Woodruff Financial Planning blog

If you have read our previous post on comprehensive financial planning, you will have seen the basic principles on what makes a comprehensive financial plan. Well, this post aims to give you some reasons why you might want to consider making a financial plan.

Today, the Government has announced a commission to examine how the country should fund long term care for the elderly.  At present, this is a major issue since this affects thousands of people, who are often forced to sell their homes to fund care in later life.

The Government commission will look into the basis for this funding for the future, and will examine practical proposals such as a State-backed insurance scheme.  We welcome this commission and feel that it is long overdue, since the issue has been largely ignored for many years.  We feel that most people fail to plan for future care needs, hoping that they will not need care.  The reality is that if care is needed, the results can be financially disastrous for the individuals concerned.  To our mind, one of the best ways to ensure a decent level of care for the elderly is to introduce some sort of State involvement, a bit like the NHS.  Whether this is best funded by a payment by the individual, or by general taxation, is up for debate.

The need for long term care funding is summed up by this quote from the Health Minister, Andrew Lansley:

“By 2026, the number of 85 year olds is projected to double.  In the next 20 years we estimate that 1.7 million more people will have a potential care need than today.  We know that one in five 65 year olds today will need care costing more than £50,000, which could force many to sell family homes.”

See here for more information: http://www.dh.gov.uk/en/MediaCentre/Pressreleases/DH_117636

It was well publicised last week that the Chancellor’s emergency budget raised capital gains tax for higher rate income tax payers from 18% to 28%.  However, trusts were also caught up in the changes, which has not yet received widespread notice.

How does capital gains tax work?
Capital gains tax is paid on the disposal of assets such as investment funds, and would affect you if you sell your investments, or switch funds within those investments.  Before the changes tax was levied at 18% of any gains over £10,100 per person, per tax year.

What are the changes?
From now on, this will remain the same if you are a basic rate income tax payer (20% rate).  If you are a higher rate income tax payer (40% or 50%), then capital gains tax will now be 28% on any gains above the £10,100 limit.

Our understanding is that if you are a basic rate tax payer and the capital gain takes you into the higher rate bracket, you will pay 28% tax on the excess which takes you above the higher rate limit.

Trusts
Trusts will also pay capital gains tax at the higher rate of 28%, and what’s more they will only have a tax-free allowance of £5,050 per tax year.  Trustees should pay particular care when making changes to their investment portfolios.

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.

I attended a meeting of trustees in London this week, to conduct a general review of their investments, and also to meet the professional legal trustee who is advising the trustees.  What struck me from that meeting was the need for trustees to seek professional legal and financial advice.

This particular trust is relatively complicated in that it seeks to provide income for some beneficiaries, and when they die, others get the capital.  As you can imagine, this could lead to some conflict over how to treat the assets and investments of the trust, as different decisions could favour one class of beneficiary over the other.

Legal advice
The presence of a qualified solicitor and STEP practitioner was invaluable to the trustees.  They were able to use his expertise to understand their obligations, their investment powers, and to talk through different options for the future treatment of the trust. I can only imagine that without such assistance the trustees could experience potential problems at a later stage.

Financial advice
We are helping the trustees to fulfill their obligations to produce an income for some beneficiaries now, and also to grow the capital for others later.  As you can imagine, this is a delicate balancing act, and needs some meticulous planning.  Essentially, we are following our usual investment process by managing risks and hopefully maximising returns and income over time, but we are paying particular regard to the needs of the various parties.  What is important in these circumstances is to undertake regular reviews.

Click here to read our simple guide for trustees on their obligations under the Trustee Act.