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Jonathan Gibson

Don’t miss this new tax rule

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Tax changes coming into force next April have prompted HM Revenue & Customs to remind taxpayers of their new obligations.

The change to capital gains tax (CGT) means that the tax due on the disposal of residential property will need to be paid within 30 days of completion.  It’s a significant change to the current rules, where CGT on selling a residential property doesn’t need to be paid for as long as 22 months after the disposal.  The current system requires reporting the disposal in line with the deadline for submitting a self-assessment tax form.

The new rules, with a shorter deadline for reporting and payment, will mostly affect those taxpayers selling a second home or rental property.  It affects these types of property because private residence relief is available on principal private residences, which means no CGT is due. However, HMRC will require CGT reporting on the sale of a private residence within 30 days of completion from April 2020, even where there is no CGT due for payment.

Even where a taxpayer gifts a residential property in return for no consideration, the new rules and timescales will apply.

It’s been two years since the HMRC announced the new rules, but HMRC believes many taxpayers will be unaware of the requirements next April.  Small-scale landlords and holiday home owners are two groups who are likely to be unaware of the new rules.

To avoid a repeat of recent cases, where a tribunal overturned late-filing penalties imposed on non-resident sellers of UK property due to insufficient publicity of the reporting regime, HMRC is making more effort to publicise these changes.  HMRC has published research aimed at a better understanding of how to warn taxpayers of the changes to CGT payments.  It found that the large number of ‘one-off taxpayers’ were the least likely to be informed about CGT.  This lack of awareness is the result of not using a formal tax agent for guidance.

While solicitors and accountants do tell their customers about reporting and payment requirements, some one-off disposal taxpayers missed deadlines regardless.  The HMRC research acknowledges that the complexity of CGT can result in taxpayers missing payment deadlines.  The research also discovered that some solicitors who took on new clients found their clients were unaware of the need to pay CGT, so had failed to pay when selling properties historically.

Failure to pay CGT on the disposal of properties was found to be most common when taxpayers did not seek professional advice.  These taxpayers would then face potential penalties and fines for late payment of CGT.

The HMRC research found there use of language confuse some taxpayers. One potentially confusing term is ‘payment on account’.  Some taxpayers, including those with experience paying CGT, thought payment on account meant a part payment of tax, rather than the payment of the entire amount due.  Payment on account tax payments faces the possibility of corrections later once HMRC has checked the calculation is accurate.

All respondents to the HMRC survey said they thought the tax charge should be communicated as early as possible, because disposing of property can sometimes be a lengthy process, involving complex tax discussions with professional advisers.

Watch out for this unexpected financial shock in retirement

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Retirement can be a risky time.

There are many risks to navigate in later life, including those which can impact on your financial health.  Added to that list is a potential financial shock that comes about as a result of a little-noticed change to the state pension system.

The risk, identified by insurer Royal London, follows a state pension system change in 2016. This change could result in older couples facing an unexpected financial shock when one of them dies.  The change means a typical pensioner could lose between half and two-thirds of their household income following such a bereavement.

The death of a partner in retirement often results in a fall in household expenditure, although not usually by as much as this forecast fall in household income.  Royal London explains this means potential living standards squeezed.  Steve Webb, Director of Policy at Royal London, said:

“As well as the emotional impact of bereavement, losing a spouse in later life can have a huge impact on living standards.  Under the new state pension system, widows and widowers will inherit little, if anything of their late spouse’s pension and income from an annuity often ceases when the recipient dies.  Household outgoings may reduce somewhat following a bereavement, but income is likely to fall by much more.  Couples in retirement need to make sure they know where they would stand and plan ahead to make sure they do not face an unexpected financial shock.”

So, what’s prompted this new retirement risk?  Before the state pension system was changed in 2016, the death of one member of a married couple in retirement would result in the surviving spouse claiming an enhanced state pension, based on the late spouse’s National Insurance record.

With the introduction of a new state pension system in 2016 came a new set of rules for bereaved spouses.  Instead of the ability to claim an enhanced state pension, there is now minimal scope to inherit a superior National Insurance record.  Royal London pointed out that pensioners in receipt of an occupational pension income in retirement will often continue to receive half of the income, in the event of the spouse dying.

Where retirement income comes from a standard “single life annuity”, it’s often the case that no future income passes onto the surviving spouse.  Ongoing income in this scenario will depend on whether death occurs during the guarantee period for the annuity, which is typically the first 5 or 10 years.

Royal London has made three recommendations for couples approaching or in retirement to help them deal with this potential retirement income risk:

  • Firstly, you should find out where you stand. Finding out your likely financial position means checking how much occupational or private pension income would continue to pay, should your spouse die before you in retirement.
  • Secondly, you need to be careful with your finances earlier in retirement. One way you can mitigate this retirement risk is building up a pot of savings or investments, creating a useful financial buffer in the event your income suddenly falls.
  • Finally, you should consider a financial product that would pay out if one partner were to die. This financial product could take the form of life assurance, although the cost of such cover can be expensive as we get older.

Regardless of the action you decide to take; it’s essential to recognise this retirement risk and plan to mitigate its financial impact on your life and desired lifestyle.

Illiquid funds built on a lie

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The liquidity of investment funds has come into sharp focus in recent weeks, following the trading suspension imposed on investors in the Woodford Equity Income fund. The fund, which reportedly had 85% of its assets invested in illiquid stocks, has been the cause of much debate.

The Bank of England governor, Mark Carney, has now thrown his weight behind criticism of the fund, explaining that such funds are “built on a lie.”  His comments refer to the inclusion of illiquid assets in funds which supposedly allow investors instant access to their money.

It’s not the first time easy to trade open-ended investment funds holding hard to trade assets have come under fire.  In the wake of the 2016 Brexit referendum, some open-ended property investment funds had to place trading restrictions on investors, as they were unable to sell assets fast enough to meet redemption requests.

Carney told MPs, “These funds are built on a lie, which is you can have daily liquidity.”

Where investment fund assets “fundamentally aren’t liquid”, said Carney, or could become illiquid during a market downturn, that “lie” could lead to market instability, as it results in investors expecting the same kind of access to their money as they might expect from a bank account.  Carney explained to MPs that investors should expect terms in line with the liquidity of the assets, and therefore not assume instant access should they wish to sell their holdings.  He said, “We do have to be very deliberate about the types of measures that need to be taken — something that better aligns the redemption terms with the actual liquidity of the underlying investment is infinitely preferable to the situation we have today.”

While his comments were not aimed explicitly at Neil Woodford, they came only a day after Financial Conduct Authority chief executive Andrew Bailey alleged the Woodford fund had exploited regulations “to the full” and had been “sailing close to the wind” when it came to its holdings in illiquid assets.

European rules for investments, known as Ucits, say that investment funds with daily dealing must hold no more than 10% of assets in illiquid assets, such as unquoted stocks.

The FCA chief revealed this week that only two UK investment funds, out of a total of around 3,000, had breached these Ucits rules on illiquid assets.  One fund to breach the limit was Neil Woodford’s Equity Income fund, with the other an unnamed small fund.

When selecting suitable investments, matching the liquidity of underlying assets with your requirements to access the money is an important consideration.

If you decide to invest in illiquid or hard to trade assets, then a closed-ended fund structure, typically an investment trust, could be better suited than the open-ended funds which have a liquidity mismatch.

Sensible investing means taking risks worth taking and at Wells Gibson we advocate taking risks supported by evidence.

Too much pension transfer advice is sub-standard

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The suitability of advice to transfer from a defined benefit (DB) pension scheme to a personal pension has faced a great deal of regulatory scrutiny in the past couple of years.

Deciding to transfer a promise of guaranteed income to the uncertainty of an invested capital value is far from simple.  This choice represents one of the most complex personal finance decisions we will ever have to make.  As a result of this complexity involved, it’s right that the Financial Conduct Authority (FCA) subject financial advisers who offer this advice to a high level of scrutiny.

The consequences for an investor making the wrong choice to transfer are severe and potentially very damaging to wealth in retirement.

The FCA has repeatedly communicated what it expects from financial advisers who advise transferring (or retaining) a defined benefit pension.  They have also been taking more enforcement action against the minority of advisers who fail to live up to the high standards expected.

In their latest update, the FCA has concluded that too much DB transfer advice remains below their acceptable standard.  It’s the first update since December 2018, where they identified unsuitable advice in more than half of cases reviewed.  At the time, the FCA made it clear standards needed to be improved.

By way of comparison, previous work carried out by the FCA concluded that, in the broader financial advice arena, suitability levels were around 90%; still room for improvement, but much better than in respect of DB pension transfers.  Within their update, the FCA noted that more than 3,000 financial advice firms hold the relevant permissions to advise on DB pension transfers.  Of these firms, all but 27 responded to a request to provide detailed information about their activities.

The majority of the firms with permissions to advise on DB pension transfers were doing so between April 2015 and September 2018; 2,426 firms out of the 3,042 firms holding permissions.  Many of these advice firms were carrying out a process known as ‘triage’, to determine whether providing full advice in respect to DB pension rights was worthwhile.  This triage process resulted in nearly 60,000 clients not proceeding to the advice stage.

Around a quarter of advice firms who are active in this DB pension transfer market are facilitating transfers on behalf of ‘insistent clients’, who wish to proceed with a course of action contrary to the advice provided.

Between April 2015 and September 2018, the FCA found that 234,951 DB scheme members received professional advice on whether or not to transfer their pension benefits.  Of those, 69% received a recommendation to move, and 31% were recommended not to transfer.  Of the scheme members advised not to transfer, 13% transferred regardless of the advice, as insistent clients.

The average transfer value was £352,303, with a total of £82.8bn worth of pension benefits advised upon.  To put this figure in context, there is £1.57trn in DB pension schemes eligible for the Pension Protection Fund as at March 2018.

Of the 171,581 clients who were recommended to transfer or who transferred as insistent clients, 70% signed up to ongoing advice from the firm advising the transfer.

The FCA expects advisers to start from the position that transferring their DB pension is unlikely to be a suitable course of action.  This starting position means the FCA is concerned about the proportion of recommendations to transfer, at 69%, which is arguably far too high. Some individual firms had much higher percentages of transfer recommendations than this, exceeding three-quarters of their proposals in some cases.

The FCA does, however, recognise that some firms with a high percentage of transfer recommendations may have filtered out those investors who were less suitable to transfer, during their initial triage process.

Commenting on this update from the FCA on DB transfer advice, Steve Webb, Director of Policy at Royal London, said:

“It is clear that standards of DB transfer advice still vary far too much.  Good advisers are rigorously screening out people who should not transfer and make clear the advantages of staying in a DB scheme.

“But some are relying on unregulated introducers to drum up business and seem to be leaning much too far towards recommending transfers.

“The sooner that action is taken against those who are not doing a proper job, the more confidence consumers can have when they seek transfer advice”.

The FCA will now directly assess the most active firms in the DB transfer market, during the rest of the year.  They will be writing to all firms where the data suggests potential consumer harm, setting out expectations and the actions these firms should now take.

Depending on the outcome of these regulatory assessments in 2019, the FCA will then consider extending their assessments to a broader range of firms next year, as well as introducing a series of events designed to raise advice standards and engage with more people.

When seeking advice on such an important issue, it’s vital to work with a highly qualified financial planner who has extensive experience and will act in your best interests.

Do get in touch with Wells Gibson if you have any questions about your pension benefits.

Is it worth paying into a pension for your children or grandchildren?

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Children are growing up fast.  For parents or grandparents, there are many ways to encourage them to take control of their finances from a young age into adulthood.  With millions of younger workers now having a pension for the first time, perhaps making very modest contributions, an option many parents are unaware of is that they can also contribute to their children’s pension pot too.

A campaign launched by mutual insurer Royal London highlights the ‘hidden advantages’ of making such pension contributions on behalf of children.  The pension contribution by the parent is treated as if the recipient had made it.  For example, if a parent pays £800 into their child’s pension, the recipient will get basic rate tax relief on the contribution, increasing the amount in the pension pot up to £1,000.

Also, there are two further benefits to the child receiving the pension contribution:

  • If the child is a higher-rate taxpayer – which is a possibility for adult children who progress quickly in their careers – they can claim higher rate relief on the contribution made by the parent; this would be done through the annual tax return process and would reduce the tax bill of the recipient;

 

  • If the recipient is affected by the ‘high-income child benefit charge’ and is earning in the £50,000-£60,000 bracket (or slightly above), the money contributed by the parent is deducted from their income before the high-income child benefit charge is worked out, thereby reducing their tax charge. For example, if the recipient is earning £60,000 a year and therefore faces a child benefit tax charge of 100% of their child benefit amount, a pension contribution made by the parent of £8,000 (grossed up to £10,000 by the addition of basic rate income tax relief) would reduce the recipient’s income to £50,000 for purposes of the child benefit charge and would completely eliminate the tax charge.

Is it only benefiting the child?  Not necessarily.  Contributions may also reduce future inheritance tax bills if the parent or grandparent qualifies for one of the standard exemptions such as gifts made from regular income.

The amount that the parent can contribute with the benefit of pension tax relief is not limited by the parent’s pension tax relief limit (known as their annual allowance) but by the annual allowance that their children face – which in many cases will be up to their yearly salary, or £40,000, whichever is the lower.  Higher earners, with income over £100,000 a year, however, face a reduced annual allowance, which can be as low as £10,000 a year, depending on the size of their relevant earnings.

Making a pension contribution on behalf of children is not an option for every parent.  However, if they have some spare cash and maybe they have reached the limit of their pension contribution, then why wouldn’t they want to help improve their children’s or grandchildren’s long-term financial security.

For more information please contact Wells Gibson at integrity@wellsgibson.uk