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Lessons from London Capital & Finance

One of the last decade’s more infamous financial scandals has finally reached a conclusion.

The name of London Capital & Finance Plc (LCF) sounds impressive, but the business behind it was anything but. In the late 2010s, LCF issued ‘mini-bonds’, raising capital from individual investors to lend on to small businesses. LCF offered rates of up to 8%, tax-free via ISAs, which unsurprisingly attracted a large inflow of cash. Then, in mid-December 2018, the Financial Conduct Authority (FCA) ordered LCF to withdraw its marketing material with immediate effect.

LCF’s investors had a worrying Christmas followed by a grim new year in which the company went into administration before January had ended. Almost 12 months later, the Financial Services Compensation Scheme (FSCS) declared that LCF had failed. However, that did not mean investors received any immediate compensation. To add insult to injury, in March 2019, HMRC wrote to LCF’s ISA holders saying that their plans did not satisfy the ISA regulations and therefore any income from them was taxable.

A raft of legal arguments followed involving both the FCA and FSCS about the nature of LCF’s offerings and whether the company gave ‘advice’ when promoting its products. In mid-April 2021, 28 months after the FCA first blew the whistle, a resolution emerged. The FSCS has since paid full compensation to about 25% of LCF investors while the Treasury will pay the remaining 75% on their investment, capped at £68,000. This will ultimately cost you, the taxpayer, about £120 million.

The Treasury’s payment will not be quick. The government first must pass primary legislation “as soon as parliamentary time allows”, after which cheques will flow within the following six months. While that may seem painfully slow, in truth those 8,800 investors are lucky to receive anything. As the Treasury statement and the need for new legislation both underline, existing law should leave most LCF investors with nothing.

The whole acronym-laden saga is a classic example of the wisdom of the saying: “If it looks too good to be true, it probably is”. Always take advice before parting with your money.

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.

Investing in shares should be regarded as a long-term investment.

An investment sector reshuffle

The fund performance league tables have gained over 530 new funds since April.

In the middle of April, the trade body of investment managers, the Investment Association, made a radical revamp to its fund sectors. As a result, many of the investment performance league tables have been changed subtly, even though the performance of the individual constituents is unaltered. The reform had two elements.

Addition of exchange traded funds  

Until the change, the Investment Association’s 39 investment sectors all contained two main types of fund:

  • the traditional unit trusts; and
  • more recently created open ended investment companies (OEICs).

To most investors, the two types looked virtually identical and over the years many unit trusts have converted to OEICs. A major feature of both is that the prices at which units/shares are purchased or sold by investors is calculated by the fund manager, based directly on the value of the underlying assets.

The Investment Association has added a third fund to this duo ­– exchange traded funds (ETFs), which are an increasingly common structure. ETFs are investment companies, similar in many ways to OEICs, but traded on the stock exchange. As a result, it is the market which sets the prices of ETFs, not those managing the funds. Managing is perhaps a generous word, as most ETFs are index funds, mirroring the constituents of a market index, such as the FTSE 100 or the S&P 500. Their structure is such that the number of shares in an ETF can expand and contract, depending upon demand, a factor that distinguishes them from investment trusts.

New sectors

The arrival of so many ETFs prompted the Investment Association to revise its Global Bonds sector, which would otherwise have had 125 new entrants. That sector has now been fragmented into 14 new bond sectors covering every niche from Global Inflation Linked Bonds to EUR High Yield.

Two Investment Association sectors, Specialist and Global, both had more than 70 new ETF entrants. In total, the Investment Association added over 530 ETFs to its sector listings. The new arrivals mean that funds can change their performance ranking merely because the sector size has been swollen by the influx.

More than ever, seeking advice is important when choosing from what are now over 4,100 funds spread across 52 sectors.

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. 

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

Are ISAs past their best-before dates?

The role of Individual Savings Accounts (ISAs) has changed since they were launched over 20 years ago, so are they still worth having?

Since ISAs were introduced in April 1999 the ISA portfolio has been extended to include:

  • Junior ISAs (for the under-18s).
  • Help to Buy ISAs (no longer on sale).
  • Innovative Finance ISAs (for crowdfunding investors).
  • Lifetime ISAs (for 18-39-year-olds and a partial replacement for the Help to Buy plans).

Despite the proliferation of ISAs, sales remain dominated by the two basic variants launched in 1999 – the cash ISAs and stocks and shares ISAs. However, tax changes in recent years have called the value of both into question:

  • The Personal Savings Allowance (PSA) allows basic rate taxpayers to receive £1,000 of interest free of tax (£500 for higher rate taxpayers and nil for additional rate taxpayers). At current interest rates, exceeding those thresholds requires a substantial deposit (e.g. £100,000 @ 0.5% = £500). As a result, for many savers an ordinary bank/building society deposit is as tax-free as a cash ISA with fewer constraints.
  • It is a similar story with stocks and shares ISAs and the dividend allowance, which allow all taxpayers to receive £2,000 of dividends free of tax. At the current average yield on UK shares, that threshold is breached at around £72,000.
  • For stocks and shares ISAs, there is also the capital gains tax (CGT) annual exemption to consider. At the current level of £12,300, it makes the CGT freedom of ISAs academic for many investors.

So, are ISAs past their best-before dates? For some investors, they probably are, particularly if savings are modest. For others, ISAs can still offer benefits:

  • They leave your PSA, dividend allowance and CGT exemptions unused.
  • There is nothing to report on your tax return.
  • If you invest regularly over a long term, the ISA tax freedoms can become highly valuable, as the growing band of stocks and shares ISA millionaires can testify.

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. 

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. 

ESG comes into its own

Three letters, ESG, have become a major driving force in investment decisions.

ESG – environmental, social and governance – considerations are playing an ever-increasing role in investment decisions. What used to be classed as ethical investment, socially responsible investment (SRI) and green investment have now to some extent merged under the ESG banner. The table below gives a taste of the broad range of ESG investment considerations.

Environmental Social Governance
Carbon emissions

Forest destruction

Pollution

Waste management

Resource use

Employee treatment

Child labour

Slave labour

Human rights

Workplace health & safety

Workforce diversity

Board diversity

Executive remuneration

Political influencing

Tax policy

In 2020, the popularity of ESG funds among the UK investing public grew dramatically, perhaps at least in part a response to the pandemic. The Investment Association’s (IA) ‘Responsible Investments’ category saw net retail sales more than treble to £10bn, almost a third of all 2020 sales and equal to the 2019 total for net retail sales. The IA 2020 statistics also show that over the year the value of funds in the category increased by two thirds, to £45.7 billion.

The latest figures from the IA show that were ESG funds to be classed as a fund sector, they would represent the eighth largest of the IA’s 38 fund sectors. However, they are not a unique sector as there are ESG funds to be found covering nearly all investment areas.

Across these areas ESG funds also take different routes to implementing the ESG approach. It is common for fund managers to rely on external ESG rating bodies, which do not always agree with each other. As is always the case with investing in funds, it is best to take advice on what is under the bonnet rather than relying on the marketing badge outside.

If you’d like more information around ESG investment, please get in touch.

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.

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

Should you incorporate?

The planned increase in corporation tax has changed some of the mathematics on incorporation.

The Budget announced a significant change to corporation tax from 2023:

  • Small companies, with profits of up to £50,000, would continue to pay the tax at the current rate of 19%, subject to adjustments for associated companies and financial periods of other than 12 months.
  • Large companies with profits of over £250,000 will pay corporation tax at a rate of 25%.
  • For companies whose profits fall between £50,000 and £250,000 HMRC have said that there will be “marginal relief provisions”, which have now been set out in the Finance Bill. As under previous corporation tax regimes, the marginal relief is given by applying the lower rate up to the small companies limit and then applying a higher than standard marginal rate to profits above that threshold. With the new rates from 2023, the £200,000 band of profits above £50,000 will suffer a marginal tax rate of 26.5%.

At present, from a tax viewpoint, it can be better to run a business via a company rather than on a self-employed basis. This is mainly because a company will allow the bulk of earnings to be received as dividends, thereby avoiding national insurance contributions (NICs). While this approach will still work for businesses with profits that would attract only the 19% small companies’ rate, it is a different picture for higher profits, as the example below shows.

The decision on business structure should never be made based on tax alone as there are many other factors involved. However, the deferred tax changes announced in the Budget may tip the scales for some. As ever, advice based on your personal – and business – circumstances is essential.

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

 

 

Global dividends in 2020

A recent report showed that global dividend payments held up much better than those in the UK in 2020.

  Source: Janus Henderson

For investors in UK shares and funds investing in UK companies, 2020 was a grim year when it came to dividends. The pandemic cast a long shadow over the pay outs to investors:

  • Early on, the Bank of England effectively stopped all the major UK banks, including those mainly focused overseas, from paying dividends. The timing of the Bank’s decision meant that the first dividends to disappear were final dividends, usually the largest of the year.
  • Later, with oil prices having hit new lows, the UK ‘s two largest oil multinationals, Royal Dutch Shell and BP, both dramatically cut their quarterly dividends. The pair were in the top three of dividend payers by overall value between 2016 and 2019, so their decision hit many income funds hard.
  • The economic uncertainty created by the pandemic encouraged many companies to cut or suspend dividends to preserve their cash holdings.
  • More than a few companies took advantage of conditions to make cuts to dividend payments that had been looming for some time, but which had been sitting in the ‘too difficult’ tray.

The picture outside the UK was recently brought into focus in the latest edition of Janus Henderson’s Global Dividend Index, which covered the final quarter of 2020 and the year as a whole. It showed that:

  • Globally, between the second and fourth quarters of 2020, 12% of companies cancelled their dividends while 22% cut them. The corresponding figures for the UK were 32% and 23%. The much higher cancellation figure explains why the UK’s relative performance looks so disappointing.
  • The global sector with the largest overall dividends reductions, amounting to $70bn, was banking, which accounted for a third of total dividend reductions. This total was more than three times that of the next sector, oil and gas. Both sectors are major parts of the UK market.

The Global Dividend Index demonstrates that globally diversified investment can produce different returns from an investment portfolio focused on the UK, despite the UK’s many multinational companies. By the end of 2020, the long-standing reign of ‘UK All-Companies’ as the largest investment fund sector had been ended by the ‘Global’ sector.

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.  

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 twenty-year IHT freeze

The freeze on the inheritance tax (IHT) nil rate band will mean more tax from more estates.

The Big Freeze

In March 2006 the then Chancellor, Gordon Brown, announced that the IHT nil rate band for 2009/10 would be £325,000. Announcing the change over three years before it would happen was seen by some as a political tactic, kicking a contentious topic down the road. Little did anyone anticipate at the time that the figure of £325,000 would still apply two decades later. However, the announcement in the Spring 2021 Budget of a further freeze on the nil rate band means that it is now not due to change until at least 6 April 2026.

As the current Chancellor explained in his speech, albeit in the context of frozen income tax thresholds, “…this policy does remove the incremental benefit created had thresholds continued to increase with inflation”. In the case of the nil rate band, that ‘incremental benefit’ is now no small number. If the figure Gordon Brown chose for 2009/10 had been increased in line with CPI inflation from 2010/11 onwards, as the graph shows, it would now be £417,000 – over 28% above its actual level.

The difference theoretically means up to an extra £36,800 in IHT at the standard rate of 40% in 2021/22. By 2025/26, the nil rate band would have been £450,000, based on the inflation assumptions made by the Office for Budget Responsibility.

The residence nil rate band (£175,000) has also been frozen until April 2026. Before the Chancellor’s announcement that he would be freezing the nil rate bands, there had been suggestions that Mr Sunak would introduce some reforms to IHT, drawing on two reports which were written by the Office of Tax Simplification at the request of an earlier Chancellor. However, there was nothing in the Budget, although subsequently a relaxation in the requirements for IHT returns from 2022 was announced.

The unspoken message from the Chancellor is that he will continue to look to IHT to raise some much-needed revenue, making estate planning more important than ever.

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

 

Were you born after 5 April 1971?

A new consultation paper has set out more details of an increase in the normal minimum retirement age. 

In February the Treasury and HMRC published a consultation paper on implementing an increase in the normal minimum pension age (NMPA) from 55 to 57. The NMPA sets the earliest age at which retirement benefits (lump sum and/or income) can normally be drawn from a pension. The rise to 57 was originally announced back in 2014, but all then went very quiet. Eventually, in September last year, the Treasury replied to a question from the chair of the Work and Pensions Select Committee by confirming the 2014 announcement remained in force: the minimum pension age would indeed rise to 57 in 2028.

Unfortunately, the Treasury minister’s response was light on detail – there was no mention of the precise timing in 2028, whether there would be any phasing in or if transitional protection would be available. Given the deep water in which the government has found itself with the increase in women’s State Pension ages (SPA), the lack of information was surprising. 

Changing pension ages

The consultation paper addresses the gaps in last autumn’s brief answer with the following proposals:

  • The NMPA will rise to 57 on 6 April 2028, coinciding with the date on which the state pension age rises to 67 (after two years of phasing in).
  • There will be no legislative phasing in for the higher NMPA, although pension scheme providers can choose to bring it in earlier than April 2028. One odd effect of this is that between 7 April 2026 and 5 April 2028 there will be people who reach age 55 and can draw pension benefits but, if they do not do so within that time frame, will have to wait until age 57 is reached.
  • You will still be able to draw benefits before age 57 on or after 6 April 2028 if you had the right to do so on 11 February 2021 or are a member of the firefighters, police and armed forces public service pension schemes.

If this change affects your retirement planning, make sure you take advice as soon as possible.

Inflation: at a turning point?

We could see a jump in inflation soon.

The pandemic has posed problems for the Office for National Statistics (ONS) when it comes to calculating the rate of inflation. For example:

  • How do you measure the price of an item or service when a lockdown means it is not for sale? Two good examples are the ‘Restaurants and hotels’ category, which in 2020 took up almost 12% of the Consumer Prices Index (CPI) and the ‘Package holidays’ subgroup of the ‘Recreation and culture’ category which had a 4.2% weighting in the Index. In February 2021, the ONS said that in the previous month it had managed to collect only 88% of the prices it had collected before the first lockdown.
  • Are the right items and services being measured? All inflation indices measure the prices of a ‘basket’ of goods and services. The ONS reviews and amends that basket each year to reflect changing spending patterns. This is often a source of humorous headlines, such as the replacement of crumpets by individual fruit pies last year.

The new ‘basket’ for 2021 would normally have been based on expenditure in 2019. However, that was in the pre-pandemic era and spending patterns changed in 2020, as we all know. The ONS has therefore created a special 2021 ‘basket’ that uses data from both 2019 and, where there have been significant changes, 2020. As a result, the weighting for ‘Restaurants and hotels’ and ‘Recreation and culture’ have both fallen while those for ‘Food and non-alcoholic beverages’ and ‘Alcoholic beverages and tobacco’ have risen. Eating and drinking in is the new dining out…

Annual inflation over the last ten years to January 2021 has averaged 1.8%, as measured by the CPI, which means overall prices have increased by almost a fifth since 2011 – bad news for anyone with a fixed income.

Although 2021 started with annual inflation of 0.7%, by May the figure is likely to be nearer to 2% as a result of price rises already built in. These include the 9.2% rise in capped gas and electricity bills and council tax increases of up to 5%.

For all the problems of pandemic measurement, inflation is still out there and needs to be built into your financial plans.

Pensions lifetime allowance devaluation continues

The Budget announced a five-year freeze to the standard lifetime allowance.

  

The standard lifetime allowance (SLA) is an important pensions number. It effectively sets the maximum tax efficient value of all your retirement benefits, in the absence of any legislative protections (of which there are many). To the extent that the SLA is exceeded there is a special flat rate tax charge which is 25% if the excess is drawn as taxable income and 55% if it is received as a lump sum.

When the SLA was first introduced in 2006, it was set at £1.5 million, a level which equated to an annual pension income of £75,000, based on a standard legislative assumption of an annuity rate of 5%. The initial legislation set out increases for the SLA to £1.8 million in 2010/11. That proved to be the SLA’s highwater mark. It was frozen in the following year and then the first of three cuts were introduced. By 2016/17 the SLA was down to £1 million.

For three tax years from 2018/19 the SLA has been index-linked, but from April 2021 it will be frozen for half a decade at £1,073,100. Had the original £1,500,000 level been index linked, the SLA would now be £2,082,100 – not far short of double the actual level.

The devaluation of the SLA has three consequences:

  • The pension protected from the SLA tax charge has fallen. On the legislative basis which applies to defined benefit (final salary) schemes, it will now be £53,945. For defined contribution pension arrangements, such as personal pensions, the erosion is greater. Low annuity rates mean that £1,073,100 will buy an inflation proofed income of just over £31,000 a year (before tax) for a 65-year-old. 
  • More people are being caught by the special tax charge. HMRC’s latest (sic) figures show over 4,500 SLA charge payers in 2017/18 against 1,240 five years earlier. 
  • The legislative protections, some of which date back to 2006, are all the more valuable.

If you think you might be affected by the SLA tax charge, either based on current benefits or when you reach retirement, take advice as soon as possible. You could find that from now on it is best to exclude pension contributions from your retirement planning.

The value of your investment and 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.