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.

The Government-backed National Savings & Investments (NS&I) has today withdrawn its inflation-linked products from sale.  See here for more information.

These products has been popular in recent months as inflation has risen, and investors sought a safe haven for their savings while most bank accounts offered returns below inflation.

NS&I acknowledges this, commenting that their sales of inflation-linked products were higher than anticipated.

Where does this leave savers looking to beat inflation?
The market for low-risk savings products has been dealt a blow, but there are still opportunities for you to beat inflation with your savings and investments.  If your savings are currently with your bank, I would urge you to revisit this as you may find that you are effectively losing money on your money.  Inflation is currently relatively high, and most accounts pay interest far lower than the increase in prices.

The Bank of England today announced that they are holding the UK base rate at a record low 0.5% for a further month.

The UK base rate has remained at this low level since March 2009.  See http://www.bankofengland.co.uk/publications/news/2010/057.htm

This comes at a time when inflation has been increasing, so the assumption would be that to keep rates low encourages spending in the economy; of course, the other side of this is that mortgages, especially base rate trackers or standard variable rates, remain relatively low.  At a time of financial conservatism, keeping household expenditure down is a welcome relief for many.

A note of caution for borrowers
Some members of the Bank of England’s policy committee (the committee which decides interest rates) have been arguing for an increase in the base rate. Since the rate cannot really go down from here, and would normally be expected to be around 5%, if you are on a variable rate mortgage, you could consider whether now would be a good time to fix rates.  If you are on a variable rate, now would be a good time to seek advice on your mortgage situation.

A note of caution for savers
Inflation is now at 5.1% over 12 months, using the latest retail prices index.  If you have your money in a savings account with your bank you will probably get around 2-3% interest maximum, even if you tie in your savings for a year or longer.  This means that you may be effectively losing money.  Now would be a good time to review your savings to see if you could make your money work harder for you.

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.

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?

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 Chancellor has announced that Child Trust funds are to be scaled back under their proposed cuts.

The Government will cease payments to Child Trust funds by January 2011.  Currently, children born get a minimum of £250 at birth, followed by a top up on their 7th birthday. Now, from 1st August 2010, the payment on birth will be £50, and the 7th year payment will cease.  The payments will stop altogether for children born from January 2011.  This will save the Government £320 million per year initially.

Existing Child Trust funds will continue until maturity at age 18, and parents can continue to pay into the plans with up to £100 per month, which would grow tax-free.

Our verdict is that these payments, while welcome, were never going to make a difference to children’s future.  Therefore, they were always going to be a candidate for cuts in the new Government.

You may have heard that the new Government is planning to raise the rate of Capital Gains tax.  This could be relevant to you if you hold any savings in shares, or an investment property. Currently, this tax is paid at 18% on any capital growth of most assets.  You can disregard the first £10,100 per year of gains made in each tax year.  Therefore, consider this scenario:

You bought some shares 10 years ago for £1,000.  You now sell your shares for £10,000.  Therefore you have made a gain of £9,000, which would be within the allowable limit before tax is applied.  If you sell the shares for £21,100, the gain would be £20,100.  Tax would be charged on £10,000 at 18%, which would be £1,800.

Why is this relevant?
If the tax rate rises, the above scenario could mean that you would pay more on such gains.  If the tax rate rises to income tax levels, as some (possibly alarmist) commentators have suggested, you could end up paying 40% on this gain.  Therefore, in the above scenario, tax charged could be £4,000 instead of £1,800.

We would hope that ordinary savers would not be hit in this way, because significant rises could penalise savers who have worked hard to build up assets for their future.  We would hope that either the rate will not rise as high as suggested, or there would be some careful exemptions or reliefs available for normal transactions.

Light at the end of the tunnel?
Iain Duncan-Smith, the new Work and Pensions minister told the BBC: ‘[George Osborne] has also talked about major exemptions for all sorts of different groups, because we don’t want this to harm entrepreneurs, we don’t want to harm families that are heading towards retirement who have actually saved.’

We are waiting for the final details to come out, so will update clients when this happens.

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).