July 2023

Jul 27

Graphic of a house wrapped in ribbon held by a hand, representing the gifting of a house deposit

The financial pitfalls of gifting a deposit

By FAS | Tax Planning

With mortgage rates hitting levels not seen in fifteen years, and house prices remaining close to record highs, taking the first step to owning property is becoming more difficult than ever for first-time buyers. Many find themselves under further pressure to purchase as a result of rising rents, which are increasing on the back of more expensive borrowing costs for landlords, and the general rise in the cost of energy, food and transport.

In this situation, parents and grandparents often take the view that gifting funds to younger family members, to help towards a deposit or provide assistance with other housing related costs, can be seen as an advance on a future inheritance.

The bank is open for business

The “Bank of Mum and Dad” is one of the UK’s largest lenders in terms of the value of gifts and loans arranged. According to data from Legal & General, around £9.8bn was gifted by the Bank of Mum and Dad in 2021 alone. The spike in mortgage rates, general increase in the cost of living, and high house prices is likely to drive the lending stream from the parental bank even higher this year. The trend of helping family with housing costs could be one of the factors behind the fastest ever drawdown from UK savings accounts. The Bank of England reported households withdrew a net £4.6bn from banks and building societies in the month of May, reversing a trend that has seen savings gradually increase over time.

We understand parents and grandparents are keen to provide assistance, and in many cases, the gifted funds can make a substantial difference to the prospects of a first-time buyer being able to secure a property, and also potentially taking out a smaller mortgage in the process. There are, however, a number of pitfalls that parents and grandparents need to consider before parting with their cash.

Tax considerations

Any gift – be it by way of a deposit for a house or for another purpose – could potentially be liable to Inheritance Tax. 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. Any amount gifted above this exempted amount is treated as a Potentially Exempt Transfer (PET). Whilst no Inheritance Tax is due immediately, 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.

Other than the annual gift exemption, when your child gets married, parents can provide a wedding gift of £5,000 each and grandparents can give £2,500 each, free from Inheritance Tax concerns. In addition, if you receive more income than you need to live on, you may be able to make regular gifts out of surplus income. The rules here are complex and we recommend seeking advice if you intend to start a regime of gifting out of excess income.

Depending on the source of the gifted funds, there may be other tax considerations, such as a potential Capital Gains Tax liability that could arise if shares or investments are sold to provide the funds, or an investment property is sold. It is important to recognise that any such liability will fall on the parent or grandparent who is making the gift.

Keep it in the family

Another pitfall is the potential for relationship or marital breakdown. Parental gifts are often provided to children who intend to purchase a property with a partner or spouse. It is important to consider what would happen in the event of relationship breakdown, which could potentially lead to the other party walking off with part or all of the value of the gift. Taking appropriate legal advice, and preparing a suitable Declaration of Trust that protects the value of the gift, could avoid this situation arising.

Parents and grandparents would also be well advised to consider the effect that unequal gifts could have on younger family members. Many are keen to treat family members equally, and this may be impossible at the time the gifted deposit is made. Furthermore, other family members may be too young to receive funds, or may not be in need of capital at the same time. This is where the use of Trusts can be helpful. By creating a Trust, family members can be named as beneficiaries and the Trustees can pass assets to them at the appropriate time. Trust planning does have a number of drawbacks and is, again, a complex area that often requires taking specialist financial and legal advice.

Looking after your interests

Whilst parents and grandparents often want to be generous in helping younger family members, we often find that their own needs and requirements are not properly considered. Parents need to carefully review their own financial needs in later life, and consider the impact that gifting funds could have on their ability to fund a comfortable retirement. It is also important to consider that the capital gifted will no longer be available to the parents or grandparents to cover any unexpected expenditure. As many will require some form of care in later life, gifting capital could reduce the level of care or support that can be afforded. It is worth remembering that it is unlikely that the recipient of the gift will be in a financial position to return the favour if funds are required.

Seek financial and legal advice

There are a number of financial and legal considerations that need careful thought before providing gifts or loans to family members to assist them to purchase a property. It is a good idea to seek legal advice to protect “family wealth” from a potential relationship breakdown, and also look at the implications the gift may have on any existing Will in place.

At FAS, we can provide assistance to parents and grandparents who wish to use their funds to help younger family members. 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 here to start a conversation.

Jul 20

benefits of active fund management - active and passive on blackboard

The benefits of active fund management

By FAS | Investments

One factor to consider when choosing an investment approach, is to decide whether you are looking to follow an active or passive investment style. Active management involves the research and analysis of a target market by a team of analysts, and the decisions of management teams who build a portfolio of best ideas. The alternative approach is to invest passively, which aims to simply track the performance of an index.

Our view is that both investment management styles have features that make them attractive to investors. At face value, a passive investment approach is the most cost effective method, and also potentially offers greater diversification. There is, however, a cost to using only passive investments, which is the potential underperformance compared to an actively managed fund which outperforms the representative market and its’ peers. Given that active managers can often outperform the benchmark by several percentage points of performance each year, and potentially often achieve downside control through asset allocation, this makes quality active funds an attractive proposition.

A tale of two halves

The first half of 2023 sprang a surprise on many analysts, as passive investment strategies broadly performed well compared to active managed funds. Many were expecting 2023 to be a year when active managers could carve out additional returns by allocating their portfolios in the most appropriate positions; however, index investing, in particular in the US and Global markets, has seen positive returns so far this year.

The performance of a handful of global technology giants, including Apple, Microsoft, Amazon and Nvidia have largely been responsible for much of the Equities gains this year. The S&P500 index is a weighted index, where a greater proportion of the index is allocated to the largest companies, measured by their market capitalisation. Apple currently holds a 7.5% weight in the index, closely followed by Microsoft, at 6.8%. The next three largest, Amazon, Nvidia and Alphabet, represent a combined allocation of almost 10%, and as a result, close on a quarter of the index is made up of these five companies.

Given these facts, it is easy to see the reason for the strong performance in passive strategies. By simply holding a US index fund, you are allocating a quarter of your investment to the largest five stocks, which have all performed well so far this year. Indeed, the S&P “Equal Weighted” index, which assigns an equal proportion to each component of the index, has underperformed the headline weighted index by 10% over the year to date.

The strong performance of the tech giants has also influenced the performance of Global passive funds, as the US dominates the MSCI World Index (the broadest index of the largest global companies), representing 69% of the global index by weight.

The second half of 2023 could see a resurgence from active managers. There is much uncertainty about the trajectory of the US economy over coming months, with many economists expecting a mild recession. Much will depend on the actions of the Federal Reserve, who have performed admirably in the fight against inflation (indeed, with much more success than the Bank of England). US inflation has now fallen back to a 3% annualised rate, and economic data has been surprisingly resilient. Corporate earnings have also largely continued to beat expectations. This strength could, in turn, mean that the long awaited “pivot” from the Federal Reserve, that is to say, the point at which interest rates are cut, may be pushed back.

In these conditions, active managers, who have freedom to allocate their portfolio, can take a high conviction position in areas that are undervalued, potentially reaping rewards from this investment approach. If indices fail to make headway, there is no reason why a skilled manager or management team cannot generate additional returns by selecting the most appropriate portfolio of assets.

Our approach

Our investment approach has always been to blend passive and active management when building our portfolios. Passive funds provide good diversification across the widest range of positions, and given the lack of fund manager at the controls, tend to be cheaper. Active managers, on the other hand, can outperform through the selection of their portfolio of assets. Our Investment Committee regularly undertakes comprehensive due diligence on the performance of actively managed funds, and meets with leading fund managers across the industry. Through these focused sessions, we can gain a clear understanding of a manager’s strategy, style and approach, and how they have aligned their portfolio for the expected conditions.

Through our active fund management selections, we also look to select different investment approaches that complement each other. For example, some managers have a clear value bias, seeking out positions in mature companies that pay attractive levels of dividend income. Other managers are biased towards growth stocks, where managers often take a high conviction approach and construct a focused portfolio of relatively few positions. By combining these different styles, we add a further element of diversification and risk management.

Time to take stock

The first half of 2023 has seen passive strategies outperform; however, the remainder of the year could see active management styles back in favour. We suggest this is an ideal opportunity to take stock of an existing investment portfolio, or pension investment strategy, to see whether any changes are needed.

Speak to one of our experienced financial planners here to start a conversation.

Jul 13

Measuring the impact of inflation

By FAS | Investments

Inflation has hardly been away from news headlines over recent months. The cost of goods and services have been driven higher since late 2021, partly as a result of a hangover from the economic policies put in place to help the economy through the pandemic, and also by the Russian invasion of Ukraine.

The UK Consumer Price Index (CPI) annual rate reached a peak of 11.1% in October last year and has been steadily falling since that date (apart from an unexpected jump in February). The pace of disinflation has been slower than expected and the Bank of England have been forced to revise their year-end inflation forecast from 3.9% to 5.2%. It is worth reminding that the Bank of England CPI target is 2%, and as a result, inflation is likely to remain a focus for policy decision makers and investors for some time to come.

How Inflation measures are calculated

Whilst the concept of inflation is readily understood, we thought it would be interesting to take a look at how CPI is calculated, as the weighting in the index, and some of the component goods and services that make up the index, may raise an eyebrow or two.

The Office for National Statistics (ONS) reviews and updates the weights for its consumer price inflation “shopping basket” of goods and services each year, in line with international statistical guidance. This is an attempt to ensure that the basket is representative of the latest household expenditure patterns, and the ONS adds and subtracts items from the basket each year in an attempt to keep the basket of goods relevant. For example, in the latest review, Digital Compact Cameras, and a “non chart” CD purchased in store, were removed.

To fully reflect the wide range of goods and services that make up our economy, the basket of goods and services needs to be broad. That being said, a number of items that remain in the basket may be questionable. For example, in this digital age, it is perhaps surprising that the cost of recordable CD’s and DVD players, and the charge for DVD rental (if, indeed, this still exists?) still feature in the calculation. Likewise, another relic of the past, the cost of a directory enquiry entry, also remains. Another interesting entry in the basket are dating agency fees.

Each of the goods or services used in the calculation is assigned a weight in the index, which is adjusted regularly. The largest component is “Housing, water, electricity, gas and other fuels”, which accounts for 14.1% of the index by weight, followed by “Recreation and Culture” and “Restaurants and Hotels” which account for 13.8% each. Transport is the next largest at 13.7% by weight and perhaps surprisingly Food and Non-Alcoholic Beverages only account for 11.9% of the index.

In May 2023, the rate of CPI stood at 8.7%, with the largest contributor to this change being the cost of Food and non-alcoholic beverages, which accounted for 2.08% of the annual increase. Housing, Water and Fuel contributed 1.79% and Restaurants and Hotels contributed 1.27%. Recreation and Culture and Transport, which are both larger components of the calculation, have risen at a slower rate, contributing 0.91% and 0.16% respectively.

Personal rate of inflation

Clearly, what we buy does not replicate the wide ranging basket of goods in the ONS calculation. The impact that inflation has on our own financial position will depend on your spending habits, which are unique, and the composition of your household expenditure will provide an indication of your personal rate of inflation. For example, a household that spends more than average on food and heating bills will potentially have a higher personal rate of inflation than a household that spends a greater proportion of income on public transport, hobbies or home maintenance.

Is your income inflation proof?

Whilst inflation has a variable impact depending on your personal rate of inflation, the impact can be cushioned if guaranteed income sources rise in line with inflation. For example, the triple lock guarantee on the State Retirement Pension led to a 10.1% increase in payments from April. Defined Benefit pensions in payment will have also increased, and in the case of schemes such as the NHS Pension Scheme and Teachers Pension, the pension payments increase in line with the full rate of CPI inflation. Other Defined Benefit pensions also increase in line with CPI, although for some schemes, the increase is capped at a maximum of 5% per annum. For those in retirement with an element of guaranteed income, the impact of higher inflation has, therefore, been reduced significantly. For those in employment, the ONS reported last month that average total pay increased by 7.2% in the year to April 2023, which was just behind the average rate of inflation over this period.

Offsetting the impact of inflation

Those generating an income from investments, will undoubtedly have found it difficult to keep pace with the rate of inflation over the last 12 months, irrespective of how your personal basket of goods and services are made up. Cash returns have certainly improved this year, although we would not be surprised to see the Bank of England taking action to reduce rates during 2024.

Generating an income through dividend and bond interest can be a useful way of limiting the impact of higher inflation, in particular if the income is generated in a tax efficient manner, for example through an Individual Savings Account (ISA).

Speak to one of our experienced advisers here to discuss generating an income from your investment portfolio.

Jul 06

Graphic of a red money box labelled 'My Pension Fund'

A boost for pension savings

By FAS | Pensions

Amongst the announcements in the March Budget, was an overhaul in pension contribution allowances, which became effective from April. The new rules allow a higher level of contribution each tax year without incurring an excess tax charge and provide valuable planning opportunities for those wishing to boost their pension savings, and in turn improve their long-term financial security. Furthermore, the new rules also allow further accrual for those who have already accessed their pension flexibly.

The benefits of pension saving

It is worth revisiting why pension saving is such a crucial element of any long-term financial planning strategy. Firstly, your contributions receive a boost from tax relief. When you pay into a pension, you receive tax relief at your marginal rate on any regular or lump sum contributions you make. Secondly, in the case of a Defined Contribution pension, all growth within the plan is exempt from Capital Gains Tax and income received is also not liable to Income Tax or Dividend Tax. Finally, you usually have the option of taking up to 25% of the value of the pension savings as Tax Free Cash once you reach the age of 55 or above.

Annual allowance increase

The annual allowance, which is the maximum amount an individual can contribute to a pension in a tax year before being subject to a tax charge, has been increased from £40,000 to £60,000, with the change being effective from 6^th April 2023.

The hike in the annual allowance significantly increases the scope for those working to make meaningful contributions each tax year. In the case of members of a Final Salary pension scheme who are higher earners, such as Doctors, Head Teachers and senior Civil Servants, this reduces the likelihood that their accrual in the scheme will breach the annual allowance.

For those with Defined Contribution arrangements, the new increased limit provides the opportunity to increase regular contributions, or boost pension savings through larger lump sum contributions. In addition to the new annual allowance of £60,000, the ability to carry forward unused pension allowances for the last three years remains. As a result, a contribution of up to £180,000 could potentially be made without being subject to a tax charge. This could prove very useful for a business owner or company director, who is looking to use pension contributions as a tax efficient method of drawing funds from their business, or individuals who receive a bonus or have lump sum savings.

Watch out for the tax traps

Whilst the annual allowance has been increased, the earnings cap remains. In other words, to get tax relief, your personal contributions cannot be any higher than your earnings in the tax year in question. The tapered annual allowance also remains in place, and higher earners need to beware of falling into this tax trap. This measure reduces the annual allowance from £60,000 to a minimum of £10,000, if an individual’s total income from all sources in the tax year exceeds £260,000. This is a complex area, and we always recommend that you speak to an adviser if you feel you are in danger of breaching the tapered annual allowance.

Help for retirees

In addition to the increase in the annual allowance, the money purchase annual allowance has also increased, from £4,000 to £10,000. Anyone who has accessed their pension savings flexibly is subject to the money purchase annual allowance for the remainder of their life. The previous limit of £4,000 was very restrictive and the more generous allowance now means that people who have flexibly drawn their pension can begin to accrue meaningful further pension savings.

This may be particularly useful for those who have taken early retirement and wish to return to employment, as they could potentially rejoin an auto-enrolment scheme or workplace pension provided by their employer, with less fear of breaching the money purchase annual allowance.

A tool for tax planning

As well as providing an income in retirement, pensions can also be a clever way of reducing the amount of income tax an individual pays in any one tax year. The bands at which Basic and Higher Rate tax are charged have been frozen since 2021, and the Additional Rate band, where income above this level is taxed at 45%, was reduced from £150,000 to £125,140 from April. Given that inflation is pushing wages higher, this creates an effect known as “fiscal drag”, where the exchequer receives more tax revenue due to the bands remaining static.

Personal pension contributions are a useful way of reducing the amount of income tax paid by an individual. The amount contributed has the effect of extending the tax bands, so that more of the income falls into a lower tax band. This is particularly important for those who fall into the tax trap where income is between £100,000 and £125,140. As the tax-free personal allowance (i.e. the amount an individual can earn before they pay income tax) is tapered above £100,000, the potential tax saving on pension contributions can be as high as 60%.

Always seek advice

The more generous allowances provided in the Budget earlier this year have increased the ability for individuals to save more into their pension, and in doing so, can help offset the impact of the frozen tax bands. There are, however, traps to catch the unwary, such as the tapered annual allowance and money purchase annual allowance, and we therefore always recommend individuals seek advice on the most appropriate way to contribute to a pension.

Please do get in touch here if you require pension planning advice from one of our experienced independent financial advisers.