Woodruff Financial Planning blog

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

You will be aware that there’s a new Government in town, and there’s also a big deficit to cut.  Well one of the targets in the line of fire now appears to be public sector pensions.  These have been described as ‘gold plated’ and ‘unaffordable’ by Nick Clegg in the last few days, and it seems that it could be possible that the Government will seek to reduce benefits for public sector employees in the future.  The new Office for Budget Responsibility has estimated that the costs for public sector pensions could double over the next 5 years, reaching £9.4 bn.

Many public sector workers receive good pensions, and often these are the most secure type – final salary schemes. These pensions guarantee the level of future pension income based on the final salary of the employee when they retire, and the number of years worked for the company.  The level of benefits offered have already been attacked in the private sector, where large scheme deficits have dragged some companies into the mire (in some cases, the black hole in the pension scheme can be larger than the annual income of the company!).

In the case of companies which have already cut back on their pensions, the norm has been to close the scheme to new entrants, offering a less favourable scheme to new employees.  Many companies have gone further and have closed their final salary scheme altogether.  An alternative has been to keep the final salary pension but to increase the contributions required by the member, or to worsen the terms so that pensions are lower in retirement.

All this could happen in the public sector, especially given that the Government needs to make some serious savings, while the bill for their workers’ pensions is increasing.  However, it is also true that the Unions might have something to say about any potential cuts in benefits.

The new Government has brought forward plans into the recent Queen’s speech, outlining their intention to raise the State retirement age more quickly.  Previously, the State pension age was scheduled to increase from 65 to 68 in stages between 2024 and 2046.  There is no detail as yet, but you should expect that pension ages will increase from the current levels, and could reach as high as 70.  This is based on the fact that there are fewer people working to pay for an increasing retired population.  We are all living longer, so we need to make adjustments to pay for our retirement.

The sweetener for all this is that the Government plans to restore the link to earnings in the State pension, which will mean that pensioners will have a better chance to maintain their standard of living.

All this proves that if you want a decent standard of living in retirement, you should not rely on the State pension to provide for you.  It is likely to pay out less than you thought, and later.  In any case, the level provided would merely provide subsistence living.

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.

Self-invested personal pensions (or SIPPs) can offer property investors a tax-efficient way of holding commercial property. There are many benefits to this approach, but there are also quite a few limitations. Therefore, you should only enter into this kind of arrangement with specialist advice. This post aims to give you some of the main pros and cons of owning property through a SIPP. 

What is a SIPP?
A SIPP is a specialist type of registered personal pension, which allows you a very wide investment choice. One of the permitted investments is commercial property.By owning a property through a SIPP you can avoid tax on the income and sale of the property, although there are limitations over the control of the property once it is owned by the pension fund.

The process of owning a property through a SIPP
A SIPP can buy and manage any commercial property as an asset of the pension scheme. Once bought, the property is actually owned by the scheme itself, which does place restrictions over the property. In particular, once in the pensions arena, the money cannot be transferred out again. This means that you would need to be aware of the general restrictions on pensions, as well as the financial and age limits which apply.

Once owned, the rent paid would be paid directly to the SIPP, and any loan repayments would also be paid by the SIPP. Any growth in the value of the property would be tax-free, as would income. General maintenance costs and other fees would be paid out of the income or assets of the pension fund.

Ultimately, as the owner of the pension fund, you would benefit through tax-free growth until you come to take the benefits from the pension fund. 

What kind of property can be owned through a SIPP?
A SIPP can only contain commercial property. This includes freehold or leasehold land, and can be overseas. Commercial property can include: 

• Shops & offices
• Warehouses & business units
• Hotels
• Nursing homes
• Pubs
• Farmland or forestry
• Development land

Usually, any property which has any residential component will not be allowable. 

Who uses SIPPs to invest in property?

• Property investors & developers
• Business owners looking to buy their commercial premises

Often, investors will seek to utilise existing pension funds held within other pensions to purchase a property. We work with clients to help them to consolidate older pension funds to form one larger pot which can be used to buy a property. 

This can also be done with new contributions, which would attract tax relief in the usual way. 

For personal contributions, for every £100 invested into the pension plan, £25 will be added as tax relief; for higher rate tax payers a further £25 can then be reclaimed through your tax return. For company contributions, these can be offset against corporation tax. 

Fees
A SIPP provider will charge various fees, depending on their charging model. You should expect to pay fees relating to: 

• The acquisition of the property with a mortgage – perhaps £1,500, depending on the work involved
• Ongoing management of the SIPP – perhaps £700pa
• Valuation, legal and lenders’ fees depending on your purchase method.

Tax
A SIPP will purchase a property just like with any other transaction. Therefore you would need to pay Stamp Duty and Land Registry fees in the normal way. Some purchases may be liable to VAT. 

Borrowing to fund the purchase
A SIPP can borrow against the scheme assets to buy a commercial property. The maximum allowed would be 50% of the net scheme assets, less any existing borrowing. It is also possible to borrow to develop land purchased by the SIPP. 

You would need to find a commercial bank which would be prepared to lend to the SIPP, although this is common practice. 

Joint purchases
You may pool together with other SIPP investors to allow a property purchase, although there can be practical issues to resolve in this scenario. 

For example, careful consideration needs to be made as to what happens if one of the investors dies or wishes to realise their investment. This can be dealt with in some form of co-ownership agreement. 

The percentage of ownership can be unequal, but care should be taken where one owner borrows while another does not, as this puts the latter at greater risk to their fund. 

How we can help
We can help you to examine the market to find the right SIPP for your needs. We can then help you to source the appropriate lenders and facilitate the purchase of the commercial property. 

Pensions are a very complex area, so it is vital that you undertake any transaction with the benefit of financial advice. 

Download this post as a factsheet.

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.

Providers are offering pension Annuities according to postcode. Make sure you shop around. http://viigo.im/25sW

Yesterday (via Twitter) I listened to an excellent podcast on pensions and divorce by a Solicitor at Colchester firm Fisher Jones Greenwood.  This prompted me to write today’s Financial Planning Blog.

If you are going through a divorce pensions are likely to be one of your largest assets, so it is right to split these assets as part of the divorce settlement.  Often one party will have a larger pension pot than the other, so as part of the divorce it is possible to split the pensions so the other side can have a proportion of these funds in their own name.

Of course, this will prompt the need for advice for both sides. If you are losing pension rights you will need advice as to how best achieve the split for your interests.  Also, you will probably need to work on making up those lost pensions as this will affect your future income. 

If you are receiving pension rights from your spouse on divorce then you will also need advice, particularly if you have never needed to manage this money in the past.  You will also need to discuss which of the options are best for you before the divorce is agreed.

We have experience of managing pension sharing orders for both sides, and as Certified Financial Planners we are qualified to show you how the pensions (lost or gained) can affect your future lifestyle.

We have produced a factsheet on the pension options open to you on divorce.  This explains the main options open to you on divorce, and why you should take advice both from your solicitor, but also from a qualified financial adviser.

If so, you need to be aware that the minimum age for taking a pension will change this year.  At the moment, if you want to retire from your scheme, you can do so from age 50.  However, from 6th April 2010 this will rise to age 55.  This means if you are considering retiring early, or want to release some tax free cash from your pension, you should start the process now.  Pension decisions can be complicated and changes can take some weeks to put into place.

Contact us if this is an issue for you.