Woodruff Financial Planning blog

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.

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.

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.

Today, the Office of Fair Trading has announced plans to make cash ISA transfers much easier. This is in response to a complaint by a consumer group.

From 2012, all cash ISA statements will have to show the current interest rate.  At the moment this appears on only 15% of statements.  This change is designed to combat those banks which lure savers in with high rates, only to later amend the rates downwards to a less competitive rate.

The second prong of attack will be to make the process easier to transfer cash ISAs within a reasonable time, so that consumers can transfer their money more easily to a new provider to take advantage of a better ISA rate.  This can be done while keeping the tax-free ISA status, but has been notoriously difficult and slow in the past.  From 2011 providers must ensure that a cash ISA transfer takes no longer than 15 days (currently 23 days).  Of course, this is still too long, but is a step in the right direction.

You should be aware that you can transfer both your cash ISAs and stocks and shares ISAs to a new provider.  You can even transfer cash ISAs to stocks and shares ISAs (but not the other way around).  With the recent rise in capital gains tax for higher rate tax payers, ISAs are a valuable weapon in the legitimate avoidance of tax on your savings. If you would like to review your ISAs, why not contact us?

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).

Today, I met with a new client.  He is approaching 60 and has been running professional practice for some years.  He is now considering retirement.

We started off by discussing his pensions, and other assets, as well has his income sources for the future.  However, it quickly became clear to me that what he really needs at the moment is to know if he can be confident to retire; after all, this is a big decision.  Once he gives up his professional practice, his income will be limited, although he can always work as a consultant.

What we spoke to him about was the concept of comprehensive financial planning.

We will begin by analysing his future goals, income, expenses, assets etc, and then put these all together to work out whether he can be confident to retire now, or whether he will need to work for a few more years to build up more resources.  This is a big decision, so needs to be taken with his eyes wide open.  Out philosophy is that it is better to know the real value of your money and assets so that you can enter retirement confident that you can be financially secure; if this is not the case, then we can start to work on what will achive your goals.

We will be able to paint a picture of his retirement as if he had retired yesterday.  If his resources are not enough, we can start to look at other options by examining different scenarios, such as retiring later, spending less money, working part time, downsizing his home etc.  After all, these decisions need some careful planning.

Once this has been done, we can agree a strategy to best meet his needs, and this will result in some major changes to his current financial situation: taking pension income, amending investments to focus on income rather than capital growth, and possibly the sale of his home.  We will work closely with his accountant as there will be other issues raised by the exit from his business.

We find this a rewarding process in that we are actually helping the client to realise his ambition to retire on enough income to achieve his future desired lifestyle.  from the client’s point of view, this is not about financial products, but more about financial planning to give him the confidence to stop accumulating and start spending.

See out Financial Navigation service for more details.

You will have probably seen the recent reports that inflation has shot up significantly in the last few months, and now rests at 3.5% as measured by the Consumer Prices Index (CPI), the inflation measure preferred by the Government.  Interestingly, the Bank of England predicts that this will drop back again later this year, before rising again.  See here for details.

This is largely due to the increase in VAT at the start of the year.  This measure strips out mortgage costs, and the Retail Prices Index (RPI), which includes these costs, was at 3.7% in January. 

This should be of concern to you if you have bank savings, or are on a fixed income (perhaps a pensioner).

I saw a couple this week, who had recently signed up to a fixed rate bond account with a major high street bank.  They had invested £10,000 each.  One client pays higher rate income tax (at 40% of interest received), while the other pays basic rate income tax (at 20% of interest received).  The rate they have been guaranteed is 2.8% per year over 2 years, but this interest is taxable.  Therefore, after tax, the basic rate tax payer will make 2.24% per year, and the higher rate tax payer will make 1.68%.  While these are not fantastic rates, they are typical of the bank market at present.  The clients consoled themselves that at least they are guaranteeing their capital.

The money won’t actually go down – the deposits will be guaranteed to come back to them as they cannot go down in value, the bank is well capitalised and the deposits would be covered by the compensation scheme.  But when you think about the effects of inflation, they do not look so great.  With inflation currently at 3.5%, they will actually be losing money in real terms.  The basic rate tax payer will be effectively losing 1.26% per year in real terms, and the higher rate tax payer will lose 1.82% per year.

Now, everyone should have some money on deposit to use as a rainy day fund, but these investments were not taken for this reason.  The fact is that they are tied in for 2 years, so they are now locked into this account (or face losing the interest).

The point is that you should not just look at the headline rate of your investments and savings.  You should also think about tax, charges and the effects of inflation.  Obviously, we can help with this (particularly with our Portfolio Management service).

We often come across financial services firms which call their advisers “Financial Planners”.  They might call themselves Financial Planners, but what most of them offer is financial product sales.  The purpose of this post is to give you an idea of what we do as Financial Planners, compared to other Independent Financial Advisers, who might work for a firm or a bank.

We do this because we feel that the role of a Financial Planner is actually distinct from that of the rest of the financial services profession.  By consequence, we believe that it is very difficult for you to determine the differences between the various services on offer – we would prefer for the role of a Financial Planner to be enshrined and protected, just like that of a Chartered Accountant or Solicitor.

Much of this information is cribbed from the Institute of Financial Planning website, which is aimed at promoting the Certified Financial Planner qualification and standards (to which we subscribe).

What is Financial Planning?
Financial Planning is the process of developing strategies to help you manage your financial affairs so you can build wealth, enjoy life and achieve financial security. Financial Planning is an effective way of ensuring you are fulfilling your life ambitions without having to worry about your finances.  Financial planning is about building towards financial independence, and is not focused on goals, income, assets, expenditure etc.  This process is not about product sales (although obviously, products would be used towards the end of the process to achieve the goals set).  Financial Planners tend to be fee-based because they charge for the creation and maintenance of a plan rather than selling a product.  This means you get what you pay for – advice rather than sales.

What is Financial Advice
Financial advice is what is supplied by the overwhelming majority of UK financial advisers.  This tends to be bespoke, targeted, transactional advice leading to a financial product sale.  As most financial advisers are commission based, they rely on selling you a product to get paid for their work.

1. What is their experience?
   Obviously, this is important; but as important is to ask their experience in dealing with situations similar to those faced by you.
2. What are their qualifications?
   This is more important than many financial advisers will lead you to believe.  Having advanced and specific qualifications shows a technical expertise, and a commitment to keeping up to date with the current trends.  After all, would you go to a doctor who only had a basic level of qualifications, and hadn’t kept up to date in 20 years?
3. What services do they offer?
   They should be able to easily define the services they offer to clients so you can decide if these are right for you.  You need to decide whether a comprehensive ongoing review is right for you, or you just want transactional advice on a one-off basis.
4. What is their advice process?
   How they go about delivering their service is also important – after all, you want to ensure that you will get a robust and consistent delivery of your service.  Our advice is to avoid advisers who cannot easily articulate their process.
5. How are they paid?
   This is important to your pocket, but also to know if you need to watch out for signs of bias.  You also need to know up-front the extent of your liabilities.  Our preference is for a fixed fee agreement, but many people prefer to operate on commission.
6. What is the typical cost of their services?
   This will help you to decide if the service is affordable and fits in with your expectations.  Ultimately, you want to avoid an open-ended commitment on your side.
7. Who else benefits from their recommendations?
   This is a question often missed.  You may have been referred to the adviser following a recommendation.  Does the introducer receive any payment from this arrangement?  We are aware of some local independent financial advisers who regularly pay out up to 50% of their income to professional introducers such as accountants.  While this is fine if the client agrees, we would be concerned that the client is not aware of the arrangement.  If you think about it, if the introducer receives payment (of such a large amount), your adviser will be forced to increase the fees or commission charged to you to achieve their profit margins.
8. Have they ever been disciplined by the Regulator?
   You would probably want to avoid advisers who have been sanctioned by their professional body, but you can actually check this out yourself by searching for the firm or adviser on the FSA Register.  All financial advisers must be on this register to be able to off you financial advice.  If they are not registered, then you are not covered (and the ‘adviser’ should be reported).

I turned on the news this morning to see a happy couple in front of the TV cameras having won a huge jackpot on the Euromillions.  This turned my thoughts back to a previous post on Sudden Wealth, which would probably describe the situation of the lucky winners today.

A psychologist was commenting on the effects of such a life-changing event, and in particular focused on issues of how the couple’s life would be different in many ways.  Obviously, most of their financial windfall will be positive, but he was cautionary about how the money would need to be managed, both from a financial planning perspective, and from an emotional standpoint too.

We think that people need to think about their financial goals at all points of their lives, but at times of sudden wealth financial strain can be quite severe.

For many people, this will not be as drastic as a huge lotto win.  But there are many other situations which can bring about a life-changing influx of money.  With this money comes the need to manage your finances.

Think about the following situations:

Sale of a business
You would hope to sell your business for a suitable sum, which after tax would help provide you with enough money to achieve your financial lifestyle needs.  No doubt you would need financial advice on when to actually sell (i.e. when you have enough to retire), but also how to manage the capital to generate a suitable income.

Inheritance
You may come into a significant sum of money which would need management both for capital and/or income.  It can be tempting to spend the windfall, when some sound financial planning will set you on a secure financial future. See our inheritance tax section on our website.

Divorce
This comes with issues for both sides.  Both parties will need to plan how their finances have changed, perhaps making up lost pension benefits or buying a new home.  Of course, if you receive pension benefits from your former spouse as part of the divorce you will need help to manage these new assets. See our leaflet on pensions and divorce.

Critical illness
If you have managed to claim on a critical illness policy then your life will have changed dramatically.  You will probably have a serious and debilitating condition, and would likely have to give up work.  The policy may have been set up to simply pay off the mortgage, but you might have also provided further benefits to help give you an income and/or make alterations to your home.  In any case, you would probably want to have some ongoing advice to ensure that this resource is best used.

Ultimate high earners
In this category might be sports stars or entertainers, who get paid significant sums for their talents; alternatively, directors or city workers might also receive bonuses as part of their package.  For some, they might want to seek a financial planner to help them organise their finances into a sound footing to avert the times ahead when the high income might dry up.

Thinking about those lucky Euromillions winners, I would say 3 things:

1. You should probably avoid the lotto – It could be you, but statistically, it probably won’t;
2. If I won the lottery, I definitely wouldn’t appear on TV spraying champagne everywhere;
3. I also wouldn’t be saying that my life would not change. With a sudden windfall, everything changes, and this needs careful management both from a financial and an emotional perspective.

Click here to download out leaflet on sudden wealth.  You may also be interested in our core services, which aim to help you plan your finances and manage your money.