Woodruff Financial Planning blog

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.

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

It is the first budget of the new Government today.  Throughout the day, we will post updates and reaction to the various announcements.

What could we expect?

Possible tax rises:

• VAT could rise
• Capital gains tax could rise
• Income tax rises have already been announced for higher earners, although it is likely that many low earners will see income tax cease through the raising of the personal allowance
• A levy on the banks
• A rise in cigarette and alcohol duty

Possible cuts:

• Freezing public sector pay and pension benefits
• Cutting Government department budgets, leading to cuts in public services

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).

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?

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).