February 2024

Feb 29

Broaden your horizons

By FAS | Financial Planning

The news that the UK economy fell back into recession at the end of last year is likely to be of little comfort to investors whose portfolios are heavily weighted towards UK Equities. It is fair to say that most UK investors will have some exposure to shares listed in the FTSE100, the index of the largest quoted UK companies. Indeed, we often come across portfolios that continue to hold a heavy concentration of UK Equities, and this is particularly true of traditional Discretionary Managed portfolios, which hold a blend of directly held shares and collective investments.

Investors who have focused on UK shares are likely to have seen an extended period of underperformance compared to investors who have adopted a global approach to investment. The FTSE100 index level has increased by just over 7% over the last 5 years, which is disappointing when compared to the performance of other global indices over the same period. Over the last 7 calendar years, the S&P500 index of leading US shares has outperformed the FTSE100 in each period, with the sole exception being 2022, which proved to be a very disappointing year for most asset classes. Moving away from the headline FTSE100 index, the performance of mid-sized UK companies in the FTSE250 index has been weaker still.

Structure of the index

One reason for the extended period of underperformance of the FTSE100 is the composition of the index itself. At the end of 2023, just under 20% of the FTSE100 is represented by financial companies, with Consumer Staples being the second largest sector. Industrials, Energy and Healthcare are the next three largest sector allocations. Over recent years, much of the outperformance of global markets has been led by stocks in the technology sector, which are significantly underrepresented in the FTSE100 index, with just over 1% of the index allocated to Tech stocks. By way of comparison, close to 30% of the S&P500 is invested in the Technology sector.

London losing its’ lustre

Another factor that is influencing the performance of UK indices is the diminishing influence of the UK in global financial markets. In 2022, the market capitalisation of French listed companies temporarily exceeded those listed in the UK for the first time. Further damage to London’s reputation has been caused by a number of leading domestic companies who have chosen to list on global exchanges rather than list on the London Stock Exchange. These include semiconductor stock ARM, who listed on the NASDAQ index last September. If this trend continues, the gap in performance between the UK and global markets could widen further.

Positive for income seekers

The above factors paint a rather gloomy picture for domestic shares. There are, however, a number of redeeming features which suggest that investors would be unwise to shun UK Equities altogether.

For investors who are seeking a high level of dividend income, the FTSE100 can be a happy hunting ground. The current yield on the index is around 3.7% per annum, which represents a significant uplift over the yield on the S&P500 index, which stands at just 1.3% and is also higher than the yield generated by the indices of our major European counterparts. The composition of the FTSE100 lends itself to an attractive dividend yield, due to the high concentration of mature companies that are cash generative. Furthermore, UK companies have a long-standing culture of returning excess profits to shareholders in the form of dividends.

Whilst UK stocks tend to offer the most attractive yields, many investors now choose to focus on total return from their investments, which combines capital appreciation or losses achieved in conjunction with dividend income received. Given the modest capital performance over the last five years, using this measure reduces the attractiveness of the FTSE100 dividend yield.

Investors seeking income can also broaden their horizons, as Global Equity Income funds increase in popularity. These funds, which are typically actively managed, invest in global stocks that offer attractive and sustainable dividend yields, and whilst it is fair to say that other geographies don’t share the dividend culture present in the UK, many mature companies listed in the US and Europe still offer attractive yields. Adding Global Equity Income to a portfolio can be a useful way of diversifying a highly concentrated exposure to UK companies.

Cheap for a reason?

The UK market is certainly attractively valued when compared to global markets. The forward price-earnings ratio – a well-known measure of whether a stock or index is cheap or expensive – stands at around 10 times earnings. This is less than half the price-earnings ratio of the S&P500 index, and indicates the UK is certainly cheap compared to US markets. The FTSE100 price-earnings ratio also stands at a discount to the same ratio for the major German and French indices.

Given the discount to other global markets, why have UK stocks continued to underperform? Perhaps the answer is that UK stocks are cheap for a reason, given the stagnation in the UK economy and lower appeal in the current market trend towards technology stocks.

The benefits of diversification

Over recent years, holding a high allocation to UK Equities may well have led to underperformance as UK shares have lagged their global counterparts consistently for an extended period.

Whilst UK Equities remain attractively valued, the FTSE100 is poorly placed to take advantage of current market momentum, which is very much focused on new industry and technology in particular. A swing in market sentiment, however, towards more value orientated companies could help UK indices regain lost ground, and this is why retaining exposure to the UK remains appropriate in a diversified portfolio. There are, however, compelling reasons why investors, who hold significant allocations to UK shares, should broaden their horizons and seek to diversify into other geographies, such as the US and Far East.

Our experienced financial planners can review an existing investment portfolio and suggest areas where greater diversification could be beneficial. This can be particularly important for those who hold portfolios that have not been reviewed for some time. Speak to one of the team to arrange a formal review.

Feb 22

Are your pension savings on track?

By FAS | Pensions

A recent study published by the Pension and Lifetime Savings Association (PLSA) caught the attention of mainstream media, and turned the spotlight on the need to plan ahead to enjoy a comfortable retirement.

The PLSA have devised three Retirement Living Standards, which help illustrate the level of income needed to provide a Minimum, Moderate and Comfortable retirement. The PLSA suggests that the Minimum level of income covers essential spending in retirement, with limited funds left over for discretionary expenditure. At the other end of the scale, a Comfortable retirement income provides a greater level of financial freedom, and leaves sufficient surplus income to pay for some luxury items.

The reason that the update to the Standards caught the attention of the media is the significant increase in the level of income required at each Standard level over the last twelve months. For a single person, the PLSA research suggests an income of £31,300 is needed to provide a Moderate standard of living in retirement, whereas this jumps to £43,100 for a couple. These figures represent an increase of over £8,000 for a single retiree, or just over £9,000 for a retired couple, in just one year. The increased costs of living, including higher energy and food prices, have naturally fed in to the higher figures, although the PLSA also highlighted the increased cost of holidays, and the cost of providing financial assistance to family members, as contributory factors.

Increased focus on saving

The PLSA survey acts as a useful reminder of the need to plan ahead for the longer term, and to review whether your pension savings are on target to meet your needs in retirement.

Of course, personal pension savings will form part of any retirement strategy; however, the State Pension will also provide a proportion of the target income amount. The triple lock has led to a significant increase in the State Pension, with the hike of 10.1% last year being followed by an increase of 8.5% from April 2024. An individual who qualifies for the full flat rate State Pension will be entitled to £221.20 per week from April, or £11,502 per annum. This falls some way short of the Moderate Living Standards suggested by the PLSA, and highlights the need for individuals to focus on pension saving to meet the shortfall between State Pension provision, and a more comfortable retirement.

Another point to consider is that many individuals do not wish to work until their State Pension age, which is now 67 for those born after March 1961. Early retirement introduces an additional period of shortfall, as years when the State Pension is not payable will need a greater level of funding from other sources, such as personal pensions.

Since the advent of auto-enrolment, most UK employees are enrolled into a workplace pension scheme. Whilst the level of contribution made by employees has increased over time, the statutory minimum level of contribution, at 8% of qualifying earnings, is unlikely to be sufficient to bridge the gap. One worrying statistic highlighted by the PLSA survey is that 51% of those questioned believed the minimum auto-enrolment contributions will be sufficient to provide their required level of target income in retirement. This reinforces the need for individuals to start planning ahead and think realistically about the level of savings needed at retirement.

It’s not just how much you save, performance matters

Whilst the amount that you pay into a defined contribution pension will have a major influence on the retirement income it could provide, it is important not to lose sight of the need to ensure that pension savings are invested in an appropriate manner. Pension savings could conceivably be in place for 40 years, and even longer if a drawdown approach is adopted, and this is a significant period of time over which good performing funds could make a significant difference to the overall pot value at retirement.

Take the example of an individual aged 57 with a pension pot of £100,000. They have 10 years left to retirement and contribute £200 per month gross into a pension. If consistent net investment returns of 4% per annum are achieved on the pension savings, the individual could expect to hold a final pension pot of around £178,000 at age 67; however, achieving consistent net returns of 6% per annum over the same time period could increase the pension pot to around £214,000, some £36,000 higher. Naturally, investment performance is never linear, and returns will fluctuate from year to year; however, this illustration highlights the difference performance can make to the overall pension pot value, and the importance of getting investment decisions right at the outset.

It is also important to review investment decisions regularly to ensure that the portfolio strategy adopted remains sensible, given the underlying economic and market conditions. It is also worth considering whether the investment approach needs to be adapted as you move closer to retirement.

The benefits of planning ahead

One key takeaway from the PLSA survey is that the level of pension income needed for a comfortable retirement is increasing. Reviewing existing pension arrangements regularly can help ensure that your pension savings are on target to meet your goals, and that pension investments remain invested sensibly to maximise growth potential over the longer term. These are areas where holistic financial planning can add significant value, and help you achieve your objectives.

At FAS, our experienced financial planners can take an unbiased review of your existing pension savings, to advise whether the level of contributions you are making are sufficient, and review existing portfolio strategies to make sure that funds are invested appropriately. Our in-depth ongoing review service will review your pension savings at regular intervals so that you can make adjustments as necessary to help meet your retirement goals. Speak to one of our planners to discuss whether your retirement plans are on track.

Feb 15

Changes to Pension Lump Sum Allowances

By FAS | Pensions

Announced in the Spring Budget 2023, the Lifetime Allowance for pension savings will be abolished from April 2024. The Lifetime Allowance is the amount of pension savings an individual can accrue before a tax charge could apply. Transitional arrangements are in place for the current tax year, which means that the existing Lifetime Allowance charge is now set at zero.

The legislation that brings about the permanent abolition of the Lifetime Allowance will introduce a raft of changes to the way that lump sum pension benefits are taxed. As is often the case, the new rules are not straightforward, and present a number of planning opportunities for pension holders in a range of circumstances. We must stress that HMRC are still working with the industry to bring about the final framework for the new rules, and therefore the content in this article is based on our understanding of the rules as they stand currently.

Lump Sum Allowance

From 6^th April 2024, a new allowance, known as the Lump Sum Allowance, will place a limit on the amount of tax-free cash that can be taken from pension arrangements. The Allowance is set at £268,275, and is exactly 25% of the current Lifetime Allowance limit, which is £1,073,100. Those with Lifetime Allowance protections will have a Lump Sum Allowance based on their protected Lifetime Allowance level.

From 6^th April 2024, whenever tax-free cash is taken from a pension, this reduces the available Lump Sum Allowance. To take account of payments of tax-free cash made before 6^th April 2024, 25% of the amount crystallised when taking benefits will be used. This produces a monetary amount that is deducted from the new Lump Sum Allowance. If the individual has used up 100% of their Lifetime Allowance, then they will be deemed to have no available Lump Sum Allowance remaining.

Further Tax Free Cash available?

The new rules may present an opportunity to draw further tax-free cash from a defined contribution pension scheme for individuals with specific circumstances. The starting point on the Lump Sum Allowance is to assume that everyone who took pension benefits prior to 6^th April 2024 received 25% of the value of their pension as tax-free cash. Whilst this applies to most individuals, there are situations when this may not have been the case.

Those with Defined Benefit (Final Salary) pensions may have received less than 25% of the value of the pension as tax-free cash, either due to the way the scheme is structured, or if they decided to take full pension income and not draw available tax-free cash. Further tax-free cash could be available; however this may only be useful if an individual is close to the Lump Sum Allowance, and would otherwise not be able to receive 25% of a further crystallisation as tax-free cash.

Those who could benefit from the new rules can apply for a Transitional Tax-free Amount Certificate from their existing pension provider. Pension holders will need to obtain evidence from the scheme where the additional allowance was created, to support their claim.

Lump Sum and Death Benefit Allowance

The other key part of the new pension regime is the new Lump Sum and Death Benefit Allowance (LSDBA). From the start of the new tax year, an individual will have a LSDBA of £1,073,100, although those holding transitional protections may have a higher allowance. This allowance is designed to cover lump sum payments made during an individual’s lifetime, and in addition, also covers lump sum payments paid on death of the individual. These payments include Defined Benefit lump sums and Uncrystallised lump sum death benefits. Any lump sum payments made during an individual’s lifetime, or to beneficiaries, above the LSDBA, will be taxable at the individual, or beneficiary’s, marginal rate of tax.

The important point to note here is that the rules apply to lump sums only. In the case of a Defined Benefit pension, or some Defined Contribution schemes, the only option open to beneficiaries is to receive a lump sum payment. This could potentially mean that beneficiaries become liable to tax if the LSDBA limit is breached.

Individuals holding modern Defined Contribution pensions should be able to avoid any adverse consequences of the LSDBA, if the pension arrangement offers Beneficiary Flexi-Access Drawdown. Payments made under beneficiary drawdown are not lump sums, and therefore benefits are not tested against the LSDBA.

Do you need to take action?

The final framework of the new pension rules is still in the process of being ironed out, and there could be further revision to the draft legislation before the end of the tax year. Our initial assessment of the draft framework is that the changes are likely to affect a relatively small number of individuals with specific circumstances.

Some pension holders could be entitled to additional tax-free cash, in particular if they have taken benefits from a Defined Benefit pension and did not draw the maximum available tax-free cash. Those with specific pension protection may also need to check to see whether the new rules carry any implications for existing defined contribution pension arrangements.

In addition, the new Lump Sum and Death Benefit Allowance could lead to more beneficiaries paying tax when receiving pension benefits following the death of the pension holder; however, this can normally be avoided by ensuring that Beneficiary Flexi-Access Drawdown is an option under the pension contract. It is important to note that not all pension arrangements offer Beneficiary Flexi-Access Drawdown and it is therefore worth checking that this is an option under an existing pension plan. If it is not an option, it may be worth considering whether the existing pension arrangement is appropriate, and if any action is needed to move the pension to an alternative plan.

It has always been important to complete an Expression of Wish declaration on a Defined Contribution pension, to guide the pension trustees on who you would like your pension benefits paid to. The new rules only strengthens the need to ensure a valid nomination is in place, so that the option to draw benefits under Beneficiary Flexi-Access Drawdown is available.

Speak to one of our experienced advisers to discuss the implications of the new rules on your pensions and whether you need to take any action.

Feb 01

Plan ahead in advance of tax changes from April

By FAS | Tax Planning

Capital Gains Tax (CGT)

After being significantly cut in April 2023, the annual CGT allowance will be halved from 6^th April 2024, and will see many more individuals subject to CGT in the next tax year.

The Finance Bill 2022 introduced the first reduction in the annual CGT exemption, reducing the allowance from £12,300 in 2022/23 to £6,000 in the current tax year. From 6^th April, this exemption will halve to just £3,000 and the legislation confirms this allowance is fixed until any further legislative changes are made.

CGT is payable on the net balance of gains and losses made over the course of a tax year when assets – such as property and investments – are sold. A direct result of the lower annual allowance is that many more people will pay CGT, with those holding substantial investment portfolios that are not in a tax-efficient wrapper, such as an Individual Savings Account (ISA), facing mounting annual CGT bills. The rate of CGT on the disposal of investments is, thankfully, not punitive. Those who pay basic rate income tax will pay CGT at 10% and higher rate taxpayers pay 20%. Higher rates of CGT are, however, charged when disposing of residential property.

Impact on portfolio planning

The reduced allowance is likely to challenge investment strategies, and could potentially lead some to reach the conclusion that they should avoid disposing of investments for fear of triggering a tax charge. Another way to reframe the decision is that you still retain at least 80%, or possibly 90%, of the gain made above the allowance, and the sale could provide the opportunity to realign an existing portfolio. This could prove to be a sensible move, if the investment has grown substantially and the level of risk has increased by virtue of the larger holding. It could also be worthwhile if the investment is underperforming and the proceeds are used to reinvest into another asset with improved prospects.

There are steps you can take to maximise the available allowances. Investments held in joint names can use both CGT allowances as the gain is deemed to be shared, and if investments are held in an individual’s sole name, arranging a transfer between spouses could help make use of available allowance that would otherwise be wasted.

Any CGT liability needs to be declared to HMRC, and even when the net balance of gains and losses falls below the new £3,000 annual allowance, disposing of assets valued at more than £50,000 will also trigger the CGT reporting requirements. This is likely to mean that many more individuals will need to complete a Self-Assessment Tax Return in the future.

Dividend Allowance

Alongside the reduction in the CGT allowance from 6^th April 2024, the Dividend Allowance is also being further reduced to just £500. The Dividend Allowance is a tax-free allowance that covers dividend income received, and captured the first £5,000 of dividend income received in 2016. This allowance was cut to £2,000 in 2018, and was further reduced to £1,000 in the current tax year.

According to Treasury data, the latest cut to the Dividend Allowance is likely to impact over 3 million individuals, from those who hold investment portfolios to company directors who are largely remunerated through dividends.

The changes are likely to be felt the most by investors with smaller portfolios of individual shares or collective investments, who may be faced with paying dividend tax for the first time. Dividend tax is charged at 8.75% for basic rate taxpayers, and therefore the impact may appear relatively light; however, the rate is hiked to 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.

Take action before April

According to Treasury figures, the combined impact of the CGT allowance changes and reduction in the Dividend Allowance will generate over £4.6bn of revenue over the next four years. This represents a significant additional tax take for the Exchequer, although investors can take steps to minimise the impact of the changes.

Firstly, the changes present an ideal opportunity to review an existing investment portfolio, to consider whether funds or stocks need to be sold in the current tax year to crystallise a gain within the CGT allowance. We often meet clients who have not reviewed existing portfolios for some time, and carry investments with large capital gains that would be crystallised on disposal. With the reduction in the CGT allowance, the tax implications of disposal will need to be carefully managed, although investors would be well served to consider the performance and future prospects of an investment, when reaching a decision that creates a CGT liability.

Using tax allowances, such as the ISA allowance, can be effective ways of minimising the impact of the tax changes. ISAs have been a staple of financial planning for many years, and the benefits of regular use of the ISA allowance, in conjunction with other tax efficient investment wrappers, could reduce tax bills in the future.

Seek advice

The reduction in the annual CGT and Dividend Allowances is likely to impact many investors from April, and for individuals with sizeable investment portfolios that are rebalanced and reviewed regularly, CGT liabilities may well be increasingly unavoidable. That being said, future liabilities to both CGT and Dividend Tax can be reduced by planning ahead and using annual exemptions where possible.

As a Chartered independent firm, we can advise on solutions from across the marketplace, and are very used to providing advice on existing investment portfolios and how these can be made more tax-efficient. Speak to one of our experienced advisers to discuss the impact of the changes from April and how it will affect your portfolio.