currency or government bonds, but in other cryptocurrencies, and as the price began to fall, investors rushed to sell the coins, effectively creating a digital bank run. The price of Luna fell over 99% in the space of a week, effectively wiping out investors.

 

No safe haven

Following the collapse in Terra Luna, contagion has spread to other leading cryptocurrencies. Bitcoin fell below $30,000, to stand over 50% lower than the previous peak of $69,000 seen in November 2021. Ethereum, Ripple, and Cardano also suffered similar heavy falls.

Supporters of cryptocurrencies have often cited the decentralised nature of the currencies as offering protection against inflation and wider economic uncertainty. Given the underlying economic conditions we are experiencing, the recent price action is a clear indication that cryptocurrencies are, in fact, a poor hedge against rising prices.

Quite surprisingly, cryptocurrencies appear to be moving more in line with Equities markets, contrary to supporter’s claims that Bitcoin and others provide diversification away from more traditional investments. A study by the International Monetary Fund (IMF) in January of this year highlighted the much closer correlation between cryptocurrencies and the S&P500 index of US shares since 2020. What has become increasingly apparent is that the cryptocurrencies are just as susceptible to broader weakness in market sentiment as other assets, such as Equities, only accompanied with significantly higher levels of volatility.

 

Unregulated assets

In addition to the risks of falling prices and contagion from failing currencies, concerns over how safe investor’s crypto assets held on exchanges are, have added to the negative sentiment.

Coinbase, a leading US-based crypto exchange, announced a very poor set of financial results on Tuesday, which showed widening losses and a 19% drop in users over the last quarter. The most important part of the announcement, however, was the admission that should Coinbase declare bankruptcy, the assets held in custody on behalf of customers could become subject to bankruptcy proceedings. In other words, customer’s assets would not be segregated and the customers would become general unsecured creditors of the business.

Unlike UK regulated investments, where investors do have some protection offered under the Financial Services Compensation Scheme in the event that something goes wrong, cryptocurrencies are unregulated, potentially leaving investors without recourse if an investment fails.

 

Invest in what you understand

As famous US investor Warren Buffett quoted “never invest in a business you cannot understand”. We feel this sage advice is true of cryptocurrencies generally. The premise of Bitcoin and its peers was to create new valid currencies, free from intervention from central banks and governments, that would be accepted more frequently as a currency over time. A limited number of organisations do accept Bitcoin as payment for goods and services, although the use of the currency is hardly becoming mainstream. Furthermore, the high levels of volatility seen in Bitcoin and other cryptocurrencies would make their use for transactions almost impossible.

 

A move towards regulation

There has been growing calls for the cryptocurrency market to be regulated over recent years, and the recent volatility is likely to increase the volume of calls for more intervention in this market. Some may see this as a positive move, potentially increasing the mainstream appeal of the investment. However, others see increased regulation as a negative, and totally at odds to the premise of decentralised currencies, which could stifle innovation.

Cryptocurrencies have also long been associated with criminal activity, such as scams, malware and ransomware attacks and money laundering, and regulation would aim to reduce the amount of illegal activity that takes place. Another key consideration is the amount of energy expended in mining tokens, with any move towards regulation likely to focus on the industry’s environmental impact.

 

FCA warning

The Financial Conduct Authority (FCA) produced the clearest assessment of the risks associated in January 2021 when stating “the FCA is aware that some firms are offering investments in cryptoassets, or lending or investments linked to cryptoassets, that promise high returns. If consumers invest in these types of product, they should be prepared to lose all their money.”

Despite warnings such as this, the cryptocurrency market has continued to gain in popularity over recent years; however the gyrations seen over the last week may well serve as a timely reminder of the inherent risks of these unregulated investments.

 

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Magnifying glass over document reading 'interest rates'

Where next for interest rates?

By | Investments

Central Banks on both sides of the Atlantic made headline news last week, as the US Federal Reserve and UK Monetary Policy Committee both raised interest rates. In a much anticipated move, US interest rates were increased by 0.50%, and in the UK, interest rates were increased by 0.25% to 1%, the first time UK interest rates have hit this level since 2009.

 

Why have rates increased?

Focusing on domestic interest rate policy, the Bank of England’s UK Monetary Policy Committee is tasked to support the Government’s economic aims for growth and employment, as well as hit an inflation target (measured by Consumer Price Inflation or CPI) of 2% per annum.

As widely reported over recent months, inflation has surged across the world, as a result of supply issues caused by lockdowns during the Covid-19 pandemic, increases in energy and commodity prices, and more recently by the Russian invasion of Ukraine. This has driven inflation far beyond market expectations, with UK CPI standing at 7% over the 12 months to March 2022, over three times the Bank’s 2% target. Furthermore, most economists believe UK inflation will increase further over coming months, with Bank of England Governor Andrew Bailey indicating the Bank’s belief that CPI will hit 9% in the third quarter and go beyond 10% by the end of the year. The anticipated increase in energy prices, as a result of the OFGEM price cap adjustment, in October, may well be the catalyst for UK inflation hitting double digits.

 

The impact of higher rates

Higher interest rates have a dampening effect on the economy generally, and affect households and businesses alike. The higher cost of borrowing impacts the ability of households to take out larger mortgages, and also increases the cost of loans and credit cards. A likely outcome of a sustained period of higher rates is that house price growth may well be limited, or indeed, could be the catalyst for house prices to fall.

Businesses need to access cheap finance to aid expansion, and if borrowing costs are higher, this could limit business plans to expand, including taking on new staff or premises.

 

Will the Bank keep on raising rates?

In light of the Bank’s forecast that inflation will rise further over the course of the year, it is likely that the Bank will raise interest rates further to try and bring inflation under control. Indeed, 3 of the 9 members of the Monetary Policy Committee voted for an increase of 0.50% rather than 0.25% last week, such was their concern that more aggressive action was needed immediately.

At present, economists are predicting UK Base Rates will reach between 1.75% and 2.25% by the end of the year, a further increase of 0.75% to 1.25% over and above the current level.

The Bank forecasts are always forward looking and they will be considering the longer term inflation forecasts before taking action. Given that CPI measures price growth over the previous 12 months, unless prices continue to rise at the same rate, the current elevated rate of inflation should begin to ease during 2023.

The Bank of England will, however, be acutely aware of the impact of higher interest rates on economic growth. Raising interest rates generally causes an economy to slow down, and with the UK economy already decelerating from a more promising position last year, the Bank will undoubtedly be considering the impact of their actions on the UK economy, which could be heading back towards recession.

Recent numbers for UK PLC have not been encouraging. UK growth stalled from 0.8% in January to just 0.1% in February, and the April 2022 consumer confidence report (as measured by GfK) showed consumers felt less confident than at any time since 2008. Services and Manufacturing surveys carried out last month also showed a drop in optimism.

Whilst the ongoing conflict in Ukraine underpins the increase in the price of food, energy and other supplies, and the continued Covid-19 lockdowns in China threaten to slow supply chains of key goods for manufacturing, it is difficult to see the current economic situation improving over the next few months.

We therefore feel that the market and economists may be off-target with their projections for UK Base Rates to hit 2% by the end of the year. Should the economic slowdown worsen, and the UK economy contracts, this may well weigh on the central bank’s decisions, and could lessen the need for the Bank to raise rates aggressively over the second half of the year.

 

What does this mean for investors and savers?

Savers should expect some respite from the very low interest rates that have persisted now for more than a decade. Whilst some banks and building societies have been slow to pass on the base rate increases in their savings products, others have been more reactive, and as always is the case nowadays, savers should look across the market for competitive rates. The bad news for savers is that the increase in savings rates is not likely to keep up with the expected increase in inflation over the remainder of this year. The “real return” (i.e. the return after the effects of inflation are taken into account) from cash savings may well shrink, leaving savers worse off.

Investors can access a wider range of assets that could look to take advantage of the prevailing conditions. Within lower risk assets, inflation linked bonds and alternative investments such as infrastructure could continue to do well, and in terms of equities, taking a global approach, and focusing on companies with strong earnings and attractive dividend yields could produce outperformance.

If you would like to review your existing savings and investments with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Young woman leans over parents to reach calculator

The Bank of Mum and Dad – what to consider

By | Financial Planning

Buying your first home has never been easy, and the increase in house prices over recent years has made the task even harder for first time buyers. As a result, prospective house buyers are turning to parents, grandparents and other relatives for help. Indeed, it is a scenario we come across regularly; and, by and large, parents are keen to give their children a helping hand to provide a deposit to enable them to buy their first home, or trade up to a larger property.

 

The UK’s 10th largest lender

If the Bank of Mum and Dad was a business in its own right, it would be the UK’s 10th largest lender measured by total loans issued, according to research carried out by Legal & General in 2019. This research, undertaken in conjunction with the Centre for Economics and Business Research (CEBR) also showed that 23% of all housing transactions undertaken in that year involved parental or family assistance, with 65% of buyers questioned saying that they would not be able to proceed with the purchase without the financial assistance. Legal & General’s research also showed the average gift made for this purpose was £25,800 for buyers in London.

By providing a gift by way of deposit, parents can enable their children to increase the amount they can borrow on a mortgage, helping them to buy a home which would be impossible without the financial assistance. Alternatively, the gift could mean that the child borrows less on their mortgage, leading to lower monthly repayments and potentially access to lower mortgage interest rates.

 

Beware the pitfalls

Despite the good intentions that parents often have to help their children, they would be well advised to consider the pitfalls before gifting funds to their children to enable them to buy a home.

Any gift – be it by way of a deposit for a house or for another purpose – could have inheritance tax consequences. Each individual can make gifts of £3,000 per tax year and therefore a married couple could gift £6,000 of capital (plus £3,000 each from the previous tax year if not used) without any inheritance tax concerns. As shown by the research above, this is less than 50% of the average financial assistance provided by parents. Any amount gifted above the gift exemption is treated as a potentially exempt transfer (PET). No inheritance tax is due immediately; however, the person making the gift needs to live seven years from the date the gift is made for the gift to fully escape inheritance tax.

If a parent makes a gift to a child who is buying with an unmarried partner, the consequences of relationship breakdown could mean that the funds are unprotected if the property is subsequently sold. It is an important scenario to consider, and this can be avoided if the solicitor dealing with the purchase prepares a suitable Declaration of Trust, which stipulates that the amount of the gift is paid back to their child from the proceeds of sale.

 

Be careful with co-ownership

Some parents decide that rather than making a gift of a deposit, they would prefer to buy the property with their children. Whilst this allows parents to enjoy an equity participation in the property, the tax consequences need to be considered further. Firstly, assuming the parents already own a home, the purchase would be seen as being a second home, and therefore be liable to the additional rate of stamp duty (3% of the purchase price).

Secondly, the share of the property owned by the parents would not benefit from Principal Private Residence Relief, and if a gain is made on sale of the property in the future, the proceeds on the share owned by the parents would potentially be liable to Capital Gains Tax, at a rate of 18% or 28% (depending on their overall tax position).

Lastly, if a mortgage is being arranged for the purchase, the parent would be jointly responsible to meet the mortgage payments if the child was unable to make the repayments.

 

Looking after your interests

Whilst there are plenty of valid reasons for the Bank of Mum and Dad to remain open for business, parents need to carefully consider their own financial needs in later life before gifting funds to help offspring onto the housing ladder. The same research undertaken by Legal & General showed that 17% of parents passing money to their children via the Bank of Mum and Dad are materially worse off financially as a result.

Giving away capital when retirement is looming can diminish the amount of savings or investments, but also reduce the level of income that could be generated by the gifted capital. The gifted funds are also no longer available to cover any unexpected expenditure, and children will often not be in a financial position to return the favour if the parents require funds.

Parents would also be well advised to consider the effect of unequal gifts made to children. If one child receives a helping hand onto the property ladder, friction within the family could be caused, in particular if the parent is not in a financial position to equalise the gift to children at the same time. It may well be sensible to consider recording the gift in your Will, and making provision so that all are treated in an equitable fashion over time.

 

Engage with financial and legal advice

Many parents are happy to open the doors of the Bank of Mum and Dad, and do the best they can for their children. There are, however, a number of financial and legal considerations that need careful thought. A good solicitor should be able to provide the necessary advice to protect the gift in the event of relationship breakdown, and any changes that may be appropriate to your Will.

At FAS, we can provide assistance to parents who wish to use their funds to help their children. We can advise on which assets are gifted, and the potential financial impact of any actions taken on their financial security. Speak to one of our experienced advisers for assistance.

 

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.