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Interest rate rises prove hard to predict

The Bank of England did not raise interest rates in May, despite earlier suggestions that it would.

About four years ago a member of the Treasury Select Committee compared Mark Carney, the Governor of the Bank of England, to “an unreliable boyfriend”. The remark was prompted by Mr Carney’s record of talking about future interest rates increases that never became reality. The epithet came back to haunt the Governor last month.

The Bank had been hinting strongly that rates would rise in May, and by early April the money markets were effectively putting the odds on a May increase at 90%. However, a combination of surprisingly bad economic numbers – growth fell to just 0.1% in the first quarter – and downbeat business surveys prompted a rethink. By the time the Bank announced the rate would be held at 0.5% on 10 May, nobody was surprised.

The next opportunity for changes to the interest rate will come on 2 August 2018, when the Bank publishes its next Quarterly Inflation Report. The medium-term expectation is still that interest rates will rise, unless something disastrous happens to the UK economy. For its part, in May the Bank repeated its familiar mantra that, “any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent”.

If you have investments in fixed interest funds, now could be a good time to review those holdings. As the graph shows, the yield on 10-year government bonds is already around double the low hit in the wake of the Brexit vote. It could rise further – depressing bond prices – if the Governor becomes more reliable in his rate rise forecasts.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

How useful is the Dow?

The Dow Jones industrial Average – the Dow – is a well-known part of the investment market, often quoted by news sources. But what does it mean, and is it useful when making investment decisions?

The Dow was created in 1896, and is arguably still used today mainly thanks to history or habit.

There are several issues with the Dow, such as:

  • The index only tracks 30 shares.
  • It has a large absolute value – around 25,000 – which means movements sound bigger than they are. ‘Dow falls 500 points’ has more impact than, ‘Dow falls 2%’, even if the two measures are identical.
  • A committee chooses which shares the Dow tracks – where most main indices choose their constituents by market capitalisation – so it has some surprising absences, such as Alphabet (Google’s holding company) and Facebook.
  • Almost uniquely, the Dow is weighted by share price rather than company stock market value, which has some strange effects. Because a high share price means a larger weighting, Boeing (with a share price around $320) has nearly double the weight of Apple (with a share price around $170), even though Apple is the largest US company and over four times the size of Boeing.

When China recently announced proposed tariffs on imported aircraft aimed at Boeing, this had a disproportionate effect on the Dow, as Boeing shares (over 9% of the Index) fell.

Investment professionals prefer the S&P 500 Index, which is capitalisation-weighted and, as the name suggests, covers the top 500 companies in the US. The largest funds tracking the US market follow the S&P 500, not the Dow.

Despite its flaws, the Dow’s prominence is a reminder that the daily noise of markets is not always what it seems, and underlines why expert advice is essential when choosing and monitoring your investments.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

Increasing inheritance benefits for couples

Couples could now save an extra £20,000 of inheritance tax (IHT), as the residence nil rate band (RNRB) increased in April 2018.

The RNRB was increased at start of the new tax year and it is due to increase by £25,000 in each of the next two years, reaching £175,000 in 2020/21. It will be indexed to the Consumer Price Index after that.

The RNRB was introduced to give married couples and civil partners an eventual total IHT exemption of £1 million. This new band was introduced rather than increasing the existing nil rate band, which has been at £325,000 since 2009.

Whilst the increase is good news, the RNRB creates a lot of complexity for the taxpayer. A good example is that the £125,000 band is reduced by £1 for each £2 of estate over £2 million. So, in 2018/19 your RNRB is lost completely if your estate exceeds £2.25 million.

However, the estate value is calculated at death, so if gifts are made only days before death to reduce the estate below the £2 million threshold, the RNRB is not lost – a potential tax saving of up to £50,000 at present. A surviving spouse or civil partner can also double that saving by inheriting any unused RNRB from their partner.

Complexities such as this mean that, between April and December 2017, just over 3,000 estates claimed the RNRB, compared to 24,000 that paid IHT, according to data obtained via a Freedom of Information request.

If you have not reviewed your estate planning in the light of the RNRB, it makes sense to do so. The RNRB can encourage deathbed gifts, as outlined above. In some instances, it can also mean couples should revise their wills to avoid leaving everything to the survivor on first death.

The value of tax reliefs depends on your individual circumstances.

Tax laws can change.

The Financial Conduct Authority does not regulate tax advice.

The pressure is dropping on inflation

UK inflation is falling faster than expected, as the March figure for the Consumer Price Index (CPI) was 2.5%.

 

This March figure, published in mid-April, surprised forecasters, who had predicted annual inflation would remain at 2.7%, as in February. That February figure was itself a surprise, as the forecasts had predicted 2.8%.

The drop for March may be the result of one-off factors, so it should be treated with caution. One issue is the way individual categories can distort the final figure. In March, alcoholic drinks and tobacco saw the sharpest drop price – from 5.8% to 3.5%. These both saw two sets of tax increases in 2017, because of the double Budgets, whereas in 2018, the Chancellor moved to a Spring Statement and did not change any taxes. It was the classic one-off.

The unexpected drop prompted debate about whether the Bank of England would raise the base rate on 10 May. However, there is still a large gap between what can be earned on short term deposits and inflation, whether or not the base rate rises.

Despite inflation falling, you are steadily losing purchasing power if you are holding more cash than you need on deposit – even before the tax impacts are considered. The onus is still on investors to invest to protect the real value of their capital.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Taking early advice on your tax return

HMRC is starting the tax year with their annual reminder to submit your tax return.

HMRC’s reminder might seem early, but its statistics show that 750,000 people (6.5%) missed the deadline for 2016/17, potentially facing an immediate £100 penalty, even if they had no outstanding tax to pay. Anyone with a 2016/17 return still outstanding could also be clocking up additional penalties of up to £10 per day.

HMRC cancelled more than a third of all the penalties initially levied in 2014 and 2015 according to statistics obtained under a Freedom of Information Request. However, it is best not to incur the fine in the first instance, even if you have what HMRC calls a ‘reasonable excuse’.

You have until the end of October 2018 to submit a paper tax return and 31 January 2019 if you file your return online. According to HMRC, 9.92 million out of 11.43 million tax returns for 2016/17 were filed online by 31 January 2018, while 0.77 million were made on paper.

You can make your tax return easier, whether or not you take professional advice, by reviewing how you hold your investments:

  • Beware holding multiple interest-earning accounts with only small deposits. HMRC has started pre-populating some returns with deposit interest data, but the process does not cover joint accounts. Keeping your savings in a single account can make more sense and, if you want to chase interest rates, makes switching providers easier. But remember, only £85,000 per account is protected by the Financial Services Compensation Scheme.
  • Consider using investment structures which do not need to be reported. ISAs are the obvious example, but there are several others.
  • If you still hold certificates for shares or funds, consider transferring the holdings to a nominee account. You will then receive one consolidated tax voucher instead of multiple vouchers.

For more information on any of the above, please contact us. There is no deadline, but the sooner you act, the easier next year’s tax return will be.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

The value of tax reliefs depends on your individual circumstances.

Tax laws can change.

The Financial Conduct Authority does not regulate tax advice.

Repayment threshold increases for student debt

The income threshold at which student loan repayments begin rose on 6 April 2018.

English and Welsh students who started their courses after 31 August 2012 can now earn £25,000 a year – up from £21,000 – before they have to start repaying their student loans. The increase could provide a saving of £360 a year, with repayment rates at 9%.

Although the change was heralded as good news, that is not the whole story:

  • Automatic enrolment pension contributions nearly tripled at the same time. For those earning £29,000 or more, this increase more than wipes out the savings from the repayment threshold increase.
  • Interest rates for student loans have not changed. Before graduation, interest remains at RPI + 3% (currently 6.1%, and 6.3% from September 2018). After graduation interest is charged at RPI for those earning up to £25,000, rising on a sliding scale up to RPI + 3% for those earning £45,000 or more.
  • As with any loan, lower repayment levels mean a longer payment period. Although student loans are capped at 30 years, after which the debt is written off.
  • The Institute for Fiscal Studies estimates that the higher threshold will cost the taxpayer £2.3 billion a year, and that the government will end up writing off about 45% of total student debt.

A basic rate taxpaying graduate who is auto-enrolled in a workplace pension scheme faces an effective marginal ‘tax’ rate of 43.4% – more than higher rate tax – for every £1 earned above £25,000:

Income tax20%
National insurance12%
Auto-enrolment pension contribution (net)2.4%
Student loan repayment9%
TOTAL43.4%

Once the higher rate tax threshold is reached, the effective marginal rate becomes 51%. The savings from lower national insurance contributions, and earnings over the auto-enrolment threshold, are more than lost on extra income tax.

If you have children or grandchildren going to university, these figures are a reminder that it could be wise to start planning university funding. However, it is perhaps better to think of graduation funding, as it may not make sense to pay off the student loan early.

Tax laws can change.

The Financial Conduct Authority does not regulate tax advice.

New risk criteria for venture capital schemes

Important changes for venture capital schemes and enterprise investment have recently come into effect.

New ‘risk-to-capital’ conditions apply to investments in venture capital trusts (VCTs), enterprise investment schemes (EISs) and seed enterprise investment schemes (SEISs). The changes took effect on 15 March 2018, when the Finance Act 2018 received Royal Assent.

Broadly speaking, an EIS or SEIS company, or a company in which a VCT is investing must both:

  1. Have objectives “to grow and develop its trade in the long term”.
  2. Carry a “significant risk that there will be a loss of capital of an amount greater than the net investment return”.

The changes are intended to end venture capital schemes – particularly EISs – which often did little more than return the investor’s original capital at the end of the tax relief clawback period. Such schemes were usually asset-backed, typically focusing on pubs, ship ownership/chartering or film production, where pre-sales were in place.

For many years the Treasury tried to exclude such ‘safe’ trades, only for other low-risk options to emerge. The new risk-to-capital condition, and its somewhat subjective criteria, is designed to put an end to this cycle.

The minimum percentage of ‘qualifying holdings’ (risk investments in small unlisted companies) for a VCT has also increased from 70% to 80%. This, along with other measures in the Act, aim to increase the level of risk undertaken in such schemes.

The Chancellor has also issued a consultation paper on a new form of EIS fund aimed at knowledge-intensive companies. The document suggests possible restructuring of the EIS tax incentives, with a greater backdating period and/or tax-free dividends after a minimum period.

The VCT, EIS and SEIS offerings in 2018/19 are likely to differ from earlier years. They may also be thin on the ground as promoters acclimatise to the new higher-risk regime and digest the heavy flow of fresh capital in 2017/18.

More than ever, if you want to invest in this area, expert advice will be vital.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

The value of tax reliefs depends on your individual circumstances.

Tax laws can change.

The Financial Conduct Authority does not regulate tax advice.

What does the pension lifetime allowance buy?

It is worth looking at what your pension pot could buy for your retirement.

The importance of pension contributions has been bolstered by the rollout of auto-enrolment pension schemes. However, it is not as clear what your savings will give you when you come to retire.

For example, Louise, a healthy, non-smoking 65-year-old, reaches retirement with £1,000,000 in her pension plan. If she uses the entire fund to buy herself an inflation-proofed income, what will be her first monthly pension payment before tax is deducted?

  1. £2,500
  2. £3,000
  3. £3,500
  4. £4,000

The answer is A, based on current pension annuity rates. After tax, if Louise has no other income, her monthly payment will be about £2,200. Include a 2/3 widow’s pension and the gross amount drops by about £400 a month (roughly £320 after tax).

This may be a surprise as the National Living Wage is nearly £1,200 a month for a 35-hour week. Especially when you remember Louise forgoes a tax-free lump sum of up to £250,000 in favour of a higher income.

The income of £2,500 a month (£30,000 a year) is only 3% of the pension pot, but it is RPI-linked. Importantly, because it is an annuity payment, it is also guaranteed throughout life – however long that may be.

Whilst annuities have gone out of fashion, the rates set a base line for retirement planning. Alternative retirement incomes, such as income drawdown, all carry some form of investment risk, meaning the potentially higher income available does not have the same degree of security.

This means the rise in automatic enrolment contributions from April is a necessary start on the way to building up adequate retirement funds. However, a realistic level of contributions will still be much higher for most people. Why not ask us what yours should be?

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

The value of tax reliefs depends on your individual circumstances.

Tax laws can change.

The Financial Conduct Authority does not regulate tax advice.

International investments and Brexit

With Brexit now less than a year away, how insular are your investments?

Brexit – or more accurately the start of the transition/implementation period of the UK leaving the EU – begins on 29 March 2019. By the end of the following year, the UK’s remaining links to the EU are due to be cut.

Since June 2016, when the Brexit referendum took place, the FTSE 100 has been one of the world’s poorest performing major indices. So it is perhaps no coincidence that, in March 2018, a survey by the Bank of America (BoA) of 163 global investment managers found the UK stock market was least popular of 22 wide-ranging investment asset classes.

If you live and work in the UK, then naturally enough you tend to think in terms of UK-based investments, be they shares, bonds or property. The BoA survey is a reminder that taking such a parochial view of investments may come at a price.

Diversification is one way investment professionals limit risk and potentially increase returns. For example, the most recent report from the Pensions Regulator showed that in 2017 the average UK defined benefit pension scheme had only one fifth of its total shareholdings in UK quoted shares.

International investment offers:

  • Access to industries not represented on the UK stock market, such as Amazon or Daimler-Benz.
  • The opportunity to benefit from different economies and different stages of the economic cycle, e.g. emerging markets. Both are especially important when UK economic growth is forecast to remain weak.
  • Exposure to foreign currencies, which can provide an additional boost to returns when sterling is weak, as it was in the 12 months following the Brexit vote.

There are many ways to increase the international element of an investment portfolio, whether it is held directly or via an ISA or pension arrangement.

For the strategy appropriate to your circumstances, please talk to us.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

Taking the early view on ISAs

There are advantages to planning your ISA investments around the start of the tax year.

With ISAs all the taxation benefits occur after investment is made, yet the focus is often on year-end contributions. Various articles on ISAs filled the weekend press in March, and are set to re-emerge like a financial sign of spring in 12 months’ time.

For other investments, such as venture capital trusts and pensions, there is a logic in waiting until the end of the tax year – you have a better idea of your income for the year and hence your tax position. The same is not necessarily true of ISAs.

Indeed, it is sensible to contribute to ISAs as early in the tax year as possible, to get the tax benefits for as long a period as possible. As a reminder these are:

  • No UK tax on dividends, an important factor as the dividend allowance has been cut from £5,000 to £2,000 for 2018/19.
  • No UK tax on interest earned.
  • No UK capital gains tax on any profits realised.
  • Nothing to report to HMRC on your tax return.
  • Allowing a surviving spouse or civil partner to inherit your ISA benefits, effectively treating your ISAs as joint investments.

Making an ISA contribution does not necessarily mean paying in cash. It can include selling an existing investment you hold personally and repurchasing it within an ISA. You may crystallise some capital gains in the process, but at the start of the tax year you almost certainly still have your full £11,700 annual exemption available.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

The value of tax reliefs depends on your individual circumstances.

Tax laws can change.

The Financial Conduct Authority does not regulate tax advice.