Category: retirement planning

Start the New Year with a Financial Health Check

New Year is a perfect time for a complete review of your finances. Run through all your financial arrangements, like investments, pension, insurance plans and bank accounts. The following checklist may help.

Setting Goals and Budgeting

Finances are a popular area where people make (and fail to fulfil) New Year’s resolutions. “Spend less” and “save more” are particularly common ones – and particularly bad ones. When setting goals, you are more likely to achieve them if they are specific and measurable. “Deposit £500 to my savings account every month” is obviously much better than “save more”.

That said, even a well-defined and accurate objective won’t work if it’s either too soft or unrealistic. Make your goals ambitious, but keep them within reach with respect to your current lifestyle and habits. Keep in mind that besides spending cuts there are other ways to improve your bottom line, especially in the long run. They are often less painful and easier to stick with, but can have enormous effect. For example, optimising your taxes or pension contributions, taking advantage of various allowances, changing the way you save and invest or choosing a better insurance plan.

Pensions

Pensions are among the most valuable assets for most people, but they often do not receive as much attention as they deserve. Moreover, pensions legislation has undergone substantial changes in the last few years. If you haven’t reviewed your pension for a while, do it now. The following are some of the questions to ask:

  • Are you contributing the right amounts? Make sure you don’t contribute too little (you may have too little to live off in retirement)) or too much (you might create a problem with the reduced Lifetime Allowance).
  • Does the investment strategy still fit your changing situation, risk attitude and time horizon?
  • Will your current pensions allow you to take advantage of the new pension freedoms? Many older schemes don’t.
  • How does your pension fit in your retirement and estate planning?
  • If you have a Final Salary Pension, have you recently requested a transfer value? These have recently gone up quite a bit and this could provide a good opportunity for you to restructure.

ISAs

Pay particular attention to ISAs. If you are not using them, you are again leaving money on the table. The annual ISA allowance is £15,240 for the 2016/17 tax year and it goes up to £20,000 for the next. These are significant amounts of money you can invest tax-free. Remember to use this year’s allowance by 5 April and don’t leave it to the last moment, as some providers take several working days to process a new deposit.

Investments

Do you have a proper investment strategy which is intended to achieve specified goals held by you? Do not confuse speculation with disciplined investment. The former is for fun and the thrill. The latter is what you need to do to achieve your financial goals. If you hold mutual funds, look at their latest reports and check where your money is actually invested. Is the risk exposure in line with your preference? When assessing investment risk, remember to always consider all your investments (including your pension, ISAs, funds and stocks) together, even when the money is technically in several different accounts and investment vehicles.

Insurance

Risk management is an essential part of sound financial planning. At the same time, insurance is an area where you can waste a lot of money if you choose the wrong product.

Go through all your insurance plans. Check how much each costs, what exactly it covers and what it doesn’t. Changes in your circumstances (e.g. your health, family situation or driving experience) may not only require a different plan, but may also qualify you for a lower premium.

Wills and LPAs

Numerous studies have shown that more than half of adults living in the UK don’t have a Will, including many in their 50’s and 60’s. If you are one of those people, writing a Will is a good New Year’s resolution to make – and one that is not that hard to arrange or anything like as expensive as you would think. We have connections with a number of law firms and can refer you to appropriate specialists.

If you already have a Will, this might be a good time to review it. Check whether it still accurately reflects your wishes and make updates if needed.

The same applies to Lasting Power of Attorney (LPA). Incapacity can strike at any time, not only in old age. If you get it sorted before it’s too late, you will save your family considerable costs and lengthy dealings with the courts. If you already have an LPA in place, check that it’s still up to date.

Contact Us for Help

If you would like help with getting your financial affairs in order and keeping them that way, we would be happy to help. Contact us. We also offer specialist pensions advisory services.

Further Details

If you live in the UK visit UK pensions advisory service. If not, visit expatriate pensions advisory service.

Brexit …

Brexit becomes reality and the markets react with heavy selling of risk assets, particularly British and European stocks and the pound. The fears have materialised and the issue is taking its toll on investment portfolios. That said, the worst thing an investor can do at the moment is acting based on emotions rather than careful analysis of the situation. With the extreme levels of volatility that we are seeing now, a bad decision can have very costly consequences.

Market Volatility

The markets’ reaction can be best observed on the pound’s exchange rate against the dollar. In the last days before the referendum, it appreciated from 1.40 to 1.50 (7%), as polls started to predict a narrow Remain victory. This morning after the actual outcome it dropped to 1.32 (12% down), but at the time of writing this article it is trading around 1.39 (5% up from the morning low). Similar volatility can be observed on stock prices (British, European and worldwide), commodities and other assets.

The Market’s Reaction Is Not Unusual

While the fact of Britain leaving the EU is unprecedented and extraordinary, the way the markets react to the decision is not unusual. It is similar to the way markets react to other surprising outcomes of scheduled events, such as central bank interest rate decisions or (on the individual stock level) company results. We see a sharp initial move triggered by the surprising outcome (this morning’s lows), followed by corrections and swings to both sides, as the market tries to digest further information that is gradually coming in and establish a new equilibrium level. These swings (although perhaps less extreme than today) will most likely continue for the next days and weeks.

What We Know and What We Don’t

At the moment the actual effects of Brexit on the economy are impossible to predict – we will only know several years from now. Even the timeline of next steps is unclear. The only thing we know is that David Cameron is stepping down as PM (that means succession talks and some internal political uncertainty in the coming months) and that the process of negotiations of the actual EU exit terms will be started in the next days or weeks.

We don’t know what the new UK-EU treaties will look like. There are some possible models, like Switzerland or Norway, but Britain’s situation is unique in many ways. We can also expect the British vote to trigger substantial changes within the EU, as the first reactions of EU representatives have indicated; therefore we don’t know who exactly we will be negotiating with. In any case, this is not the end of trade between the UK and EU countries. The EU can’t afford to not trade with the UK or apply punitive protectionist measures against us.

Where Will the Markets Go Now?

Under these circumstances, no one can predict where stocks or the pound will be one month from now or one year from now. Nevertheless, for a long-term investor, such as someone saving for their pension, these short time horizons don’t really matter. If you invest for 10 years or longer, our view is that you don’t need to fear the impact of yesterday’s vote. Leaving the EU might take a few percentage points from the UK’s GDP and from stock returns, but in the long run it won’t change the trend of economic growth, which has been in place for centuries.

The greatest risk that the Brexit decision represents for a long-term investor is not what the market will do. In any case, it will recover sooner or later. The main risk is the investor acting on emotions, under pressure and without careful analysis of all consequences. The investors who lost the most money in past market crashes such as in 1987, 1997 or 2008 were those who panicked and sold at the worst moment, when it seemed like the economy and the financial system was going to collapse. Those who were able to take a long-term perspective and stayed invested have seen their investments recover and even surpass previous levels.

Our Recommendation

We recognise that this is a momentous event and it will take time to fully digest the implications. For now, it is important that investors maintain their disciplined approach and do not act in haste to sell off their investments. This would only serve to crystallise losses which currently only exist on paper. We recommend that they sit tight unless their goals have materially changed. We also ask them to note that we are not taking this lightly and will be maintaining our portfolio structures under review in accordance with our overall investment philosophy. If we judge that changes need to be made we will provide advice as appropriate and this will be dealt with as part of our normal review process.

 

 

New Pension Freedoms Bring Opportunities As Well As Risks

Recent years have seen some significant changes to the tax treatment and rules governing pensions and death benefits. Many of these changes have been quite favourable, bringing new freedoms and tax saving opportunities. However, these freedoms go hand in hand with responsibilities and risks. We will look at the most important challenges and ways to ensure your investments achieve the best possible performance, serve your income needs and at the same time remain tax efficient – both in retirement and when your wealth eventually passes to your heirs.

The Changes

The Government has recently changed financial and tax legislation in many areas, but there are two things which are particularly important when it comes to retirement and inheritance tax planning.

Firstly, you now have greater freedom to decide how to use your pension pot when you retire. You can take the entire pension pot as lump sum if you wish (25% is tax-free, the rest is taxed at your marginal rate), you can take a series of lump sums throughout your retirement, you can buy an annuity or get one of the increasingly popular flexible access drawdown plans.

Secondly, you now have complete freedom over your death benefit nominations. Before the reform, which came into effect in April 2015, you could only nominate your dependants (typically your spouse and children under 23). Now you can nominate virtually anyone you wish, such as your grandchildren, siblings, more distant relatives, or even people outside your family. Furthermore, the taxation of death benefits has become more favourable. If you die before 75, death benefits are tax-free (lump sum or income, paid from crystallised or uncrystallised funds). If you die after 75, death benefit income is taxed at marginal rate of the beneficiary (lump sum is subject to 45% tax, but that may also change in the near future). The reform has turned pensions and death benefits into a powerful inheritance tax planning tool.

The Challenges

While the above is all good news, there are some very important restrictions and things to watch out for. Neglecting them can have costly consequences. For instance, the Lifetime Allowance not only still applies, but has been significantly reduced in the recent years (it is only £1m now). Besides the annual pension contribution allowance it is one of the things that require careful planning long before you retire. In retirement, pension income is typically subject to income tax, which must be considered when deciding about the size and timing of withdrawals, particularly if you have other sources of income.

Asset allocation and investment management is another challenge. Maintaining a good investment return with reasonable risk is increasingly difficult in the world of record low interest rates. It is tempting to completely avoid low-yield bonds and other conservative investments in favour of stocks, but such strategy could leave you exposed to unacceptably high levels of risk, particularly in the last years before your retirement. A balanced portfolio of stocks and bonds is often the best compromise, but asset allocation should not be constant in time – it should be regularly reviewed and should reflect your changing time horizon and other circumstances.

Death benefit nominations are another area where changes in financial and life circumstances may require reviews and adjustments, particularly after the age of 75, when potential death benefits are no longer tax-free. For example, if your children are higher rate taxpayers, you may want to change the nominations in favour of your grandchildren, who may be able to draw the income at zero or very low tax rate, allowing you to pass wealth to future generations in a tax-efficient way. If you have other sources of income and are a higher rate taxpayer yourself, you may even choose to not draw from your pension at all and keep it invested to minimise total inheritance tax.

Conclusion

The above are just some of the many things to consider. Depending on your particular situation, there might be tax saving opportunities which you may not be aware of. Conversely, ignorance of little details in the legislation or mismanagement of your investments may lead to substantial losses or tax liabilities. The new freedoms (and related challenges) make qualified retirement planning advice as important as ever before.

 

 

Sell in May and Go Away – Should You?

If you’ve been investing for a while, it is very likely you’ve heard the “Sell in May and go away” adage many times. This time every year, all major financial media outlets publish their own pieces on it. The recommendations in such articles range from “it is nonsense – stay invested” to “it’s true and really improves returns”, often also including the very popular “but this year is different”. Where is the truth? Is “Sell in May” just a myth, or does it have a sound foundation? What should you do?
Sell in May and Go Away Origin
It is not known who came up with it first and when. The saying is based on (perceived) stock market seasonality and it generally means that market returns tend to be higher in the first months of a year and lower in the next months. Therefore, it is better for an investor to sell stocks in May to avoid the weaker period that follows.
Unfortunately, the saying is very vague about the exact timing. Should you be selling on the first day of May or the last? Or the 8th May, for instance? Additionally, if you sell your shares, when should you buy them back?
You will find several different variations and interpretations of the saying. Probably the most popular version is one that divides the year into two halves, one running from November to April (better returns – hold stocks) and the other from May to October (stay out). Others suggest you should stay out of the market until year end. Yet another version is “Sell in May and don’t come back until St Leger Day” (the September horse race, or the end of summer).
Are the Returns Really Different?
Despite its vagueness, the “Sell in May” adage (particularly the May to October version) is indeed based on some statistically significant differences between stock market returns in different parts of the year (seasonality). Various studies have been done working with different time periods and stock indices in different countries. Many of them have concluded that there are parts of the year when average historical returns have been higher and volatility lower than in other parts of the year. The month of May seems to be the dividing line between the good and the bad period, although exact date, as well as extent of the return differences, depends on the markets and years included in the research.
In short, historical data suggests that market returns tend to be weaker in the months starting with May, so the “Sell in May” saying does have some foundation. Does it mean you should sell? No, and there are several reasons why not.
Lower Returns vs. Negative Returns
While much of the research shows that returns tend to be lower in summer and early autumn, that doesn’t mean stock investors are, on average, losing money in that period. Although the market declined in some individual years, if you were holding stocks from May to September, May to October, or May to year end every year in the last 20, 30 or 50 years, you would have made money in the end.
When deciding whether to sell in May or not, do not compare the average or expected stock market returns to those in the other period. They must be compared to the alternative use of your capital.
To Sell or Not to Sell in May
When making the decision, you are comparing two scenarios:
1. Stay invested in the stock market. Your return is a combination of the increase or decrease in stock prices and dividend yield (do not underestimate dividends).
2. Sell stocks, invest the money elsewhere (often a savings account or a money market fund) and buy stocks back at some point. Your return is the interest earned, but you must deduct transaction costs, which can be significant and sometimes higher than the interest earned. Furthermore, buying and selling will have tax consequences for many investors.
Returns of option 1 are less predictable and can be very different in individual years, as they depend on the stock market’s direction. Returns of option 2 are more stable, but with transaction costs and today’s low interest rates they will be extremely low or even negative. It’s the good old risk and return relationship.
If your time horizon is long and the outcomes of individual years don’t matter, option 1 (staying in stocks), repeated consistently over many years, will most likely lead to much higher return than option 2. If your time horizon is short (for example, you are approaching retirement), you should consider reducing the weight of stocks and other risky investments in your portfolio – not just in May, but throughout the year.

Budget Statement 2016: Key Takeaways

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Budget Statement 2016: Key Takeaways

Chancellor George Osborne delivered his annual Budget speech yesterday. While there are winners and losers as usual, this year’s Budget can be considered quite favourable to middle income families and savers. The pension tax relief is safe (for now) and Capital Gains Tax goes down, among other things. Whilst the Budget contained a wide range of measure, our analysis concentrates on those aspects, which are most important to our clients, namely, taxes, pensions and investments. The full speech is available here.

Personal Allowance and Higher Rate Threshold Up

The Personal Allowance, which is the amount you can earn without having to pay Income Tax, will increase from the current £10,600 to £11,000 for the 2016-17 tax year and £11,500 for 2017-18 (up from the previously announced £11,200).

The higher rate threshold will rise from the current £42,385 to £43,000 for 2016-17 and £45,000 for 2017-18. It is estimated that about 585,000 taxpayers will fall out of the 40% tax bracket as a result.

Both of these are in line with the Government’s previous promises to increase the Personal Allowance to £12,500 and the higher rate threshold to £50,000 by April 2020.

Pension Tax Relief Remains

The fears of pension tax relief cuts or other radical changes to the existing pensions system have not materialised, at least for now. In light of the loud opposition to these plans, pointing out that such measures would discourage people from saving for retirement, the Chancellor has decided to not proceed at this point. The only reference in his speech was the following:

“Over the past year we’ve consulted widely on whether we should make compulsory changes to the pension tax system. But it was clear there is no consensus.”

Of course, this does not mean the issue is safely off the table forever. The Chancellor still needs to find ways to meet his goal of “surplus by 2019-20” and pensions certainly remain among the possible targets. For the 2016-17 tax year though, the allowance stays at £40,000 (for those earning under £150,000), with pension tax relief equal to your marginal tax rate. As previously announced, the Lifetime Allowance falls to £1m effective from April 2016.

ISA Allowance £20,000 and New Lifetime ISA

While pensions have been subject to shrinking allowances in the last years, the trend has been the opposite with ISAs, apparently one of the Government’s preferred ways for people to save for retirement. This time the Chancellor has announced that the annual ISA allowance would jump to £20,000, although only from April 2017. For the 2016-17 tax year the allowance remains at £15,240, same as this year, as previously indicated.

A completely new type of ISA will be introduced in April 2017, called Lifetime ISA. Young savers will be able to contribute up to £4,000 a year and receive a 25% bonus from the Government. That is extra £1 for every £4 saved, a maximum of £1,000 per year. You must be under 40 when opening the account; you will be entitled to the bonus every year up to the age of 50, but only if you have opened an account before 40 (therefore those reaching 40 before 6 April 2017 will miss out). Furthermore, to qualify for the bonus the money must only be used either to save for retirement or to buy a home. If you withdraw cash before the age of 60 and use it for purposes other than buying a home, you will lose the bonus (including any returns on it) and pay a 5% penalty.

The Lifetime ISA is intended as an alternative to pensions for young workers (“many of whom haven’t had such a good deal from the pension system”) and will most likely further develop in the next years. With its home ownership objective it will replace the previously announced Help to Buy ISA, which remains in place until 2019 and can be transferred to the new ISA after April 2017.

Capital Gains Tax Down (Excluding Property)

Shares and other investments sold outside an ISA or pension scheme are subject to Capital Gains Tax when the annual CGT allowance (currently £11,100) is exceeded. As another welcome change to investors, the rates of CGT will drop from 18% to 10% (basic rate) and from 28% to 20% (higher rate).

Importantly, these reductions won’t apply to capital gains from property sales, which will continue to be taxed at the existing rates. This is consistent with the Government’s recent actions against Buy to Let and intended to “ensure that CGT provides an incentive to invest in companies over property”.

Other Changes

The following are some of the other announcements from this year’s Budget speech.

  • From April 2017 there will be two new tax-free allowances (£1,000 each) to support micro-entrepreneurs and the “sharing economy”. The first will apply to property income (such as when renting out your home), the other to trading income (such as when occasionally selling goods and services online).
  • Corporation Tax will decrease further than previously announced, to 17% from April 2020.
  • Contrary to expectations, fuel duty will continue to be frozen for sixth year in a row.
  • From April 2018 there will be a new levy on soft drinks with high sugar content. The proceeds will help finance more PE and sport in schools.
  • Last but not least, Armed Forces veterans in need of social care will be able to keep their war pensions, rather than use them to pay for care.

Conclusion

For the time being, pensions remain the primary way to save for retirement and their tax and other advantages are hard to beat by the alternatives, even with the reduced CGT. Their major downsides are the reduced Lifetime Allowance and Annual Allowance for high earners, effective from 6 April. Of course, further changes may come in the next months and years.

With 25% bonus from the Government, the new Lifetime ISA offers attractive net returns, as long as you meet the conditions. It is only £4,000 per year, but that could add up and compound over time. Even if you are too old to qualify yourself, make sure your children know and take advantage of it when it starts to be available in April 2017.

Lastly, if you are likely to exceed the CGT allowance, consider deferring the sale until 6 April where possible. Not only you will have a new allowance to use, but also CGT rates will be lower by 8 percentage points if you exceed it.

Possible Brexit Consequences and Your Portfolio

Whether you support Leave or Remain, you may be wondering how leaving the EU (or staying in) can affect your investments. Will British stocks underperform if the UK leaves? Will the pound continue to be under pressure until the June referendum, but recover if people vote to stay in the EU? Is there anything you can do to prepare your portfolio for either outcome?
The Brexit referendum is a typical example of an event with known timing (23 June) but unknown outcome. Plenty of these occur in the markets on a regular basis, including corporate earnings, macroeconomic data or central bank policy announcements. While this one is obviously of extraordinary significance, the underlying principles of market psychology still apply.
One of these principles is that anticipation can result in as much volatility as the event itself (if not more). In other words, when investors know that something is going to happen, or might happen with a certain non-zero probability, the market often “reacts” before the outcome is announced. In line with the Efficient Market Hypothesis, prices immediately reflect all available information.
The pound has weakened by 9% against the dollar and by 11% against the euro in the last 3 months. It seems like big part of the damage has already been done. Will it depreciate further? It is impossible to predict.
When anticipating an event, sometimes the market overshoots and then corrects, making a counterintuitive move when the actual outcome is finally known (like the pound strengthening after the referendum even if Leave wins). The saying “buy the rumour, sell the fact” comes to mind. Sometimes it’s the opposite. Other times it’s completely random. No one can tell before it happens.
With the above being said, there are two things we consider highly likely:
Firstly, until the June referendum we will probably continue to see increased volatility in the pound’s exchange rate (saying nothing about the direction). As the first days have confirmed, the debate will be heated. New questions and new fears will arise. Both camps will achieve small victories and suffer small defeats. The perceived probability of leaving the EU will change as new opinion polls will come out.
Secondly, given the high profile and non-stop media coverage of the matter, the economic significance and consequences of Brexit are probably exaggerated at the moment by both the Remain supporters (doom and gloom if we leave) and the eurosceptics (prosperity guaranteed if we rid ourselves of EU bureaucracy).
Contrary to what it may seem, the world has not come to a standstill, waiting for the UK to decide. There are other events and other factors which will continue to influence the economy, the stock market and the currency, before and after the referendum. Some of them will probably have much greater effects than Britain leaving the EU – possible candidates include oil price (the FTSE is energy heavy), interest rates, slowdown in China or the US, wars (e.g. Ukraine, Syria) getting worse and spilling over, or shocks in the financial sector. This time last year, it was Grexit, not Brexit, dominating the headlines. The fact that no one talks about Greece at the moment does not mean that the sovereign debt problem (in Greece and elsewhere) has been resolved. It can strike back at any time and hurt British banks and the economy even if we are already out of the EU.
The above does not mean that consequences of a possible Leave vote will be negligible or non-existent. However, they are too complex for anyone to understand and forecast. We don’t know the referendum outcome. If it’s Leave, we don’t know how the future arrangement will look (in any case, the UK will not cease to trade with Europe). Most importantly, the global economy and external factors will definitely not remain constant, further complicating any predictions.
Therefore we believe that avoiding panic and sticking to your long-term investment strategy is the best course of action. Remember that trying to outsmart and time the market rarely leads to superior results.

Bear Market Coming? Stick with Your Strategy

Following a multi-year rally, 2015 wasn’t particularly successful in the global markets and, so far, the start of the new year hasn’t been any good either. The UK’s FTSE 100 index is below 6,000, lowest in more than three years. It’s times like this when various doomsday predictions start to appear, warning against events “worse than 2008”, using words such as “crash” and “meltdown”, and pointing to factors such as rising interest rates, growing political tensions, China, rising commodity prices, falling commodity prices and many others.
The truth is that no one really knows what is going to happen. Not the TV pundits, not the highly paid bank strategists and stock analysts, not even the Prime Minister or the Bank of England Governor.
That said, when you have significant part of your retirement pot invested, it is natural to feel uneasy when you hear such predictions, especially if they come from an analyst who got it right last time and correctly predicted some previous market event (he was lucky).
When the markets actually decline and you see your portfolio shrinking in real time, the concerns may become unbearable. Fear and greed get in charge, both at the same time. It is tempting to think about selling here and buying the stocks back when they are 20% lower a few months from now. Easy money, so it would seem. Nevertheless, that would be speculating, not investing. The problem with the financial industry (and the media) is that these two are confused all the time.
Time in the Market, Not Timing the Market
While some people have made money speculating, academic research as well as experiences of millions of investors have shown that it is a poor way to save for retirement. When a large number of people take different actions in the markets, some of them will be lucky and get it right purely due to statistics (luck). However, it is extremely difficult to repeat such success and consistently predict the market’s direction with any accuracy.
In the long run, the single thing which has the greatest effect on your return is time, not your ability to pick tops and bottoms. The longer you stay invested in the market, the more your wealth will grow. You just need the patience and ability to withstand the periods when markets fall, because eventually they will recover and exceed their previous highs.
Time Horizon and Risk Tolerance
The key decision to make is your risk tolerance – how volatile you allow your portfolio to be, which will determine your asset allocation. While personality and other personal specifics come into play, the main factor to determine your risk tolerance is your investment horizon. The longer it is, the more risk you can afford and the more volatility your portfolio can sustain. If you are in your 40’s and unlikely to need the money in the next 20 years, you should have most of your retirement pot in equities. If you are older and closer to retirement, your portfolio should probably be more conservative, because you might not have the time to wait until the markets recover from a possible crash. It is important to get the risk tolerance and the asset allocation right (an adviser can help with that) and stick with it.
How to Protect Your Portfolio from Yourself
Because the above is easier said than done, here are a few practical tips how to protect your retirement pot from your emotions and trading temptations:
1. Have a written, long-term investment plan. It is human nature to consider written rules somehow harder to break than those you just keep in your head. It is even better if you involve your adviser to help you create the plan. Not only is an adviser better qualified and more experienced in the investment process, but another person knowing your rules makes them even harder to break.
2. Do not check fund prices and the value of your portfolio every day. This doesn’t mean that you shouldn’t review your investments regularly. But the key is to make these revisions planned and controlled, rather than emotion-based. You will be less likely to make impulsive decisions, which more often than not are losing decisions.
3. Maintain an adequate cash reserve. This should be enough to meet any planned short-term expenditure and also provide a reserve for unexpected expenses. It will help you avoid the need to encash investments at a time when investment values are low.

Would you like to discuss this article with an adviser?

Gravel Road Investing

Owners of all-purpose motor vehicles often appreciate their cars most when they leave smooth city freeways for rough gravel country roads. In investment, highly diversified portfolios can provide similar reassurance.

In blue skies and open highways, flimsy city sedans might cruise along just as well as sturdier sports utility vehicles. But the real test of the vehicle occurs when the road and weather conditions deteriorate.

That’s why people who travel through different terrains often invest in a SUV that can accommodate a range of environments, but without sacrificing too much in fuel economy, efficiency and performance.

Structuring an appropriate portfolio involves similar decisions. You need an allocation that can withstand a range of investment climates while being mindful of fees and taxes.

When certain sectors or stocks are performing strongly, it can be tempting to chase returns in one area. But if the underlying conditions deteriorate, you can end up like a motorist with a flat on a desert road and without a spare.

Likewise, when the market performs badly, the temptation might be to hunker down completely. But if the investment skies brighten and the roads improve, you can risk missing out on better returns elsewhere.

One common solution is to shift strategies according to the climate. But this is a tough, and potentially costly, challenge. It is the equivalent of keeping two cars in the garage when you only need one. You’re paying double the insurance, double the registration and double the upkeep costs.

An alternative is to build a single diversified portfolio. That means spreading risk in a way that helps ensure your portfolio captures what global markets have to offer while reducing unnecessary risks. In any one period, some parts of the portfolio will do well. Others will do poorly. You can’t predict which. But that is the point of diversification.

Now, it is important to remember that you can never completely remove risk in any investment. Even a well-diversified portfolio is not bulletproof. We saw that in 2008-09 when there were broad losses in markets.

But you can still work to minimise risks you don’t need to take. These include exposing your portfolio unduly to the influences of individual stocks or sectors or countries or relying on the luck of the draw.

An example is those people who made big bets on mining stocks in recent years or on technology stocks in the late 1990s. These concentrated bets might pay off for a little while, but it is hard to build a consistent strategy out of them. And those fads aren’t free. It’s hard to get your timing right and it can be costly if you’re buying and selling in a hurry.

By contrast, owning a diversified portfolio is like having an all-weather, all-roads, fuel-efficient vehicle in your garage. This way you’re smoothing out some of the bumps in the road and taking out the guesswork.

Because you can never be sure which markets will outperform from year to year, diversification increases the reliability of the outcomes and helps you capture what the global markets have to offer.

Add discipline and efficient implementation to the mix and you get a structured solution that is both low-cost and tax-efficient.

Just as expert engineers can design fuel-efficient vehicles for all conditions, astute financial advisors know how to construct globally diversified portfolios to help you capture what the markets offer in an efficient way while reducing the influence of random forces.

There will be rough roads ahead, for sure. But with the right investment vehicle, the ride will be a more comfortable one.

Article by

Jim Parker, Vice President, Dimensional Fund Advisers

Business owners to profit from pension flexibility

Business owners to profit from pension flexibility
Business owners looking to extract surplus profits from their business will be looking forward to April’s new pension income flexibility. Not only will pension funding remain the most tax efficient way to extract profits, but those funds will also become far more accessible than ever before.

Allowable contributions have the double benefit of reducing the profits subject to corporation tax, without incurring an employer National Insurance liability. Extraction by salary or bonus will reduce profits before tax, but will not side step NI.

The only previous downside for business owners was that pension funds were not as readily accessible as cash. But all that will change from April if the owner of the business is over age 55. This could lead to business owners seeking advice on how to maximise their contributions.

How much can be paid?
Potentially if someone has not paid anything into their pension for some time they can pay up to £230,000 now. This would be done in two stages. First, by using carry-forward from the 3 previous tax years. This amounts to £150,000 using allowances from 2013/14, 2012/13 & 2011/12. Plus, in order to carry-forward they would also have to pay the maximum £40,000 for the current year. Potentially they may also be able to pay a further £40,000 towards next year’s allowance now if their current input period ends in the 2015/16 tax year.

Unlike paying pension contributions personally, company contributions are not limited by the business owner’s earned income. Instead, the company just has to be able demonstrate that the contributions were ‘wholly and exclusively for the purpose of trade’. However, the company would typically need to have enough profits in the accounting year to get the full benefit of corporation tax relief.

The financial dangers of hoarding cash
There may also be a spin off benefit of paying surplus profits to a pension instead of capitalising it:

Inheritance tax
Shares in unquoted trading companies normally attract IHT business property relief (BPR). But cash built up in the company bank account or investments held within the company could be regarded as an ‘excepted asset’ and not qualify for BPR. To qualify for relief; cash has to have been used in the business in the past two years or earmarked for a specific future business purpose. Clients should always obtain professional advice to get clarity on their particular situation.

With many companies still stockpiling cash following the credit crunch, some business owners could be unwittingly storing up an IHT charge. Amounts over and above their company’s usual working capital could be included within their estate.

Paying into their pension could help ease this. There is typically no IHT payable on pension death benefits provided the contributions weren’t made when they were in ill health. Extracting the cash from the business in the form of a pension contribution could result in an immediate reduction in the business owner’s estate.

Capital Gains Tax
Holding excess cash in the business could cause similar issues when shares in the company are sold. Entrepreneurs’ relief is valuable to business owners as it can reduce the rate of CGT payable on the disposal of qualifying shareholdings to just 10%. To qualify the shares must be in a trading a company. A trading company for this purpose is one which does not include substantial non-trading activities.

While cash reserves are not looked at in isolation, holding substantial cash and other investments could contribute to a company losing its ‘trading’ status. And unlike BPR, entrepreneurs relief is all or nothing. If cash and investments trigger a loss in relief it affects the full value of the business disposed of; not just the non-trading assets.

CGT will not be an issue if they intend to pass their shares on death to other family members. But it could have huge implications for business owners approaching retirement and planning to sell their business as part of their exit strategy. Extracting surplus cash through pension planning to ensure entrepreneurs’ relief is secured on sale of the business will be an important consideration.

The cost of delay
Each year clients delay, the maximum amount they can pay using carry-forward will diminish. The annual allowance cut from £50,000 to £40,000 in 2014/15 will reduce the amount that can be carried forward by £10,000 for each of the next 3 years. By 2017/18 the maximum carry-forward will have dropped from £190k to £160k.

What difference could this make to your retirement pot? Well, if your planned retirement was in 10 years, a net annual growth rate of 4% after charges on £190k would provide a pot of over £281K. By contrast, waiting three years and investing £160k, the accumulated pot would be £210k – almost £71k less.

Time to act
With the main rate of corporation tax set to fall by 1% from 1 April it makes sense to bring forward pension funding to maximise relief. Paying contributions in the current accounting period will see a reduction in the profits chargeable at a higher rate of corporation tax.

All in all, there are many compelling reasons to use pensions to extract profits which aren’t required for future business use. And the longer they leave it the greater the danger of missing out on valuable reliefs.

10 good reasons to pay into a pension before April

There are less than three months to go before the new pension freedom becomes reality. With the legislation now in place, the run up to April is time to start planning in earnest to ensure you make the most of your pension savings.

To help, here are 10 reasons why you may wish to boost your pension pots before the tax year end.

1. Immediate access to savings for the over 55s

The new flexibility from April will mean that those over 55 will have the same access to their pension savings as they do to any other investments. And with the combination of tax relief and tax free cash, pensions will outperform ISAs on a like for like basis for the vast majority of savers. So people at or over this age should consider maximising their pension contributions ahead of saving through other investments.

2. Boost SIPP funds now before accessing the new flexibility

Anyone looking to take advantage of the new income flexibility may want to consider boosting their fund before April. Anyone accessing the new flexibility from the 6 April will find their annual allowance slashed to £10,000.
But remember that the reduced £10,000 annual allowance only applies for those who have accessed the new flexibility. Anyone in capped drawdown before April, or who only takes their tax free cash after April, will retain a £40,000 annual allowance.

3. IHT sheltering

The new death benefit rules will make pensions an extremely tax efficient way of passing on wealth to family members – there’s typically no IHT payable and the possibility of passing on funds to any family members free of tax for deaths before age 75.
You may want to consider moving savings which would otherwise be subject to IHT into your pension to shelter funds from IHT and benefit from tax free investment returns. And provided you are not in serious ill-health at the time, any savings will be immediately outside your estate, with no need to wait 7 years to be free of IHT.

4. Get personal tax relief at top rates

For those who are higher or additional rate tax payers this year, but are uncertain of their income levels next year, a pension contribution now will secure tax relief at their higher marginal rates.

Typically, this may affect employees whose remuneration fluctuates with profit related bonuses, or self-employed individuals who have perhaps had a good year this year, but aren’t confident of repeating it in the next. Flexing the carry forward and PIP rules* gives scope for some to pay up to £230,000 tax efficiently in 2014/15.
For example, an additional rate taxpayer this year, who feared their income may dip to below £150,000 next year, could potentially save up to an extra £5,000 on their tax bill if they had scope to pay £100,000 now.

* Contact me if you don’t know what this is.

5. Pay employer contributions before corporation tax relief drops further

Corporation tax rates are set to fall to 20% in 2015. Companies may want to consider bringing forward pension funding plans to benefit from tax relief at the higher rate. Payments should be made before the end of the current business year, while rates are at their highest. For the current financial year, the main rate is 21%. This drops to 20% for the financial year starting 1st April 2015.

6. Don’t miss out on £50,000 allowances from 2011/12 & 2012/13

Carry forward for 2011/12 & 2012/13 will still be based on a £50,000 allowance. But as each year passes, the £40,000 allowance dilutes what can be paid. Up to £190,000 can be paid to pensions for this tax year without triggering an annual allowance tax charge. By 2017/18, this will drop to £160,000 – if the allowance stays at £40,000. And don’t ignore the risk of further cuts.

7. Use next year’s allowance now

Some may be willing and able to pay more than their 2014/15 allowance in the current tax year – even after using up all their unused allowance from the three carry forward years. To achieve this, they can maximise payments against their 2014/15 annual allowance, close their 14/15 PIP early, and pay an extra £40,000 in this tax year (in respect of the 2015/16 PIP). This might be good advice for a individuals with particularly high income for 2014/15 who want to make the biggest contribution they can with 45% tax relief. Or perhaps the payment could come from a company who has had a particularly good year and wants to reward directors and senior employees, reducing their corporation tax bill.

8. Recover personal allowances

Pension contributions reduce an individual’s taxable income. So they’re a great way to reinstate the personal allowance. For a higher rate taxpayer with taxable income of between £100,000 and £120,000, an individual contribution that reduces taxable income to £100,000 would achieve an effective rate of tax relief at 60%. For higher incomes, or larger contributions, the effective rate will fall somewhere between 40% and 60%.

9. Avoid the child benefit tax charge

An individual pension contribution can ensure that the value of child benefit is saved for the family, rather than being lost to the child benefit tax charge. And it might be as simple as redirecting existing pension saving from the lower earning partner to the other. The child benefit, worth £2,475 to a family with three kids, is cancelled out by the tax charge if the taxable income of the highest earner exceeds £60,000. There’s no tax charge if the highest earner has income of £50,000 or less. As a pension contribution reduces income for this purpose, the tax charge can be avoided. The combination of higher rate tax relief on the contribution plus the child benefit tax charge saved can lead to effective rates of tax relief as high as 64% for a family with three children.

10. Sacrifice bonus for employer pension contribution

March and April is typically the time of year when many companies pay annual bonuses. Sacrificing a bonus for an employer pension contribution before the tax year end can bring several positive outcomes.
The employer and employee NI savings made could be used to boost pension funding, giving more in the pension pot for every £1 lost from take-home pay. And the employee’s taxable income is reduced, potentially recovering personal allowance or avoiding the child benefit tax charge.