Woodruff Financial Planning blog

The Government today proposed to scrap the compulsory retirement age for most employees.  At the moment, it is perfectly legal for an employer to set a compulsory retirement age for its workforce, which can mean that employees can be forced to retire at age 65, whether they want to or not.

This seems unfair and discriminatory. As we live longer, the traditional retirement will no longer apply.  This may mean that some people choose to retire later (working longer), or may semi-retire.  This proposal seems a sensible step in making retirement decisions more flexible, and also allowing employees freedom of choice.

Of course, the reality for many people as they get to retirement age is that they have not done enough to save during their working life, meaning that real hardship could be forced upon them if they are required to retire in the normal way.  This proposal does not remove the problem of a lack of retirement income, but can mean that the over 65s are not forced into poverty.

The consultation period for this proposal ends in October, after which legislation could be brought in to turn this into law from April 2011.

You may have seen that the Financial Services Authority, the UK financial regulator, has today launched the results of its findings into advice given by advisers who recommended unregulated investment schemes.  See here for the report (the results are pretty damning).

This got us to thinking about why regulated investments are generally better than unregulated investments.

So here is a list of some of the main reasons we can think of (feel free to add to the list).

• Risk
  We feel that most unregulated investments are extremely risky, and often invest outside of normal markets.  This is fine if you are a sophisticated and experienced investor, and the unregulated investment forms a small part of your overall portfolio; however, our experience is that most of these schemes are marketed to ‘normal’ investors, who over-expose themselves to this high risk (even borrowing to make the investment). Regulated investments tend to operate in more conventional markets, and usually spread their investments more widely. Regulated investments tend to have a more easily defined risk profile, so you can select the ones most appropriate to your style of investing.
• Controls
  Regulated investments have strict controls and limits on their investment and borrowing powers.  These can be checked before you invest, and need to be approved in advance.  There are requirements for capital security for the underlying investments so that if something goes wrong with the holding company, your assets are protected. This is certainly not the case with unregulated schemes. Also, many unregulated schemes make wild and unsubstantiated claims about their investments, and may not be held to account if these prove false.
• Complexity
  We often find it difficult to understand the complexity of unregulated investments, so we would expect that you would too.  Our general mantra is never to invest in what you cannot understand.
• Liquidity
  Our concern with many unregulated investments is that they could be very difficult to cash in should you need access to your capital. Most regulated investments trade on an exchange, leaving them much more liquid, should you need access to your money.
• Value
  It is much easier to value your regulated investments than with other types of investments.
• Charges
  There is nothing to say that unregulated schemes are more expensive, but this is often the case.
• Due diligence
  Because unregulated schemes are not confined by normal investment regulation, it can be very difficult to drill down into the methodology of the schemes, and how they are structured.  This makes it very difficult for you to understand them, and for advisers to explain them to you.
• The right to cancel
  Regulated investments give you a cancellation period, during which you can change your mind; there is no such right under unregulated schemes.
• Financial Ombudsman
  It is unlikely that the Financial Ombudsman could come to your aid if you have a complaint with an unregulated investment.
• Compensation scheme
  Similarly, it is unlikely that the Financial Services Compensation Scheme would come to your aid if you lost your money.

As with all things involved with investing money, there are no guarantees: always seek the advice of a professional before you take the leap – it is important to consider all your circumstances.

The Financial Services Authority (the body which currently regulates the Financial Services sector), has today launched a consultation paper on Responsible Mortgage Lending.  Their main theme seems to be that “the existing regulatory framework had been ineffective in constraining particularly risky lending and unaffordable borrowing.”

Assessing affordability for mortgages
The FSA rightly says that lenders have been too keen to allow more risky lending in the past.  This has been evidenced with self certification products, as well as ‘fast track’.

Self certification mortgages were originally designed for those people who could not prove their income such as the newly self-employed.  Fast track is still used by many lenders where the loan to value is lower than 75% of the value of the home, and the risk to them is deemed to be low.  Income is still assessed, but documents are not checked.

What ended up happening with these types of loans was that o they became so called “liar loans” – people used the system to inflate their income so that they could justify bigger loans.  Lenders were not concerned about this practice so long as house prices rose.  Of course, eventually this ground to a halt, and the practices were exposed.  Also, many mortgage brokers have been caught out supporting their clients through what is effectively mortgage fraud.

The regulator is concerned that the banks should have more robust methods for establishing affordability for loans. Therefore, they have proposed that all new lending should be assessed for affordability.  This would effectively ban self certified and fast track mortgages.

Interest only
The regulator has been concerned for some time that interest only is becoming much more widespread – probably as a result of the increasing cost of housing.  People have set up loans with no mechanism in place to repay the original capital, and this could end up being a massive problem in the years to come, as they struggle to repay this debt.

The proposal is to assess affordability as if a repayment mortgage is being taken out, even where interest only is the preferred vehicle.  We suspect that the FSA would like to outlaw pure interest only mortgages on main residences, where there is no savings vehicle in place to repay the capital.

Our view
Overall, we would broadly support more responsible lending since this would help to keep the housing market more stable, and encourage the public not to over-extend themselves financially.  We need to get out of the belief that your house is your biggest asset, since this holds back the finances of millions of people who struggle to afford bigger mortgages while ignoring other financial needs.  People need to realise that their home is not an asset in the traditional sense since it cannot be cashed in (you always need somewhere to live).

We have been worried for some time that interest only is becoming the norm, especially in younger buyers.

What all this means for the self employed is that they should seriously consider their lending needs before starting a new business, since in the future it may be very difficult to get funding for such people without full accounts, and enough income to justify the loan.

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.

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

The new Government has announced that the Financial Services Authority (FSA) is to be replaced by a new regulator, the Consumer Protection Agency (CPA?).

You may not immediately think this is of relevance to you, but this signals a major shake-up of the financial services industry.

Of course, it is of interest to us, since our activities are regulated by the FSA currently, and therefore responsibility for this will pass to the new agency.

It seems that the new regulator will come under the control of the Bank of England, which will have more say over the wider economy than at present. Whether the BoE wanted this, or indeed whether this is a good thing is beyond our ability to comment.  The new Consumer Protection Agency will have responsibility for the regulation of the conduct of the banks, insurance companies, and financial advisers, like us.  This could have the confusing aspect that larger organisations may be regulated by 2 bodies – the Bank of England, and the CPA.  Obviously, the details of the proposal will iron themselves out.

What does this mean for our services?
Well, it may be too early to say, but it is unlikely that a whole new set of staff will be conjured up for the new agency.  Therefore, I would expect that the CPA will initially be staffed by most of the existing staff doing the same role at the FSA – a case of a the same old regulator under a different name; initial evidence of this could be seen in the appointment of an existing high ranking officer of the FSA to the Bank or England to facilitate the transition but then I suppose this was always likely to happen.  I suppose the biggest change may be in the overall policy of the new agency; until now, the FSA has focused on principles based regulation, with a whole raft of initiatives. If this changes, you may see a different style of financial advice in the future.

Our concern as a small business in the financial services sector would be that the change may not be substantial enough.  If the FSA is reformed to become the CPA in name only, what does this achieve for the consumer other than the reprinting of thousands of brochures and websites all over the country as our existing stocks become obsolete?  Of course, if you are a compliance consultant you will probably be rubbing your hands with glee at the prospect of a whole new set of rules to follow, but as business owners we will be diverted from the primary goals of our business to serve our clients’ interests (and of course to make some money). We are yet to be convinced that this is a worthwhile change either for us as a business, or more importantly for our clients.  Of course, we were not consulted on the change!

Maybe that is yet to come…?

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.

OK, so here’s a Monday morning rant (of sorts); maybe only of interest to those in the financial planning community!

We’re in the business of providing financial advice.  As such, we run a pretty tight ship, having standardised procedures, so that everyone in the business knows their role and can contribute fully.  Michael Gerber would be pleased.  For clients, they get a consistent service, built around compliance procedures which ensure equitable treatment on all sides (Treating Customers Fairly, in FSA parlance).

However, we have a constant spectre looming over us in the form of constant change to financial regulations.  I am a fan of regulation because from a client’s point of view it serves a purpose to keep the business professional.  However, as a business owner, I sometimes tear my hair out.

This week we all read that the Financial Services Compensation Scheme is to bill all financial adviser firms lord knows how much each because of the failures of a few high profile companies.  These companies, by all accounts, seem to have been negligent in their attitude towards regulation and their customers.  As a result they collapsed spectacularly, leaving customers out of pocket.  Where this becomes our problem is that the compensation scheme steps in to protect consumers (quite rightly); the problem is in the application of the scheme.  Because the liabilities are so high, there is not enough in the compensation scheme fund to pay out to those affected.  What does this mean?  Well all the remaining firms who have been acting by prudent and fair conduct are thereby penalised.

The upshot of all this is that as a business owner I am now expecting a bill, of how much I don’t know.  This is unforeseeable, and very difficult to plan for.  What’s more, I will be expected to pay within a very short timeframe.  Personally, I don’t see this as a fair or equitable approach to the problem.  Of course, I recognise the validity of the overall scheme, but surely there must be a better way to plan for the future funding requirements of the scheme than to ask financial advisers simply to dip their collective hands in their pockets every time there is a crisis?

Add to this a possible change in Government later this year.  If the Tories win as is widely predicted, they have committed to a wholesale change to financial services regulation.  They say they will scrap the FSA, and replace it with their own pet body.  What does this mean for consumers?  Well, who knows?  I can tell you what it means to me as a business owner – I will be forced to spend countless hours and money adapting to the new rules.  Add to this the communication to clients, changing of literature etc, and we are talking about millions of pounds across the financial services industry.  Personally, I’m not sure that wholesale change is the way to go.  I would rather see a few tactical changes applied rather than starting the whole exercise from scratch.

Comments are welcome!