Winter Newsletter - 2007
Welcome to the winter edition of the Wealth Matters newsletter. Almost every client conversation at the moment starts with a discussion about the state of the markets, whether residential property, equities or commercial property. We haven't invented a wand yet to make all these assets shoot up 20% in the next 2 months. If we do we'll keep you posted!!
However, we have invented an investment system called WRAPS™, which diversifies risk and gives excellent long term returns. In almost two years since we launched the system, over 150 clients have invested with us and not one person has left it.
There is actually little reason for taking an overly pessimistic view of equity markets at the moment, if you are investing for the medium to long term. You still own the same number of units. It is the unit prices that have changed, and the value of your investment is the number of units multiplied by the unit price. Like house prices, unit prices can fluctuate, and the value is only an issue if you are selling the house, or selling down all the units. However, if the funds are sound with good fundamentals, (as we believe our WRAPS™ funds are), then there is no need to panic and sell down. The last thing you should do is sell units when the markets are low. When the markets are low, it is a time to buy.
The next 2-4 weeks will tell us a lot about the state of the US economy and whether fears of a US recession are valid, but believe in the funds, believe in the system, and remember we have had significant growth for the last 4 years. ISAs are 10 year investments and pensions typically more than 20 year investments.
In reality, individual market sectors move up and down at different times for different reasons. For example, the shares of one UK bank (not Northern Rock!) have fallen more than 20% compared with the FTSE, during the last few months. Conversely, a tobacco manufacturer has outperformed the index by more than 10% over a similar period.
All equity - and, indeed, property - investments should be seen in a long-term context. Shares are notoriously open to fluctuating values and property can take time to sell, but historically, they have both offered potential for growth. What is important in any investment portfolio is to avoid too much exposure to individual sectors. The asset allocation strategy we have within WRAPS™ combats this issue. As per our investment literature, as it is January, we are re-balancing all client portfolios set up prior to 1st Sept 2007.
We will continue to review the funds that make up WRAPS™ and we will keep you informed on any pertinent matters.
We hope that you find the following articles of interest. If you have any comments, questions or views, please email us at:info@wealth-matters.co.uk
According to recent government figures, the population of the UK is rapidly aging. As each one of us reaches another birthday, there are fewer and fewer young people coming in to replace us.
It had been hoped that immigration could stem the flow of rising average ages, but, as can be see from the chart, not only is the proportion of men and women over 85 set to exceed 20% of the population within 25 years, but the under 18s will by then also only represent about 20%.
Does this matter? Well, yes; because the state pension, care for the elderly and overall tax revenue that the government has to spend depends on the number of economically active people. So if there are fewer people of working age, there is less money coming in to cover state pensions and to provide personal care for the elderly.
Put starkly, by 2047, it is estimated that there will be just 2.4 people over age 18 available to support every pensioner. In 1967, the figure was 5.13 people and even today, it is 4.08 people. The situation is getting dramatically more extreme. Even over the next decade or two, when many of us may be thinking about retirement, the ratio will fall to just over three people of working age to every pensioner.
The message is very clear, if you wish to have a comfortable retirement, you need to plan; and to do so soon. If you do not, you face a reducing state pension, because it will simply be unaffordable for those in work to pay for; you may also find that health services and care for the elderly become overstretched and become increasingly the preserve of those able to pay for it.
But enough of the doom and gloom. Except for those already very close to retirement, there is still time for investments to be set up that can help to provide a buffer against the inevitability of deteriorating public services for the elderly. After all, most people will have their homes paid for well before they need to rely on a pension, so that they will have resources available to them.
However, the importance of formal planning, rather than relying on increasing house values, to provide for retirement income cannot be overstressed. While it is possible to release equity from the home while still enjoying its use, this is not necessarily the most effective way of accessing income or capital later in life. More importantly, relying too much on any one asset class, such as residential property, can mean that a downturn in the market leaves you exposed.
A diverse asset allocation strategy may mean that you miss out on the best growth in any one sector, but it also means that part of your capital is protected against adverse moves. Better by far to avoid putting all your eggs in one basket, and to invest in equities, property, deposits and other assets that will not necessarily move in the same direction at the same time.
Even within an equity portfolio, there is good sense in introducing a degree of diversity; perhaps by looking at different business sectors, such as energy companies and IT infrastructure operators, rather than just large or mid-cap companies. Similarly, there can be some merit in investing in different parts of the world, although this introduces a currency risk on top of the normal investment issues.
It is important always to seek independent financial advice before making any decision regarding your finances. If you would like any assistance, please contact us.
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It is probably unfair to talk about “pre” and “post” Northern Rock because the real problems started in the US sub-prime markets. The problem is that in its striving for rapid growth, it to some extent replicated the errors made by the American lenders by offering money in areas where the risk of default was higher than average.
It is not necessarily that loans made by Northern Rock have an exceptionally high default rate; the problem leading to the “run” on it was more a matter of confidence in its ability to continue meeting its obligations over the longer term. This, in turn, was caused by a tightening in UK money markets that saw the rate at which banks lend money to each other – on which Northern Rock and others rely – soaring, as capital markets started to feel the pain of defaults in the US.
Whatever the reason, it is highly unlikely that the underlying problems are yet resolved and there are predictions that a further set of defaults will hit the US early next year when borrowers come to the end of low interest rates offered under "teaser" loans at the height of the property bubble in 2005 and 2006.
Combine this with the difficulty that UK banks and building societies are already experiencing in raising money on capital markets to finance further lending and it is not difficult to predict that lending will soon become tighter. This is likely to result in lower loan-to-value lending multiples and a tightening of salary multiple criteria.
This could well impact on the housing market – already reeling from a fall in new instructions partly because of the new Home Information Packs – with more buyers chasing fewer properties with less money to spend. This is a recipe for a sustained slow-down in the home market. It could also lead to higher interest rates, whatever the Bank of England’s Monetary Policy Committee might do.
How to defend yourself against higher rates
If lenders have to raise interest rates, they are likely to do so selectively, at least initially. Those affected will be those who are borrowing high proportions of the value of their home, as well as those who have a poor credit history.
An obvious defence against this is to ensure that your mortgage repayments are always met on time or that, if you do run into problems, you discuss this with the lender immediately, rather than letting matters run on. Lenders can be very helpful to those who get into temporary difficulties and are less likely to take drastic action if they are consulted early.
Another step that can help you in the longer term is to try to repay more capital early, in order to reduce the overall size of your mortgage. However it is important to be aware of how early repayment is treated. In some cases, you will be credited immediately and future interest payments calculated only on the outstanding balance. In some cases (especially with offset mortgages) your repayments may remain the same, which means that you are actually clearing more of the debt each month. However with some mortgages, the capital is held in limbo until the end of the year and only then is it credited to you. In the meantime, you have been paying interest on the entire mortgage and may not even receive interest on the money you have paid in. (And even if you do receive interest, this is subject to tax.)
It is important always to seek independent financial advice before making any decision regarding your finances. If you would like any assistance, please contact us.
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In addition to ensuring that couples only pay inheritance tax on estates of more than £600,000, the Chancellor also took the opportunity of his first Pre Budget Report to alter the way Capital Gains Tax applies. For some, this is good news …
… but for others, particularly business people, this will probably mean paying more tax; in extreme cases, more than three times as much.
Together with the introduction of a single CGT rate of 18%, the proposed removal of taper relief, which currently means that the longer you own an asset before selling it, the less capital gains tax you pay, will result in everyone paying the same rate of tax on the sale of any assets other than their main home.
It is important to be aware that the first £9,200 of gains each year is exempt; this figure tends to rise, modestly, each year. So if you bought some shares in 1990 for £2,000 and now sell them for £10,000 then, provided you have no other realised gains during the year, there is no tax to pay.
The problem is that by unifying the rate, matters may be simplified, but many people will actually end up paying more tax than previously. Those affected are largely anyone selling business assets – such as the shares in a family business, or in a company you actually work for – with the exception of higher rate taxpayers who have held the shares for less than two years. But even basic rate taxpayers who have held non-business assets for more than five years will end up paying more tax, from next April.
In an extreme case, a basic rate taxpaying employee who sells shares in the company he works for after just a few years could end up paying 18% in tax, rather than the current 5%.
Due to a concerted campaign by the four leading business organisations in the UK, the Chancellor has indicated that he will consider re-introducing the retirement relief that was removed towards the end of the 1990s by his predecessor (and current boss) Gordon Brown. This is likely to increase the personal exemption from £9,200 to £100,000 for those selling business assets at point of retirement.
So for a higher rate taxpayer who has built up a business from scratch over 30 or 40 years and is now selling it for perhaps £1,000,000, they will, thanks to the Chancellor, face a tax bill of £162,000 from next April, whereas the same sale this year would have attracted a tax bill of just over £96,000. For someone who had managed to become a basic rate taxpayer at the time the gain was realised, the tax bill would have been just £48,000; less than a third of the new amount.
It is unlikely that the Chancellor’s largesse will extend to those realising gains under share-based profit schemes.
For business owners and employees alike, the impetus to convert profits into pension contributions has never seemed more pressing.
It is important always to seek independent financial advice before making any decision regarding your finances. If you would like any assistance, please contact us.
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In a rare reversal for HM Revenue and Customs, the House of Lords has upheld an Appeal court ruling that allows a family run business to minimise their tax liability by paying dividends to both parties, even though one person is the main fee earner.
This case was all about the taxman trying to use one company in Sussex which it claimed owed it £42,000 in back taxes, in order to be able to collect and estimated £1 billion in “unpaid” tax from other small companies.
The circumstances were simple, the company is jointly owned by husband and wife, but the husband was the sole director and principal fee earner. Minimal salaries were paid and dividends used to pay the profits equally to both parties.
As a result, instead of the husband’s income attracting higher rate tax on a large chunk, much of the income was paid to the wife, who is not a higher rate taxpayer. HMRC wanted to tax her income as if it was his. Fortunately, the Law Lords disagreed; which caused thousands of small businesses to heave a sigh of relief.
However, there is every chance that having spent an estimated £1 million on legal costs, the taxman will be unwilling to let this go and we can expect to see legislation at an early stage to outlaw this method of remuneration for family businesses. Alistair Darling’s boss (and predecessor) is a past master at introducing stealth taxes and closing loopholes, and it is too much to hope that this government can leave small business – long the powerhouse of economic growth in the UK – alone.
There is, however, an underused way of protecting money against the taxman, which could well come into its own, should this option be closed down (possibly as early as the Pre Budget Report in December, if Darling cannot wait for his first Budget). This is the rather unattractively named “Salary Sacrifice”.
It works very simply. Salaries are subject to tax and National Insurance contributions. This affects both employers and employees because while employees only pay 1% NI contributions on earnings above £34,840 (as well as 11% up to this level, once the earnings threshold of £5,200 a year is exceeded), employers pay 12.8% on every penny above the earnings threshold.
However, pension contributions do not attract NI contributions for either party. So if the employee and employer agree to cut the salary, the employee saves up to 40% in income tax and anything from 1% to 11% in NI contributions. But the employer will also save 12.8% on the entire contribution, making it highly cost effective.
Of course, pensions are about future income, salaries are for today. But since it is now possible for a person over age 50 (rising to 55 in three years’ time) to draw pension benefits at the same time as working, this need not be a problem. Especially as it is possible to draw just the tax free cash and leave the balance of the money to roll up in a highly tax efficient environment. So a taxed income of £10,000 sacrificed by a higher rate taxpayer would save £4,100 for the employee, £1,280 for the employer, generate an immediate tax free lump sum of £2,500 and a residual pension fund worth £7,500 (ignoring charges in this case).
It is important to be aware, however, that the total benefits package must be justifiable. So paying a part time worker £6,000 a year and topping this up with a pension contribution of £100,000 is unlikely to get past the taxman.
It is important always to seek independent financial advice before making any decision regarding your finances. If you would like any assistance, please contact us.
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