Woodruff Financial Planning blog

Your financial plan is designed to project into the future, so you need to think about how that future will pan out.  With this in mind, you need to make certain assumptions about how certain things will change over time (inflation, investments, expenses etc).  This article describes the areas you should consider, and why they are important.

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.

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

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.

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?