Welcome to Wealth Matters Spring Newsletter. We deferred this newsletter until after the budget, which was also deferred by a number of weeks, due to the state of the economy. Will the shoots of spring plants, be mirrored by green shoots in the UK economy? Who knows?
The budget offered mixed news, more good than bad given the state of the global economy and public finances. Many difficult decisions were deferred, but over the next few years taxes will have to increase, whilst at the same time there will be cut backs in public services.
Analysis of the new rules is vital at this time, especially for people earning close to or over £100,000 per annum, who will be hit by large tax rises. The main headlines were focussed around the 50% tax rate for individuals earning over £150,000 and the reduction in tax relief available to these top earners, on their pension contributions. However, what was overlooked by many people, was the effect of the gradual loss of the personal allowance for anyone earning over £100,000. The introduction of this rule in April 2010 means that the effective rate of tax to be paid between £100-113,000 of earned income is 60%, rising to 61% if personal National Insurance contributions are added. The new rules have created a great need for advice. Please contact your adviser, if you would like to discuss how you should adjust your tax and investment planning, in light of these developments.
In amongst all the bad news, you may have missed the rise in global stock markets over the last 2 months, many by over 20% (I hope that when you read this article, that still remains true!!) However, our WRAPS™ investment system has been significantly outperforming it’s benchmarks and added significant value to your investment portfolio. From 1st January to the end of April 2009 a massive 17 out of 20 of our funds have outperformed their benchmark. Our WRAPS™ investment system is now live to view on our website. If you wish to see the latest report and cannot remember your LOG IN username and password, please contact the office and we will be happy to assist you.
Finally, congratulations go to Vivien Powell, our office manager for passing her Equity Release Qualification Exam and Dawn Ashworth, one of our para planners, for passing her CII Investment and Risk exam.
With equity markets so far failing to recover what many people, probably realistically, see as an overreaction to the Credit Crunch and other economic reverses, investors could be forgiven for considering selling up and running for cover.
But unless you really believe that things are going to get much worse, then this could be precisely the wrong thing to do – at least without taking professional advice and giving matters a lot of thought.
With the FTSE100 as much as 40% below its long term trend, the temptation to liquidate your assets in a time of uncertainty is perfectly natural. But there could be a number of reasons not to do so.
Costs
There are, however, potential costs associated with selling both directly held shares and units within a collective investment – and in the case of an Individual Savings Account, you could be giving up the special tax status of your investments, because you cannot convert equities into cash holdings (although you can do the reverse) within an ISA. In some cases, there could be hidden as well as explicit charges, so it is worth considering whether the additional costs are not outweighed by the potential for recovery.
Timing
The ideal aim in investments is to buy at (or near) the bottom of the market and to sell at the top. Of course, this can only be achieved with 20x20 hindsight, which would require a Tardis to achieve! However, one thing we can seek to avoid is the precise reverse, by selling at the bottom, when we have purchased at a higher price.
Of course, in some cases, such as with Northern Rock, holding on to the shares in the hope of recovery would have been a waste of time, as it looks as if there will be no compensation for the nationalisation. In the case of the other banks whose shares have lost a large proportion of their previous value, the question is more complex, because a judgement needs to be made regarding whether the price will recover and, if so, how far. Even if they do not reach the level at which you bought, any increase from now would reduce the overall loss (and remember a realised loss can be set against other gains, for tax purposes).
With other investments, including unit trusts and similar vehicles, you need to consider whether the chance of recovery is greater, so that selling now might be seen as at the ‘bottom of the market’; indeed, even if the market has further to fall, as some people believe, the question remains would you be better off by holding on through the dip, waiting for an eventual ‘bounce’.
Alternatives
If you do sell your equity based holdings, the question is where to put your money to avoid risk of loss – or it simply failing to keep up with inflation (which may soon be pretty low, in any event). Bank deposits are generally offering little return – with some creditable exceptions – and gold is currently relatively highly priced, so the scope for gains may be limited.
What to do instead
What should be considered currently is your asset allocation strategy, to ensure that you are not overly exposed in individual areas, perhaps due to market movements.
It is also worth considering whether now – or very soon – represents a good time to buy into equity markets. If you consider that prices must soon start picking up. Then this is a possible option.
You should take individual professional advice before making any decision relating to your personal finances. The value of investments is not guaranteed; you may get back less than you put in.
NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.
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The middle of this century may seem a long way off, but if you are currently in your mid 40s, by the time you reach your late seventies – and probably relying on a pension – the changes currently being made to the state pension will affect you.
As we outlined last month, the basic state pension has been around for 100 years. ‘Top up’ arrangements in the form of Graduated pensions, then the State Earnings Related Pension (SERPS) and latterly the State Second Pension (S2P) are more recent innovations. On top of this, those with very small incomes are entitled to a means tested Pension Credit, to ensure that they have at least a basic level of income in retirement.
The problem is that the state has never been able to provide enough for a comfortable retirement –especially as state pensions are ‘unfunded’, on other words it is paid out of current taxation, rather than built up in advance as a fund, from which the pensions are paid.
Private pensions
That is why from 1956, it has been possible for individuals to arrange their own pension schemes, receiving tax relief on contributions and special tax breaks on the growing funds. It is also possible to withdraw part of the fund as a tax free lump sum, on retirement.
The rules have gradually evolved over the years, with the latest changes – which were quite significant improvements – being introduced in April 2006.
So what is changing?
Two things are due to happen from 2012. Firstly, the State Second Pension will start to change from earnings related to a flat-rate top-up to the basic state pension. This is effectively converting a form of savings into a tax as it is redistributive, aimed at improving the lot of those who are lower paid, at the expense of higher earners. Ultimately, this is intended to reduce reliance on the means-tested Pension Credit by 2050.
The second change is the introduction of the new Personal Accounts. From 2012, these will be a compulsory form of pension for all employees who are not in an employers’ pension scheme (which must meet certain criteria). There will be an opt-out for those who prefer to make their own arrangements (or simply not to participate) but they will have to renew this decision every three years or be opted back in automatically. The scheme will include a contribution of 3% of earnings within a certain band from the employee, 4% from the employer and 1% from the government.
Personal Accounts will be run by the government and may offer a range of investment options although the details, including charges are not yet clear.
What should you do?
You probably already have a pension scheme of your own, or may be the member of an employers’ scheme. In the latter case, you will need to ensure that the scheme is adequate to avoid automatic enrolment in the new scheme; in the former case, you will need to decide whether to join the Personal Account scheme as well, or opt out (and continue doing so) in order to rely on your own pension planning.
In either case, you should ensure that the money you (and your employer, if appropriate) are putting aside is adequate to provide realistic retirement benefits for you.
You should take individual professional advice before making any decision relating to your personal finances. The value of investments is not guaranteed and will fluctuate; you may get back less than you put in. The level and bases of taxes and reliefs are based on our understanding at the time of writing and are subject to change.
NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.
FINANCIAL NEWS ON THE WEB HAS BEEN PRODUCED BY THE INSURANCE MARKETING DEPARTMENT LTD. YOUR INDEPENDENT FINANCIAL ADVISER DOES NOT EXERCISE ANY EDITORIAL CONTROL OVER THE CONTENT AND MERELY PROVIDES THIS INFORMATION AS A SERVICE TO ITS CLIENTS, WHO SHOULD SEEK PROFESSIONAL ADVICE BEFORE TAKING ANY ACTION IN CONNECTION WITH ANY INFORMATION PROVIDED THEREIN.
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With investment markets depressed and interest rates at historically low levels, now may not seem like the time to be considering converting the pension pot you have built up over many years into an income.
For some people, there may be little choice but to access their pension fund because they are made redundant in their mid- to late 50s and have little prospect of getting another job. For others, it may be that ‘early’ retirement has always been a target and they are now within striking distance of achieving their goal.
Of course, annuity rates, which are based on interest rates as well as life expectancy, are not particularly attractive at the moment, but the option of using their accumulated retirement pot to generate an unsecured pension could well be of interest. One reason for this is that you can (provided you are over 50 now, or 55 from April 2010) take your pension commencement lump sum, which is usually up to 25% of the accumulated pension fund and is currently free of tax without purchasing an annuity – or even drawing an income from the balance of the fund.
This flexibility means that you can ‘have your cake and eat it’ by securing a lump sum but avoiding switching all your investments from equities into gilts (which are what back annuities) at a time when the FTSE100, in which many pension funds are invested, is some 31% below its long-term trend.
“Drawdown”
The ability to draw an income directly from your pension fund has been around for more than a decade now, but thanks to changes introduced in 2006, it is no longer necessary actually to draw an income if you don’t wish to. Instead you can access your ‘tax free cash’ and leave the rest of your pension fund to grow (or recover, in this case) to produce a higher income in future.
For example, with a pension fund worth £400,000, a 55 year old man might today expect to have a retirement income of as much as £38,000 a year, ignoring any tax free cash or widow’s benefits (source: www.sharingpensions.co.uk). This is, of course taxable, so the net figure could be in the region of £29,500 (based on the assumption that there are no other levels of income, so that basic rate tax only applies).
By taking a tax free lump sum of £30,000, the net income would be roughly the same, but the pension fund would still be worth £370,000. Should markets recover, this would enable the investor to decide what to do next year, which could include, repeating the exercise, altering the amount taken or buying an annuity. (Of course the growth is unlikely be sufficient to ‘make up’ for amount taken as a lump sum, so the eventual annuity would potentially be smaller.)
Death benefits
There are some differences in the way funds are treated on death, after benefits have started to be taken. In this case, £120,000 worth of the fund (i.e. 4 times the £30,000 tax free cash, as up to 25% of the fund crystallised can be taken in this format) will have been “crystallised”. So in the event of death, the balance of the fund £280,000 (i.e. £400,000 less £120,000) will be available for use to purchase a dependent’s annuity or returned to the estate. However, although the remaining £90,000 (i.e. £120,000 less the £30,000 taken as cash) could be used to provide a dependent’s income in the same way, should the money be returned to the investor’s estate as a lump sum, a tax charge of 35% would apply.
Age 75
At age 75, everything changes in any event, because it is no longer possible to take any more tax free cash, and a minimum income must be drawn from the pension fund. In fact the additional tax on death may make this unattractive to many who do not have strong religious objections to annuitisation.
This approach many not be suitable for everyone and, as ever, you should take individual professional advice before making any decision relating to your personal finances. The value of investments is not guaranteed; you may get back less than you put in. Levels and basis if, and reliefs from, taxation are subject to change and their value depends on the individual circumstances of the investor.
NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.
FINANCIAL NEWS ON THE WEB HAS BEEN PRODUCED BY THE INSURANCE MARKETING DEPARTMENT LTD. YOUR INDEPENDENT FINANCIAL ADVISER DOES NOT EXERCISE ANY EDITORIAL CONTROL OVER THE CONTENT AND MERELY PROVIDES THIS INFORMATION AS A SERVICE TO ITS CLIENTS, WHO SHOULD SEEK PROFESSIONAL ADVICE BEFORE TAKING ANY ACTION IN CONNECTION WITH ANY INFORMATION PROVIDED THEREIN.
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When interest rates are falling, mortgage costs tend to go down at the same time (although not, as we have seen recently, by quite as much). The reason for this discrepancy is that banks actually need to get money in from depositors, to lend it out again (wholesale markets having largely dried up with the credit crunch), so depositors still need to have a reasonable rate of return, as well as the banks covering their costs.
That banks have to rely on retail savers for the money they lend is not new, simply something that the banks had forgotten in their mad (almost literally) rush to use wholesale capital to back what have transpired to be less than reliable lending strategies. The extent to which banks pay the price through defaults on mortgages will depend largely on how well the economy performs in 2009. The fewer redundancies, the lower the level of repossessions, because those still in jobs may have homes that are worth less (possibly even below the amount of their mortgage) but will still be able to repay interest and capital.
Whatever the reasons, the interest rate paid by borrowers is falling, which means that maintaining the same level of repayment will actually result in your mortgage being paid off more quickly than planned. In some cases, the benefit may not be felt immediately, because, ‘overpayments’ are not credited until the end of the year. But for most modern mortgages, especially the offset type, the benefit is immediate, because overpayments are credited on the same day.
What is an offset mortgage?
In simple terms, an offset mortgage is one where the amount you pay each month is agreed in advance, but interest only charged on the difference between what you owe and the money you hold in savings and current accounts with the same bank. This means that if you have a mortgage of £150,000 and savings of £50,000, although you are nominally charged interest (and possibly capital) based on the full amount, the actual interest component will be based on £100,000 (in this case).
In simple terms, if this was an interest-only mortgage at 5%, you would pay £625, but only £416.67 of this would be interest; the balance of £208.33 each month would reduce the amount of the mortgage outstanding. Of course, this means that next month, your mortgage will actually be smaller by this amount, so less interest will actually be due so the overpayment will be slightly larger. And these overpayments can mount up very quickly.
So is this always a good idea?
Overpayments mean that your mortgage is paid off earlier, so you should actually pay less interest over the entire term of the mortgage, than if you had always paid the ‘right’ amount. However, there are those who would recommend caution because paying more than you need to puts the money in the bank’s pocket, rather than your own. This means that should you suddenly require access to the money – perhaps because you unexpectedly lose your job – it may be difficult to borrow the money back again (even if your offset mortgage theoretically allows you a draw-down facility against previous overpayments).
It may therefore be worthwhile considering a strategy that allows some degree of overpayment, while retaining direct access to some of the capital.
What about the banks?
In general, overpayments are in the interests of the banks, because this gives them back money that can be lent elsewhere. One of the problems facing the economy is a lack of liquidity in the banking sector. Anything that can be done to improve this must be a bonus.
As ever, you should take individual professional advice before making any decision relating to your personal finances. Your home may be repossessed if you do not keep up repayments on your mortgage. Think carefully before securing other debts against your home. Fees for mortgage advice may be charged and for details of these please contact your usual adviser.
NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.
FINANCIAL NEWS ON THE WEB HAS BEEN PRODUCED BY THE INSURANCE MARKETING DEPARTMENT LTD. YOUR INDEPENDENT FINANCIAL ADVISER DOES NOT EXERCISE ANY EDITORIAL CONTROL OVER THE CONTENT AND MERELY PROVIDES THIS INFORMATION AS A SERVICE TO ITS CLIENTS, WHO SHOULD SEEK PROFESSIONAL ADVICE BEFORE TAKING ANY ACTION IN CONNECTION WITH ANY INFORMATION PROVIDED THEREIN.
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