Woodruff Financial Planning blog

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.

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.

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).

If you are reading this, then you probably have a sizable amount invested in investments or pensions.  Most people do some research when they set up their investments (and this applies to most advisers too!).  However, many (most) investments are rarely reviewed.

If you think about it, if you have many thousands of pounds invested you really should be keeping a strategic eye on this money (after all your financial security depends on it).  If you bought a car for £20,000 wouldn’t you get it serviced each year? The alternative is to expect something to go wrong in the future, probably when you most need that money.  Well, your investments or pensions could/should end up being much more valuable than you car, but when was the last time you reviewed them?

What should you look to review with your investments?

• You should be able to know the rough value of your holdings at any point
• You should understand the level of risk you are prepared to take, and the likely positive and negative outcomes this may generate;
• Where your money is invested, and what this means for you;
• When to make strategic changes to your portfolio;
• Know when to switch out of funds;
• Know what the investment and income outlook is for your investment.

We don’t think you need to look at things daily, but you should look at things at least annually.  Failure to do so could mean that you end up taking more risk than you meant to, and could end up leaving you with a nasty shock at a later date.

If you have an adviser, ask yourself how often they sit down with you and explain all of the above to you.  If the answer is that they do not, then perhaps you should think about changing your adviser!

How do we help clients with this?
We offer our Portfolio Management Service, which aims to help clients manage risks with their money, and to maximise returns on their investments.