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Lessons from rising inflation and interest rates

As 2021 drew to a close, inflation finally forced the Bank of England’s hand. What will higher rates mean for you?

Source: ONS.

The November inflation figures, released in mid-December, once again exceeded the Bank of England’s (BoE) expectations. At the start of November, the BoE had said that CPI inflation was “expected to peak at around 5% in April 2022”. Six weeks later it changed its tune: “Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022”.

What does that mean to you?

  • The effects on your personal spending will fluctuate. Inflation is not constant across all goods and services. For example, November’s data showed that while overall inflation was 5.1% a year, in the health category prices rose only 1.4% across the 12 months, while for transport (for example those petrol prices and secondhand cars) the annual increase was 12.5%.
  • The buying power of your cash savings is depreciating fast. The Bank responded to the latest jump in inflation by raising Bank Rate from 0.1% to 0.25%. Viewed another way, over a year a deposit of £1,000 would earn £2.50 (before tax) in interest at Base Rate, while current inflation would erode its buying power by about £50.
  • Your next pay rise probably won’t cover the erosion of buying power. The Bank’s forecast of an April peak for inflation – primarily driven by the next Office of Gas and Electricity Markets (OFGEM) utility price cap rise – will coincide with the increase in National Insurance contributions announced last September. For example, if you earn £40,000 a year and, like many employees, your salary review takes effect in April, you will need a pay rise of 8.2% to maintain the buying power you had a year ago.
  • Your insurance cover will need a review. If you have life assurance and/or income protection that is not inflation-proofed, then you will need to increase the level of cover to maintain the real value of your protection. With buildings and contents insurance, that often happens automatically and goes unnoticed.
  • Any inheritance tax (IHT) liability on your estate has probably gone up. The current Chancellor has followed in the footsteps of his predecessors by freezing the IHT nil rate band. As inflation drives up asset values, such as your home, that could mean more of your estate is exposed to 40% tax.

The value of your investment and any income from it 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.

Tax laws can change. The Financial Conduct Authority does not regulate tax or benefit advice.

 

Escaping the higher minimum pension age

A surprise change of tack on pension ages was revealed when this year’s Finance Bill was published.

In February 2021, the government confirmed that it would go ahead with a two-year increase in the normal minimum pension age (NMPA) from 55 to 57 from April 2028. The NMPA is the earliest age at which you can start to draw benefits from a pension arrangement, unless you are covered by a limited range of exemptions.

The news coincided with the publication of a consultation document which by July had resulted in draft clauses for this year’s Finance Bill. One part of the draft that surprised some pension experts was that the proposed legislation allowed people with an actual or prospective right to retire between age 55 and 57 to transfer their pension to a new provider with their existing pension age safeguarded. However, the transfer had to occur by 5 April 2023. As many personal pensions set their minimum benefit age equal to the NMPA, there was a concern that the legislation would encourage buy-now-while-stocks-last pension transfers merely to lock in age 55.

The Finance Bill, published on 4 November 2021, closed off this option by limiting it to transfers made before that date. The move was a surprise – there was no hint of the change in the Budget – but it was nevertheless welcomed by many pension organisations. The Economic Secretary to the Treasury justified the lack of any notice by explaining that a prior warning “could have led to unnecessary turbulence in the pensions market”. Other longer-standing concessions on early retirement ages remain in force.

In practice, a pension age of 55 – still legally possible if you reach that age before 6 April 2028 – is only a viable option if you have a large pension pot and, preferably, other sources of income. For example, at age 55 the current lifetime allowance of £1,073,100 would buy an inflation-proofed pension of under £1,500 a month (before tax). A level pension would be much higher – about £3,500 a month – but could you live for 30 years or more with no pension increases?

The value of your investment and any income from it 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.

The global dividend recovery

Research shows that in Q3 2021, dividend payments increased sharply in all major markets and are expected to return to pre-pandemic levels before the year’s end.

Sources: Janus Henderson, Link Group.

In 2020, global dividends fell by 11.9% year-on-year in USD terms according to an index calculated by the investment manager Janus Henderson. In the UK, dividends suffered a much greater drop, with a decline of 42.9% recorded by Link Group, a leading corporate services provider. The UK’s significant underperformance had much to do with the Bank of England forcing UK banks to suspend dividend payments.

Both Janus Henderson and Link Group recently published their latest dividend reports covering the third quarter of 2021. The gloom that pervaded 2020 had disappeared:

  • On a global basis, overall dividend payments jumped a record 22.0% year-on-year to an all-time high for the third quarter of the year.
  • In the UK, total dividend payments were 89.2% higher than in the same period of 2020.

Both sets of figures were helped by a boom in dividends from mining companies, which accounted for two thirds of the increase in global dividends according to Janus Henderson’s calculations. The biggest global dividend payer in the third quarter – and likely for the whole of 2021 – is BHP, an Australian miner whose shares are currently listed in both London and Sydney.

In the UK, miners took the top three positions in the dividend payers’ league for Q3 2021. Five mining companies paid special (one-off) dividends totalling £4.3 billion, about £1 in £8 of all dividend payments over the quarter. The result was that the concentration of dividend payments among a small number of companies in the UK grew significantly – just five companies (including that trio of miners) accounted for over half of Q3 dividends.

On a global basis, Janus Henderson expects dividends to surpass their pre-pandemic peak by the end of the year, a rapid recovery from their low point in March. While Link Group estimate that 2021 UK dividends will be 45% higher than 2020’s, that would still be 17.4% below the level of 2019.

If you are looking for income, these latest sets of dividend data are a reminder of the power of companies to generate income for their investors.

The value of your investment and any income from it 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.

The pension annual allowance trap

Latest HMRC figures show that the annual allowance continues to help fill its depleted coffers.

The annual allowance is an important number in the pension world. It sets the maximum tax-efficient amount of total contributions in a tax year – from any source – that can be made to pension schemes for your benefit. If the allowance is exceeded, then any tax relief you receive on the excess is effectively clawed back by the annual allowance charge. However, the tax status of the benefits bought with the unrelieved contributions remains unchanged, meaning potentially that 75% is taxable when withdrawn.

Until 2011, the annual allowance was set at a level that made it a somewhat academic topic – in 2010/11 it stood at £255,000. Then, in 2011/12, it was reduced to £50,000 – a cut of about 80%. The Chancellor’s aim was to lower the cost of tax relief at a time when the top rate of income tax was 50%. Three years later, from 2014/15, there was another reduction, this time to £40,000. In 2016/17 the axe fell for a third time, but on this occasion, it was more a salami-slicing than a chop. The main allowance remained at £40,000, but it became subject to a taper that could bring it down to as little as £10,000 for high-income earners.

The effects of these changes are visible in the graph. In 2010/11, only 140 people reported a liability for the annual allowance charge on their tax returns. That jumped to 5,570 the following year and 18,870 in 2016/17. At last count – three tax years ago – over 34,000 people were caught with total excess contributions of £817 million. The vast bulk of that excess would have been taxed at 40% or 45%, netting perhaps £350 million for the Treasury.

The Chancellor was forced to relax the rules for tapering in the 2020 Budget because potential tax bills were prompting NHS consultants and other senior public sector staff to take early retirement or limit their working hours. While the change should have reduced those paying the annual allowance charge in 2020/21, the problems it causes have not disappeared. That means you should always take advice on contribution levels, particularly if you are lucky enough to still be a member of a final salary pension scheme.

The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.

Placing a cost on retirement

How much income do you need for a comfortable retirement? New research has put a post-pandemic price on the answer.

One traditional way to answer the question of how much income you will need in retirement is to fix the amount as a percentage of pay. For example, when final salary pension schemes were more common, their target was often around two thirds of earnings. While this approach produces an easy to calculate number, it is arbitrary. For low earners it may produce too low a number, while at the opposite end of the scale the result may be too high.

An alternative is to focus on retirement living standards, an option that has been supported in the UK by the Pension and Lifetime Savings Association (PLSA) and is mirrored by approaches used in other countries. The PLSA sets three levels of post-pandemic retirement:

MINIMUM MODERATE COMFORTABLE
What standard of living could you have? Covers all your needs, with some left over for fun. More financial security and flexibility. More financial freedom and some luxuries.
House DIY maintenance and decorating one room a year. Some help with maintenance and decorating each year. Replace kitchen and bathroom every 10/15 years.
Food and drink A £41 weekly food shop. A £47 weekly food shop. A £59 weekly food shop.
Transport No car. 3-year-old car replaced every 10 years. 2-year-old car replaced every 5 years.
Holidays and leisure One week in the UK and a long weekend in the UK every year. 2 weeks in Europe and a long weekend in the UK every year. 3 weeks in Europe every year.
Clothing and personal £410 for clothing and footwear each year. £730 for clothing and footwear each year. £1,200 for clothing and footwear each year.
Helping others £10 for each birthday present. £30 for each birthday present. £50 for each birthday present.

Where would you want to be on those scales? It’s likely that most of us would veer towards ‘Comfortable’.

Now for the annual cost in terms of after-tax income:

MINIMUM MODERATE COMFORTABLE
  London Elsewhere London Elsewhere London Elsewhere
Single £13,200 £10,900 £24,500 £20,800 £36,700 £33,600
Couple £21,100 £16,700 £36,200 £30,600 £51,500 £49,700

 

If the numbers surprise you, then it is probably time to start checking that your retirement funding will meet the standard of living that you want.

The value of your investment and the income from it 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.

The Autumn Budget – taxed and spent

After already increasing taxes by £42 billion a year in 2021, the main focus of Chancellor Rishi Sunak’s Autumn Budget was on spending.

The first Autumn Budget in three years – and Mr Sunak’s third in less than 20 months – featured no significant increases in tax. The task of raising extra revenue had already been dealt with earlier in the year, with a range of measures, including allowance freezes and increased corporation tax.

The Budget’s main highlights on the personal front were:

  • There were no changes to inheritance tax and only one technical administrative change to capital gains tax. Both capital taxes had been the subject of extensive reports from the Office for Tax Simplification, so the Chancellor may have abandoned ideas of reform for the short term.
  • A change to pension tax relief was announced, but not the one some had feared. It involved a potential increase in relief for low earners from 2024/25.
  • The increases to National Insurance Contributions and dividend tax, announced alongside the NHS/Social Care package in September, were confirmed and will start to take effect from April 2022.
  • The income tax personal allowance and higher rate threshold (outside Scotland) were left frozen, despite higher inflation effectively making the freeze a greater tax increase.
  • The main ISA contribution limit was frozen at the £20,000 level originally set in April 2017.
  • The increase to the new and old state pension will be in line with inflation to September 2021 (3.1%) rather than the Triple Lock, saving the Treasury (and costing current and future pensioners) over £5 billion a year.

Although the Chancellor said in his speech, “My goal is to reduce taxes”, this will not happen next year. It is not too early to start thinking how you might start cutting tax through year-end tax planning.

The value of your investment and any income from it 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.

Are your young adults missing out on their Child Trust Fund?

HMRC says many teenagers are missing out on Child Trust Fund cash.

The first Child Trust Funds (CTFs) matured just over a year ago, at the start of September 2020. CTFs will continue to mature until January 2029 as their owners reach the magic age of 18. At present, about 55,000 CTFs mature every month.

HMRC has been looking at the CTFs that have already matured. Its interest is more than academic because over the life of the scheme, HMRC set up one million CTFs – about 15% of the total. HMRC took the CTF establishment role when parents or guardians had failed to do so within 12 months of receiving a CTF government voucher. HMRC randomly allocated an approved CTF provider to each such orphan.

In a recent press release, HMRC said “Hundreds of thousands of accounts have been claimed so far, but many have not”. Annoyingly – and perhaps deliberately – HMRC does not spell out specific numbers of non-claimants, but said if only 10% miss the date, that amounts to over 5,000 a month.

It should come as no surprise that many parents, guardians and children have forgotten that a CTF exists. To judge by data issued earlier this year, over 80% of CTFs are worth less than £2,500, with many probably only valued in the hundreds, having received no more than one voucher of £250 or £500 before government payments ceased.

If you want to find a ‘lost’ CTF, the best starting point is HMRC’s online tool (see https://www.gov.uk/child-trust-funds/find-a-child-trust-fund). To use this, you will need to create a Government Gateway user ID and password if you do not already have one.

CTFs that carry on beyond their owner’s 18th birthday continue to offer the same tax benefits as ISAs – no UK tax on income or capital gains. However, the underlying investments may be unattractive – deposits with minimal interest rates, for example. The same investment drawbacks can apply long before maturity, so it is worth reviewing any existing CTFs. A transfer to a Junior ISA (JISA) could be a better option than carrying on with a CTF.

The value of your investment and the income from it 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.

The September mini-Budget

Double-digit tax increases to fund the latest social care reforms will have a ripple effect on taxpayers.

When the Chancellor announces tax rises that are measured in double-digit billions, normally you can assume he is presenting a Budget. That was not the case in September, when Rishi Sunak set out measures that will bring a net £12 billion a year into the Treasury’s coffers from next April. That sum is about the same amount as would be raised by increasing basic rate income tax from 20% to 22%. Indeed, some experts suggested that is what the Chancellor should have done. Instead, he took a politically safer route:

  • In 2022/23, all the main and higher rates of National Insurance Contributions (NICs) will rise by 1.25%. For example, if you are an employee under age 66 earning more than £50,270, then in the next tax year you will pay NICs at the rate of 13.25% (12.0% currently) on your earnings between £9,568 and £50,270 and 3.25% (2% currently) above that level. Your employer will also pay NICs on your earnings above £8,840 of 15.05% (currently 13.8%). If you earn £60,000 a year, your NICs bill will rise by £630 – about £52.50 a month.
  • In 2023/24, the NICs rates will drop back to the current level and to capture the extra 1.25%, a new, separate Health and Social Care Levy will be introduced. The net effect of this will be the same as the 2022/23 NICs increase, but with one exception: the new levy will also apply to the earnings of anyone (employed and self-employed) above State Pension Age (66 currently).
  • From 2022/23, 1.25% will be added to the tax rates that apply to dividends once the £2,000 dividend allowance is exhausted. Consequently, the top tax rate on dividends will rise to an awkward 39.35%.

The changes could have major impacts on your financial planning, particularly if you run your own business. To discuss how they affect you personally – and what actions you might be able to take – please contact us.

The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.

Paying for England’s social care reforms

In September, the government revealed its long-awaited plans to reform England’s funding of social care, but many home care residents won’t reap the benefits.

On becoming Prime Minister, Boris Johnson announced that he had “…a clear plan we have prepared” to deal with the funding of social care in England. The statement was met with a certain amount of scepticism, if only because governments of every hue had a track record of failing to produce and/or implement a social care plan.

A little over 25 months after Mr Johnson’s statement, he and his Chancellor, Rishi Sunak presented details of that ‘clear plan’, parts of which remain unclear. The main part applies only to England as the devolved nations each have their own different care funding arrangements.

The main features of the proposals are:

  • The plans will apply to anyone entering care from October 2023. Earlier entrants will continue under the current rules, even after 2023.
  • There will be a cap of £86,000 (index-linked) on the total care costs. This is not as simple as it seems: it applies only to personal care costs, not the ‘hotel costs’ of care (accommodation, food, etc.). The government’s one example of how the new regime operates was based on hotel costs of £10,000 a year – less than £28 a day.
  • The capital limit above which an individual must meet all their care costs (until the cap is reached) will rise from the current £23,250 to £100,000 – a 330% increase.
  • The corresponding lower capital limit, below which individuals are not required to use savings or the value of their home to meet care costs, will also rise, but by a more modest 40%, from £14,250 to £20,000.
  • If individuals have capital between those two limits, they will be expected to make an ‘income tariff’ contribution from that capital, which the government says will be “no more than 20 per cent”. In other words, if an individual’s capital is £70,000, they could have to contribute £10,000 in the first year (20% of [£70,000 – £20,000]).

While the proposals will save some families hundreds of thousands of pounds, for others these changes will make no difference – many care home residents will not live long enough to reach the £86,000 cap.

So, farewell then 6 April? 

The UK’s unusual tax year end date is coming under scrutiny in tandem with potential changes to the tax year basis for the self-employed.

The start of the tax year in the UK is 6 April. It is a date steeped in history – think quarter days and the introduction of the Gregorian calendar in 1752. In the age of HMRC’s Making Tax Digital programme, that 6 April legacy date looks rather bizarre. So, why not make the tax year begin on a more sensible date?

The government’s financial year (and the corporation tax year) starts on 1 April, a modern quarter day. This summer, a paper from the Office of Tax Simplification (OTS) set out details for a “high level exploration” of bringing the personal tax year into line. The OTS also promised that its work would outline the “additional broader issues” of making 1 January the tax year start date.

Self-employed year basis change?

Somewhat ironically in the following month, HMRC announced a consultation on changing the basis year period used for calculating self-employed tax liabilities. At present, if you are self-employed, you are normally taxed on the profits made in your trading year that ends in the tax year. So, for example, if your trading year ends on 30 June, then in 2021/22, it is the profits for your trading year ending on 30 June 2021 that are taxed.

HMRC wants to scrap this principle and tax the self-employed on their actual trading profits in the tax year starting from 6 April 2023. This would mean pro-rating the profits of two trading years. It also implies some difficult problems in the 2022/23 transitional year. For somebody with a 30 June year end, it could mean taxing profits from 30 June 2021 to 5 April 2023 all in the one tax year.

Fortunately, HMRC does suggest that there would be an optional spreading of “excess profits” over five years. However, the consultation paper made no reference to any revisions to the tax year end date, despite what looks like a golden opportunity…

Meanwhile, back in 2021, do not forget that if you file a paper tax return, your 2020/21 return is due by 31 October. File online and you have another three months.

The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.