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Could your protected pension allowance tip over the edge?

An obscure adjustment to old pension benefits, mandated by the courts, might cost some pension owners many thousands in additional tax.  

The problems caused by the tapering of the annual allowance have been making the pension headlines for some time. Whereas the original focus was on NHS consultants and doctors, the issue is now rippling through other higher paid parts of the public sector, such as the senior levels of the armed forces and civil service. The government has started to suggest reforms, but these have concentrated on tweaking membership of the pension schemes involved rather than reforming the pension tax legislation.

Another pension allowance conundrum is now looming, this time involving the lifetime allowance, which effectively sets the maximum tax-efficient value of all your pension benefits. The lifetime allowance has been reduced on three occasions, bringing it down from £1.8m in 2011/12 to £1.0m in 2016/17.

On each occasion the cut was accompanied by the launch of a ‘fixed protection’ option, allowing those affected to retain the existing allowance. So, for example, the 2012 version of fixed protection allowed the £1.8m lifetime allowance to be retained.

However, there was an important condition attached to all these fixed protections: they are lost if any additional contributions are made or any benefits are increased beyond the pension scheme’s normal indexation rules. At worst, an extra £1 of pension could see a fixed protected lifetime allowance of £1.8m reduced to the current standard lifetime allowance of £1.055m. In an extreme case, that could create an extra tax liability of over £400,000.

In theory the restriction means anyone with fixed protection should studiously avoid any risk of falling into that extra pension trap. In practice, some people – particularly the non-advised – forget or are unaware of the pitfall.

Now there is another potential danger, even for the diligent. An arcane 2018 High Court ruling on how to deal with equalisation of certain state-related pension benefits from the 1990s threatens to make automatic small increases to the benefits of some members of final salary pension schemes. Potentially enough to tip some over the threshold.

The situation now is that:

  • The law, as interpreted by the High Court, says these ‘GMP equalisation’ adjustments must be made.
  • Many pensions schemes have been, or are in the process of, calculating what those payments should be; but
  • Everything has gone on hold for fear of the tax consequences. HMRC has not issued any guidance on the matter and is still ‘carefully considering’ what to do.

If nothing else, the problem is a reminder that if you have any form of pension protection, it can be highly valuable and advice should always be sought before any changes are made.

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

New thinking for Labour on taxes?

New proposals for reforming capital gains and income tax have been published by an influential think tank which could make their way into an election manifesto.

The Institute for Public Policy Research (IPPR) is “the UK’s pre-eminent progressive think tank”, according to its website. This may sound like boasting, but it is probably a fair description of the IPPR’s position in the nerdy world of political think tanks.

Unsurprisingly, its thoughts regularly work through to become Labour Party policy and, less frequently, are also ‘borrowed’ by other political parties. It is therefore worth taking note when the IPPR publishes proposals on personal tax reform, which it did in September. With an election apparently drawing ever closer, the IPPR’s ideas assume even greater relevance.

Its latest proposals, in a paper entitled, “Just tax: Reforming the taxation of income from wealth and work” focus on two areas.

Taxing capital gains

The IPPR starts from the premise that “that income from wealth should be taxed the same as income from work”. This translates into a plan to:

  • tax capital gains as income;
  • scrap the capital gains tax (CGT) annual exemption of £12,000 and replace it with a minimal allowance of perhaps £1,000;
  • remove the CGT exemption which currently applies on death; and
  • withdraw most CGT reliefs, other than those for an individual’s main residence.

The IPPR floats the possibility of reintroducing some allowance for inflation (remember indexation relief?) or a minimum rate of return linked to 10-year bonds (which currently yield about 0.6%).

Income tax and National Insurance Contributions (NICs)

The IPPR proposal here is more radical and will affect many more taxpayers:

  • Income tax and NIC rates should be merged to produce one rate, which applies to all income, from whatever source;
  • The personal allowance should be reduced to bring it into line with the starting point for NICs (about £8,600); and
  • Tax rates should rise gradually, rather than using the current band approach. For example, the IPPR suggests the rate could start at 2% and rise to 50% on income above £100,000.

If this system were adopted on a tax-neutral basis, that is, producing the same income for the Exchequer as the current structure, the IPPR says that “around 80%” of taxpayers would see a rise in take home pay. The obvious corollary goes unmentioned.

If you needed a reason to revisit your tax planning now rather than later, the IPPR may have just supplied it…

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

Annuity rates hit 25-year record low

Annuity rates hit their lowest level since 1994 in September, with implications for those making retirement decisions.

Since the introduction of pensions flexibility in 2015, annuities have become much less popular as a way of converting a pension fund into income. The most recent figures from the Financial Conduct Authority show that over five times as much money is placed in income drawdown now as goes towards annuity purchase.

Now annuity rates have been back in the news, with several press reports citing calculations from the Moneyfacts comparison website that rates had hit their lowest level in 25 years. According to the data, a 65-year-old purchasing an ordinary pension annuity, with no increases in payment and no minimum payment period, could expect to receive just 4.1% – £410 a year per £10,000 of investment. That was a significant drop from the start of 2019, when an extra £58 a year was on offer.

In the short term, the cause of the annuity rate decline has been the drop in long-term interest rates since January. For example, the yield on a 15-year UK government bond fell from 1.56% at the start of the year to 0.86% by mid-September. This fall in long-term rates has been a global phenomenon, resulting in negative interest rates spreading to many international bond markets.

The longer term fall in annuity rates also reflects declining interest rates, which have been on a multi-decade downward path. In addition, increased life expectancy has put downward pressure on annuity rates, although this effect has receded latterly as recent statistics have suggested life expectancy improvements are flatlining.

The preference for drawdown, however, comes with investment and mortality risks – investment returns may be below expectations and/or you may outlive your pension pot. If nothing else, the annuity rate can provide a benchmark against which to consider the rate of income withdrawals.

If you are approaching retirement, make sure you take advice before dismissing annuities completely, especially if you are risk averse or will have few other sources of retirement income.

If you are some way from retirement, remember that 4.1% figure when you think about how much you want to contribute to your pension. After all, at 4.1% a £25,000 pension annuity – with no inflation protection or spouse’s benefits – will cost about £610,000…

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.

Interest rates back on the slopes

In September the US and European central banks cut interest rates, again.

When the US central bank, the Federal Reserve, cut its main interest rate by 0.25% at the end of July, it was the first reduction in over 10 years. Less than two months later, the Fed announced a second cut by another 0.25%.

The Fed’s move followed on from a rate change at the European Central Bank (ECB). Here, the main rate was left unchanged (at 0.0%), but the negative rate applied to deposits made by commercial banks was moved from -0.4% to -0.5%. A bank leaving €1m with the ECB for a year will have to pay €5,000 for the privilege.

The Bank of England kept its interest rate unchanged at 0.75% in September, not least because, like the rest of the UK, it is waiting to see what happens on the Brexit front. Investors in government bonds appear to be expecting further rate cuts as the return available on gilts maturing in six months to 12 years’ time is less than the current base rate.

The central banks are worried about a slowing global economy and the risk of a recession. They are less concerned about their nations’ savers. This stance was highlighted in a headline in Bild, Germany’s best -selling newspaper, which took aim at Mario Draghi, the head of the ECB: “’Count Draghila is sucking our accounts dry’.

Depositors in the UK are not yet facing negative interest rates, although there are plenty of bank and building accounts (including ISAs) closed to new business which pay next to nothing (e.g. 0.1% for the Halifax Bonus Gold account). At the time of writing, the best rate available for instant access was 1.61% from a sharia account, compared with the latest published CPI inflation rate (for August) of 1.7%.

There are still income yields of 4% and more available – for example the average UK share dividend yield at the time of writing was 4.23%. However, the higher income comes with greater risk to capital, making independent investment advice essential. There has been evidence enough just this year, in the problems at London Capital and Finance, that chasing the highest yields without advice can be a dangerous strategy.

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.

Cracking down on compliance pays for HMRC

New figures show HMRC’s “customer compliance” efforts are yielding substantial sums.

In early August, HMRC issued its annual report and accounts for 2018/19. While not everyone’s choice of holiday reading, it did contain some eye-opening information about the “compliance yield” – how much HMRC raised from its work in countering tax avoidance schemes, tax evasion and plain fraud.

HMRC puts the figure at £34.1bn out of total revenue raised in 2018/19 of £627.9bn. Of that £34.1bn, £13bn was hard cash collected as a result of investigations, a 27% increase on investigations from the previous year. The sharp rise was partly due to individuals settling with HMRC ahead of April’s introduction of the controversial Loan Charge, targeting disguised remuneration schemes.

UHY Hacker Young, the accountants, suspect that HMRC’s improved compliance cashflow could also be due to last year’s offshore tax campaign. This established a ‘requirement to notify’ HMRC of undeclared income or gains by September 2018, or face penalties of up to 200% of the amount due, plus interest.

There was probably also a boost from the implementation of the OECD’s Common Reporting Standard, generating automatic exchange of information between national tax authorities. This may have become apparent from the appearance of questions about tax residence in many financial documents or from existing institutions with which you hold investments.

In its accounts, HMRC highlights that it places about 500,000 ‘Wealthy Individuals’ into their own separate ‘customer group’. To join this select group requires an income of over £150,000 or assets above £1 million. Those lucky members are the focus of special teams with “an in-depth understanding of the finances, behaviours and compliance risks of wealthy individuals” and “strong data-led approaches to identify who is not paying the right tax”.

The unspoken message from HMRC is that sidestepping tax, whether by contrived avoidance schemes, evasion or fraud, is becoming ever more unlikely to succeed. On the other hand, there remain plenty of straightforward planning opportunities with which we can help you.

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

How do you feel about taking a pension at 75?

Is a state pension age (SPA) of 75 looking more likely?

Recommendation
The SPA should better reflect the longer life expectancies that we now enjoy and be used to support the fiscal balance of the nation. The SPA in the UK is set to rise to 66 by 2020 (Pensions Act 2011), to 67 between 2026 and 2028 (State Pension Act 2014) and to 68 between 2044 and 2046 (State Pension Act 2007). We propose accelerating the SPA increase to 70 by 2028 and then 75 by 2035.

The statement above in the report Ageing Confidently – Supporting an ageing workforce, released in August by the Centre for Social Justice (CSJ), is slightly misleading. A SPA of 68 is pencilled to be phased in between 2037 and 2039. Further legislation will not be introduced until after another SPA review is completed, which, by coincidence, won’t happen until after the next election is due.

The CSJ is not a think tank that regularly makes the headlines, but it does have a high-profile chairman – Iain Duncan Smith, the former Conservative leader and former Secretary of State for Work & Pensions. During that tenure he pushed through some of the SPA increases outlined above. With this in mind, the statement by the CSJ could be interpreted as kite-flying on behalf of the Conservative government, just as the Institute of Public Policy Research (IPPR) plays a similar role for the Labour Party.

The CSJ’s argument for raising SPA with such haste is financially driven. The report notes that at present there are 28.2 pensioners for every 100 people of working age, but by 2050 this is projected to increase to 48 per 100 – almost one pensioner for each two working age members of the population. As the state pension system is funded on a pay-as-you-go basis, that jump has serious consequences even before the impact of rising healthcare costs is considered. Raising SPA to 75 by 2035 would keep the ratio at between 20 and 25 per 100.

Such a steep rise in SPA would be politically problematic as the ongoing protests and resulting court cases about increases in women’s SPA prove. However, the CSJ’s point about whether the current SPAs will continue to be affordable isn’t going away. If nothing else, it’s a reminder that supplementing the state pension with private provision is a surer path to a reliable retirement income.

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.

 

Probate delays affecting estate settlements

There are currently long delays in gaining probate on the estates of the recently deceased.

Late in 2018, the government issued a written statement announcing its intent to go ahead with controversial increases in probate fees for England and Wales. Instead of the current flat fees of £155 for applications through a solicitor and £215 for individual applications, draft legislation was issued with a sliding fee scale that rose to £6,000 for estates valued at over £2m. To many, the measure looked more like a new tax than a fee increase.

A start date wasn’t set, but the legislation was widely expected to come into force around the end of April 2019. However, the statutory instrument to bring about the change has not yet been presented to the House of Commons. HM Courts and Tribunals Service (HMCTS), which administers probate, has recently told the Law Society that it does not know when, or if, any fee changes will happen. The delay could be due to Brexit dominating parliamentary business, the near universal criticism of the measure and/or a possible election coming up.

Alongside this uncertain legislative approach, HMCTS has launched a new probate administration regime that has already encountered teething problems. This in turn has run into an acceleration in probate applications as solicitors and executors have rushed to pre-empt the planned fee increase and pushed through the paperwork.

The result has been a backlog at probate registries throughout England and Wales. HMCTS is now advising solicitors not to chase any applications until at least eight weeks have passed. However, HMRC has said it will make no concessions on when it will start charging interest on inheritance tax, which is due by the end of the sixth month after the month of death.

Bereavement is already a difficult time for many families, so these delays could cause more stress and remind us that winding up an estate can be painfully slow. If you have life assurance policies, one way to sidestep that delay – and potentially save inheritance tax – is to place the policies in trust. Alas, trusts carry their own complications, so do seek professional advice before taking any action to change policy ownership.

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

 

Who are the top 1% of income tax payers?

A recent report looking at who pays the most income tax reveals some interesting findings.

The Institute for Fiscal Studies (IFS) published a briefing note in early August with a detailed answer to the question of what it takes to enter the 1% club. Around 310,000 people make up this cohort, with some predictable and not so predictable traits:

  • They have taxable income of at least £160,000 in 2014/15. The historic nature of the data reflects both HMRC’s systems and the fact that the 2015/16 numbers were distorted by the introduction of new dividend tax rules in the following year.
  • Typically, they are male aged 45–54 based in London, with an additional £550,000 of income. To quote the IFS, the 1% club is “disproportionately male, middle-aged and London-based”.
  • They live in 10% of the 650 parliamentary constituencies, which contain half of the top 1% population. In 2000/01, 78 constituencies were needed to reach the halfway mark.
  • They have over a quarter of their income made up from partnership and dividends, as the pie chart shows. This reflects the fact that many are business owners.
  • They manage fluctuating income levels. The top 1% is not a stable group, which may be some solace if you do not currently have the necessary membership credentials. The IFS found that roughly a quarter drop out each year and only half remain for five consecutive years. The corollary is that there is a much higher chance of being in the top 1% at some point in your life than in any given year. The IFS calculated that 3.4% of all people (and 5.5% of men) born in 1963 were in the top 1% at some time between 2000/01 and 2015/16.

However, being a member of the 1% taxpayers club also means accounting for 27% of all income tax collected by HMRC. So failing to qualify may reflect some careful and expert financial planning…

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

 

Money purchase annual allowance penalties – pick a number

A Freedom of Information (FoI) request has revealed a gap in HMRC’s knowledge about how many people have been hit with penalties around the annual allowance.

The annual allowance, which effectively sets the tax-efficient ceiling on annual pension contributions, used to be a subject of little interest, even among pension professionals. When it started life in 2006 at £215,000, it was of limited relevance beyond a small minority of highly paid executives.

These days the annual allowance is one of the most contentious aspects of pension legislation. The table below, using data provided under an FoI request published at the start of this year, helps to explain why.

While the taper rules for the annual allowance have been causing many problems in the public sector, for example the widely reported issues among NHS consultants, there is another aspect of the annual allowance rules which has just had a light shone on it by the new FoI request.

Withdrawing income

Since 2015/16 there has been a reduced allowance – the money purchase annual allowance or MPAA– which applies, regardless of income level, as soon as you first draw retirement income using pension flexibility. To enforce this, the law says that within 31 days of starting flexible income, your provider must supply you within a ‘flexible access statement’. You then have 13 weeks to inform any money purchase scheme to which you or your employer are contributing. Failure to do so is subject to penalties of an initial £300 plus further amounts of up to £60 a day until HMRC are notified.

The FoI request asked a simple enough question: how many people had suffered the penalties? HMRC’s reply was that it did not have an answer and it would be too costly for it to find out.

Whatever you feel about that response, it is a reminder of how complex the rules for pension contributions have become, even for those who police them. The safest course of action is to seek expert advice before making any change to your pension arrangements to make sure you don’t become an under-reported casualty.

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. 

Flexing a ten-year old muscle…

The US Federal Reserve has cut its main interest rate for the first time in ten years, but will it have a knock-on effect?

 Source: US Federal Reserve

The last time the US central bank, the Federal Reserve, cut its main interest rate was in December 2008, in response to the fallout from the financial crisis. That last drop was preceded by nine interest rate cuts since September of the previous year.

The final 2008 cut, ten days before Christmas, took the Federal Funds rate down from 1.00% to a range of 0.00-0.25%. As the straight line on the graph shows, the rate remained there, just above zero, for the next seven years. It was subsequently gradually nudged up, a quarter of a per cent at a time, reaching 2.25%–2.50% last December.

The new 0.25% cut announced from the beginning of August was widely anticipated, although there were some investors who had forecast a 0.50% reduction. The backdrop to this cut, however, is very different from that of December 2008. Now the US economy is close to full employment and, while growth did cool in the second quarter, it is still running year-on-year at 2.3%. In other times, such conditions would not prompt a rate cut. The central bank is acting now because it wants to prevent the economy slowing any further, at the end of an unusually long period of growth.

On this side of the Atlantic, the European Central Bank has hinted that it could cut interest rates soon. Although the bank took no action in July, it did change its meeting statement to say that it “expects the key ECB interest rates to remain at their present or lower [our italics] levels at least through the first half of 2020”.

The Bank of England’s next interest rate move remains unclear after maintaining the current rate again for August. The various Brexit scenarios could see rates increased to protect a falling pound or as a gradual return to ‘normality; or rates could be cut to stimulate the economy.

‘Lower for longer’ has been a description of the path of interest rates since 2008. It is now beginning to become ‘lower for ever’. Make sure that if you have cash on deposit beyond a rainy-day reserve, you have a good reason for doing so.

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.