Woodruff Financial Planning blog

If you are an employer, you will probably have heard about the NEST pension scheme, which will go live in October 2012.  These proposals are expected to go into force, although some review may take place under the new Government (there is a review underway at present, which is due to report back in September 2010).

Under the new rules, employers will have greater responsibilities to provide workplace access to pensions for their employees.

1. You will be required to enrol your employees into a scheme which meets the new standards
2. There will be a minimum contribution amount for employers and employees (see below)

NEST is designed to be:

• low cost
• open to any employer that wants to use it to meet the new duties
• an online pension scheme that’s easy to use
• easy for you and your workers to understand
• run in members’ interests by NEST Corporation

When will your company be expected to comply with the new rules?
The scheme is coming into effect in stages according to the size of employers from 2012 over a number of years.  The largest companies will be expected to set schemes up first, with the smallest coming in the following years.  The Pensions Regulator will give you one year’s notice of when your new legal duties come into effect. It will also write to you three months in advance to remind you that your duties are due to take effect and that you need to have a scheme in place.  Click here for a list of when companies will be expected to set up NEST schemes.

What are the minimum contributions?
There will be a gradual increase in the amounts that you must pay in to your employees’ accounts:

You will also be responsible for deducting employees’ contributions from their net pay, and to pay this money to the NEST scheme.

You may not have heard of qualifying savings plans, as these have become unpopular over the last few years.  These used to be popular with direct sales forces selling expensive with profits plans.  However, they are still available and have come back into focus following the recent changes to tax rates.

What are Qualifying savings plans (QSPs)?
These are savings plans which commit you to a minimum of 10 years savings.  If you save for 7.5 years, or 10 years if the initial term is longer, you will be able to withdraw your savings from the plan without any further tax, even if you are a higher rate tax payer.  The plans also come bundled with life cover.

QSPs have advantages over other products in that you can save a lot of tax when you come to cash in your plan, even if you are still paying higher rate tax.  If you had a general investment account, you would be liable to capital gains tax on the cashing in of the plan.  This is currently 28% for higher rate tax payers, and 18% for basic rate tax payers.  The QSP would avoid this tax quite legitimately, although it would still pay tax on the savings income while invested, normally at around 16-18%, as opposed to up to 40% or 50% with other savings plans. We would assume that you maximise your ISAs, since they are largely tax free, but once you have done that, you could consider QSPs.  QSPs have an advantage over pensions in that you are not constrained over what you do with the capital, and when you withdraw the money, although taking the money early would remove the tax-free status.  You can write the plans into segments so that you can choose to cash some of the plan in early, albeit attracting tax at that point; this gives you the ability to access cash when you need it, and retains the tax-free status of the remaining savings.

Who should consider a qualifying savings plan?
We would assume that you would maximise your annual ISA allowances (£10,200), but after that…

Savings for high earners
If you pay higher rate income tax, you could consider paying into a QSP, mainly to get your money free of tax at the end of the policy.  Thus, you would save paying capital gains tax of 28% (or 18% as a basic rate tax payer) on the cashing in of your plan.  The plan could be used to fund your retirement, weddings, university or private education costs.

Those reaching their pensions cap
It is becoming more common to reach the limit for pensions contributions.  In the recent budget, the Chancellor announced that they are considering bringing in a limit to contributions of £45,000.  For those contributing over this limit, a QSP could be useful.

Regular bonuses
QSPs can receive annual contributions.  If you receive a regular bonus, the QSP may be a useful tool for you (so long as the bonuses can be realistically predicted).  You can use the plan to shelter your bonuses from tax.

Converting capital
If you receive a lump sum, say from an inheritance, a QSP can be used to convert the capital (which would be taxable at up to 28%) over a number of years into a lower tax QSP.

Life cover
The QSP comes with life cover bundled into the plan.  This can be used as a form of inheritance tax planning, as the cover is usually available with limited medical underwriting, and therefore can work well for older people with pre-existing conditions.  The life cover can be split from the savings element, and gifted into a trust.

Obviously, this is a complicated area, so we recommend that you seek independent advice before taking out such a plan.  Please contact us if you need any advice in this area.

Here are the main details of the emergency budget, announced today.  We have commented on the implications to your personal finances.

• VAT – rises to 20%
  From January 4th 2011; this will increase the cost of goods;
• Income tax – raising the personal allowance by £1,000 from April
  A gain of up to £170 per year.  Higher rate income tax payers will not benefit from this change.

• Capital gains tax rises – to 28% for higher earners
  Basic rate earners remain at 18%; no return to taper relief or indexation relief.  This does help to keep things simple;
• Tax credits – reducing benefits to those earning over £40,000
  The government seeks to apply these to ‘those with most need.’
• Employer’s National Insurance – threshold to rise
  This means employers will pay slightly less tax

• Corporation tax – reduced
  Large companies cut from 28% to 24% over 4 years, and small companies to 20%
• Bank levy
  No details as yet, although France & Germany agree to follow suit;

• £30 billion reduction in spending by Government departments
• Capital expenditure on Government to remain level
  This should help businesses and employers to retain contracts and work;
• Public sector wages – 2 year pay freeze for those earning over £21,000
  Those below this amount will receive a £250 pay rise each year.
• Public sector pensions – A review into costs and benefits
  These were set to double in cost over 5 years.
• Pensions – phasing out the compulsory retirement age
  This will help with flexible retirement planning, a real necessity to modern lives.
• Pensions – bringing forward the proposed raising of the retirement age
  We will have to retire later than many expected, claiming our State pension later;
• Pensions – no forced annuity purchase at age 75
  This is a good move, since it will promote more flexibility with pensions planning.  Details are set to follow.
• State Pensions – rising in line with earnings, or 2.5% from April 2011
• Child benefit – frozen for 3 years
  The Government has kept the benefit open to all, but reduced the benefit in real terms.
• Disability living allowance – medical required
  It will be harder to claim this benefit
• Housing benefit – lower limits
  There will be restrictions on the amounts payable
• Alcohol and cigarettes – no changes
• Incentives for new business set ups outside of the South East
  1st 10 employees will save on Employer’s National Insurance

You will be aware that there’s a new Government in town, and there’s also a big deficit to cut.  Well one of the targets in the line of fire now appears to be public sector pensions.  These have been described as ‘gold plated’ and ‘unaffordable’ by Nick Clegg in the last few days, and it seems that it could be possible that the Government will seek to reduce benefits for public sector employees in the future.  The new Office for Budget Responsibility has estimated that the costs for public sector pensions could double over the next 5 years, reaching £9.4 bn.

Many public sector workers receive good pensions, and often these are the most secure type – final salary schemes. These pensions guarantee the level of future pension income based on the final salary of the employee when they retire, and the number of years worked for the company.  The level of benefits offered have already been attacked in the private sector, where large scheme deficits have dragged some companies into the mire (in some cases, the black hole in the pension scheme can be larger than the annual income of the company!).

In the case of companies which have already cut back on their pensions, the norm has been to close the scheme to new entrants, offering a less favourable scheme to new employees.  Many companies have gone further and have closed their final salary scheme altogether.  An alternative has been to keep the final salary pension but to increase the contributions required by the member, or to worsen the terms so that pensions are lower in retirement.

All this could happen in the public sector, especially given that the Government needs to make some serious savings, while the bill for their workers’ pensions is increasing.  However, it is also true that the Unions might have something to say about any potential cuts in benefits.

The new Government has brought forward plans into the recent Queen’s speech, outlining their intention to raise the State retirement age more quickly.  Previously, the State pension age was scheduled to increase from 65 to 68 in stages between 2024 and 2046.  There is no detail as yet, but you should expect that pension ages will increase from the current levels, and could reach as high as 70.  This is based on the fact that there are fewer people working to pay for an increasing retired population.  We are all living longer, so we need to make adjustments to pay for our retirement.

The sweetener for all this is that the Government plans to restore the link to earnings in the State pension, which will mean that pensioners will have a better chance to maintain their standard of living.

All this proves that if you want a decent standard of living in retirement, you should not rely on the State pension to provide for you.  It is likely to pay out less than you thought, and later.  In any case, the level provided would merely provide subsistence living.

OK, so it’s early days for the new Government, but we thought you might find it useful to have a run down of the likely proposed changes to your finances from the new regime.  Please bear in mind that much of this is speculation at this point!

Emergency budget
There will be a budget within 50 days.

Income tax
It seems that the Liberal Democrat pledge to increase the income tax threshold to £10,000 will stay.  This means no-one will pay tax below £10,000 earnings.  There is no indication yet as to when this would be introduced,

National Insurance
The Labour policy to raise National Insurance by 1% will be scrapped.

Married couples
There has been talk of a tax break for married couples and civil partners worth around £150 per year.

Inheritance tax
The Tory policy to increase the threshold to £1 million looks to be put on ice.

VAT
Neither party has ruled out an increase in VAT.  An increase to around 20% seems likely.

Capital Gains Tax
It seems likely that this will rise from the current rate of 18%, potentially nearer to 25-30%.  This would hit investors hard.  otherwise, there could be a proposal to create bands of capital gains tax, similar to income tax.  This would complicate the system.

Abolition of pensions higher rate relief
This was a Liberal Democrat policy, and looks quite likely to happen.  This would mean that higher rate income tax payers would lose the additional benefit of making pension contributions, and would be restricted to the same benefits that basic rate tax payers get.

Scrapping compulsory annuities at age 75
There seems to be a commitment to scrap the current requirement to take an annuity at age 75.  This should allow those with complex affairs to better manage their retirement incomes.

Other cuts
£6 billion of cuts to public services have already been announced, but this is small change compared to the budget deficit.  Therefore expect other cuts to public services.  One such change is a review into public sector pensions, so this should mean reductions in future benefits for public sector workers (while preserving accrued rights).

With the UK election due on the 6th of May, we thought it might be useful to look at the policies of the main 3 political parties.

Tax

Comments
It is obvious that after the election that taxes need to rise, or services need to be cut (or both), to combat the heavy borrowing taken by the State during the credit crunch.  We would expect more measures to be announced after the election.

Financial products

Comments
Employers won’t be happy about the proposed changes to company pensions, but we do think this is a good thing. Anything which encourages people to start saving towards their retirement will go some way to solving our demographic time bomb.

The commitment to increase pensions in line with average earnings is a welcome change, although this does not make up for the many years where state pensions fell behind average incomes.

We are generally not in favour of replacing the FSA (with the Bank of England or anyone else). This is not because of any particular view other than we are not convinced that this change would make any difference to consumers.  Actually, most of the same people would probably run the new regulator, and all this would achieve is more cost to us as a business, and therefore to our clients.

For more information see:

http://www.labour.org.uk/policies/home

http://www.libdems.org.uk/pocket_guide_to_policy.aspx

http://www.conservatives.com/Policy.aspx

Here is our summary of today’s budget.  This is not designed as a comprehensive list of the areas covered, but rather a commentary on the financial implications.

Stamp Duty
Stamp duty below £250,000 has been abolished for 1st time buyers from midnight tonight. 90% of first time buyers won’t pay stamp duty. This applies for this tax year and next tax year only.

But for properties over a £1million, stamp duty will rise to 5% (from 4%). Mind you, that’s a whopping £50,000 tax on such a property purchase!

Entrepreneurs relief
Good news if you own a business – entrepreneurs relief has been doubled to £2 million.  This means that you only pay 10% tax on the profits from the sale of your business, rather than 18%.

ISAs
As previously announced, maximum allowable tax-free ISA contributions are to be £10,200 from April (for everyone).  These limits will increase by inflation each year in future.

Income tax, national insurance, VAT, capital gains tax
No changes not already announced.  Obviously, the 50% tax on earnings over £150,000 has already been announced.

Tax relief on pensions
Confirmation of previously announced restrictions on tax relief on pensions, which affect top earners.  See here.

Public sector pensions
Reforms will be made to cut the pensions bill, which sounds ominous if you work for the state…

Freezing of inheritance tax thresholds
For a further 4 years, which effectively means a slight tax increase as assets (hopefully) increase in value.

Mortgages
HMRC is to open discussions with mortgage lenders on the formal introduction of an income verification service.  We are unsure how this would work in practice as this data is out of date by its nature for the self-employed by at least 9 months.

Fuel duty rises
Next month’s planned 3p increase in fuel duty will be staged to soften the blow. It will go up by 1p in April, another 1p in October and a final 1p in January 2011.

Bank bonuses
An extra tax on bank bonuses has already been announced.  The 50% extra tax has raised £2 billion (twice as much as predicted).

Tax evasion
The Government will be harsher on those caught evading tax offshore. They expect to raise up to £500 million per year.  Those caught will be fined up to 200% of the tax evaded.

Housing benefit
To be cut back for expensive properties.

Basic bank accounts
Everyone will be guaranteed access to a bank account – surely a necessity of modern life?

This post is designed to do 2 things.  Firstly, we’ll give you a brief overview of the tax relief regime for pension contributions. Secondly, we’ll give some commentary as to where this is going politically.

How does pension tax relief work?
The tax relief on pensions is one of the things that makes them so attractive.  In short, if you make personal contributions to a registered pension scheme, the Government will give you some of your income tax back.

For for every £100 gross pension contribution, you only actually pay £80 net (out of your bank account or wages).  The Government tops up the other 20% (based on the current income tax rate).  Therefore, for a £100 per month contribution from your wages, your pension fund will actually receive £125 – an uplift of 25%.  Now what other investment can guarantee this kind of growth on day one?  This tax relief is a big reason why pensions are a good way to save for the long-term (although there are some restrictions on them as well).

Higher rate income tax payers
For higher rate income tax payers, you pay income tax at 40%.  You can reclaim the further 20% tax (the difference between the higher and basic rates).  Therefore, for your £100 gross contribution, you would pay in £80 net from your account or wages, and then reclaim the remaining £20 through your tax return.  Thus, if you pay in £100 from your wages, £125 goes into your pension pot, and you get £25 back as well through your tax return.

All this adds up to a significant benefit for all savers, but particularly higher rate tax payers.

Limits
You are allowed to pay in up 100% of your earned income, or £3,600pa gross, whichever is the greater.  This means that low earners or non-earners (including children) can pay into a pension plan, and event receive contributions from a third party (say a partner or parent), and still claim tax relief.

From April 2010 the maximum allowed to be paid into a pension plan and still attract tax relief is £255,000.

Political changes
Obviously, we are nearing an election and have a massive public deficit.  Therefore, the Government is trying to do 2 things: to demonstrate a clear difference between themselves and the Opposition; and to reduce the burden on the public finances of a benefit which seems to be delivered to those who least need it – i.e. higher earners.

The Government recently announced it would introduce a new income tax rate for earners over £150,000 at 50%, effective from April 2011.  This would have increased the tax relief payable to such earners, so they also brought in complicated measures to stop this.  The restrictions apply to all contributions for such high earners, including those made by employers, and they are also seeking to stop people from making massive contributions this tax year to pre-empt the changes next year (the anti-forestalling measures).  For more information see this link to the Pensions Advisory Service website.  The measures will reduce the tax relief available to earners over £150,000 so that relief will be tapered away to that payable to basic rate tax payers for contributions for earners over £180,000.  If you earn over £150,000 and you already make significant contributions to your pension, you will not be penalised so long as you can demonstrate a pattern in your pension contributions of no more than £20,000pa; those looking to pay in extra in the short-term will be penalised.

Clear?  That’s what we thought!  The easy answer is to seek guidance from us if you think you may be caught in the new rules.

Pension tax relief in figures
Let’s look at some of the sums involved, courtesy of a recent article in the Economist and another in Citywire.

• The current tax relief regime costs £28.4 billion, or 2% of GDP
• 25% of this figure goes to the richest 1% of the working population
• Abolishing tax relief on higher rate contributions could save the state £10 billion per year.

These are significant figures, and we actually do think that some reform of pension tax relief is needed, although we could not support the proposed changes.  These changes are far too complex and probably will not have the results that the Government want.  We can see that many high earners, already disenchanted with pensions, will be put off pensions altogether.  This may result in less take up of pensions, and less roll-out to the lower paid workforce in general.  Of course, many higher earners also retain professional advisers, which will see them look to alternative arrangements (such as EFRBs) to obtain an advantage.

We would prefer to see a simplfied system of tax relief on pensions.  Why not apply a level rate applicable to all earners, with a top limit on contributions?  This seems the fairest way, and does not discriminate against basic rate tax payers.  We realise that many people (including some clients) would not support this, but we see it as strange to give the biggest benefits to those who can most afford them.  Why not simply offer everyone the same level of tax relief, and those who save more will get a greater benefit?

See our pensions section of our website.