Recent changes to Inheritance Tax (IHT) legislation are certainly helping individuals to pay less tax on death, however it’s fair to say the system is slightly more complicated.
Last year, the government introduced a new allowance, the Residence Nil-Rate Band (RNRB) to reduce the impact of IHT on families and to make it easier to pass on their home to children and grandchildren. The allowance applies where a residence is passed on death to a direct descendant. The RNRB increased from £100,000 to £125,000 in April 2018 and will rise to £175,000 in tax-year 2020/21 when it will continue to rise in line with the Consumer Price Index. One thing though, the RNRB cannot exceed the value of the home passed onto children and grandchildren.
The RNRB is different to the existing nil-rate band which applies to everyone and will remain at £325,000 until tax-year 2020/21. Married couples and civil partners may transfer their assets to one another tax-free and the surviving partner can use both allowances. This means that couples can pass on up to £650,000 in tax-year 2018/19. However, if the estate includes their home and is to be passed onto their children and/or grandchildren, they can pass on £900,000 when both RNRB allowances of £125,000 are included. By tax-year 2020/21, they will be able to pass on up-to £1mn in assets tax-free. Furthermore, the RNRB is available to anyone who has downsized, (or rightsized as we like to refer it as!) or ceased to own a home on or after 8thJuly 2015.
Because the RNRB only applies to direct descendants, it does not apply to individuals with no children or to individuals who would like to leave their home to others not regarded as direct descendants.
Another complication is the tapered reduction in the RNRB at a rate of £1 for every £2 by which an estate’s value exceeds £2mn. However, assets given away in the 7 years before death will not be included in the value of the estate when calculating the tapered reduction – this potentially encourages death bed tax planning to ensure one’s estate falls below £2mn!
Worth also adding that buy-to-let properties do not qualify if they have not been a residence of yours.
Despite the RNRB being welcomed by clients and their advisers, the number of individuals with an IHT liability continues to increase.
Estate planning is a key area where Wells Gibson can add value and is a core part of our Wealth Planning service – in fact, there are a wide range of effective IHT planning techniques at our disposal and these include gifting allowances, Potentially Exempt Transfers or PETs, trusts and Business Property Relief-qualifying investments.
As always, if you have questions and would like to discuss IHT further please contact us.
Whichever way one voted, it is hard not to be dismayed by the shambles that is Brexit, created by all sides. In the event that any deal agreed gets voted down in Parliament, or there is no deal, there is a material chance that the government could fall. One or both of these events would come with great uncertainty.
Wells Gibson sets out three key investment risks relating to Brexit and three key strategies embraced by Wells Gibson to help reduce these risks.
Risk 1: Greater volatility in the UK and potentially other equity / share markets
In the event of a poorly received deal or no deal, it is certainly possible that the UK equity / share market could suffer a market fall as it tries to come to terms with what this means for the UK economy and the impact on the wider global economy. A collapse of the Conservative government and a Labour victory would add further uncertainty.
Strategy 1: Diversify globally across equities / shares
Although it is the world’s sixth largest economy (depending on how you measure it), the UK produces only 3% to 4% of global GDP, and its equity / share market is around 6% of global market capitalisation. Well-structured portfolios hold diversified exposure to many markets and companies. Changing your mix between bonds and equities / shares would be ill-advised. Timing when to get in and out of markets is notoriously difficult. Provided you do not need the money today, you should hold your nerve and stick with your strategy.
Risk 2: A fall in Sterling against other currencies
In 2016, after the referendum, Sterling fell against the major currencies including the US dollar and the Euro. There is certainly a risk that Sterling could fall further in the event of a poor or no deal.
Strategy 2: Own non-Sterling currencies in the growth assets
In the event that Sterling is hit hard, it is worth remembering that the overseas equities that you own come with the currency exposure linked to those assets. Remember too that a fall in Sterling has a positive effect on non-UK assets that are unhedged i.e. the investment manager is not using strategies to offset the impact of currency fluctuations. Whereas, the bond element of your portfolio should be hedged to avoid mixing the higher volatility of currency movements with the lower volatility of shorter-dated bonds.
Risk 3: A rise in UK bond yields (and therefore a fall in bond prices)
The economic impact of a poor or no deal and/or a high-spending socialist government could put pressure on the cost of borrowing, with investors in bonds issued by the UK Government (and UK corporations) demanding higher yields on these bonds in compensation for the greater perceived risks. Bond yield rises mean bond price falls, which will take time to recoup through the higher yields.
Strategy 3: Own short-dated, high quality and globally diversified bonds
Any bonds you own should be high-quality to act as a strong defensive position against falls in equity / share markets. Avoiding over-exposure to lower quality (e.g. high yield, sub-investment grade) bonds makes sense as they tend to act more like equities / shares at times of an economic and equity / share market crisis.
Some thoughts to leave you with
Even if you cannot avoid watching, hearing or reading the news, it is important to keep things in perspective. The UK is a strong economy with a strong democracy. It will survive Brexit, whatever the short-term consequences, and so will your portfolio. Keeping faith in global capitalism and the structure of your Wells Gibson portfolio, as well as holding your nerve, accompanied by periodic portfolio rebalancing is key.
‘This too shall pass’ as the investment legend Jack Bogle likes to say.
What is Financial Planning Week?
Financial Planning Week is a chance for people nationwide to access free financial planning sessions offered by CISI Certified Financial Planners.
This is an opportunity for anyone at any stage of life to book in for an hour long, one-to-one, confidential session between the 3rd-10th October 2018.
The annual campaign, organised by the-not-for profit professional body the Chartered Institute for Securities & Investment (CISI), is a national initiative to help improve the financial fitness of the UK public, while highlighting the fact that CERTIFIED FINANCIAL PLANNERTM practitioners represent the pinnacle of professionalism for their knowledge, skills and integrity. You can also explore the Financial Planning Week website for handy tips and tools on how you can plan well to live well.
Click the link above to find a planner near you and book your free session or you can contact us directly.
Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) represent tax-advantaged opportunities to invest equity capital into very small and often very early stage, or even start-up, privately held businesses. The words ‘equity’, ‘privately held’, ‘small’ and ‘early stage’ immediately point out some of the risks.
There is a certain human appeal towards investing in the next potential Google or similar tech start-up or to own a share of a biotech firm commercialising some aspect of research for the good of mankind. Intuitively, one knows that this is a risky, dice-rolling business and that for every winner there are bound to be some losers and some also-rans. However, the tax breaks afforded by HM Government, for these schemes, risk clouding the due diligence that these investments duly deserve.
It is a mistake to think that these tax breaks are noble in nature. Their purpose is to encourage the supply of capital to these companies in the hope that they will employ more people, who will pay income tax, make NI contributions (individual and company) and pay VAT on goods bought with their wages – and that they will generate higher corporate earnings on which corporation tax can be charged. The tax breaks are provided to improve the risk-return relationship that potential investors in these companies face.
EIS was launched in 1993-1994, as an evolution of the Business Expansion Scheme that went before it. Since it began, it has raised billions of pounds for thousands of small companies. In fact, according to the EIS Association, the official trade body for the Enterprise Investment Scheme, in May 2018, HMRC released the first of its estimates in respect of the number of companies raising funds and the amounts raised through EIS for 2016-17: 3,470 companies raised a total of £1.8mn of funds under the EIS scheme in 2016/17. Remember this is an estimate and judging by previous years, we can expect these numbers to increase.
The VCT scheme was first introduced in 1995. VCTs are similar to investment trusts, raising capital by the sale of shares in the trust, which is then invested into qualifying trading companies.
Researchpoints out that around three quarters of advisers recommend EIS investments and a great majority of these advisers stated that tax benefits were one of the main reasons why they recommend EIS to clients. These findings are surprising and even alarming to us. The tax tail seems to be wagging the investment dog, particularly because a majority believe these investments should be considered before other more mainstream tax breaks (e.g. ISA and pension) have been fully utilised.
Furthermore, it seems a high percentage of private investors who regard themselves as sophisticated or experienced hold EIS investments and an even greater percentage had considered them. When choosing an investment, a high percentage stated that the expected level of return was one of the most important criteria. This alarms us. Even self-selected ‘sophisticated’ investors would appear to be taking far higher risks than they are aware of, not least the risk of real disappointment that returns are poor (or their capital is lost entirely, before the tax breaks they receive).
The fees on EIS and VCT funds are, as one might expect, high in comparison to passive or systematic mutual funds. Annual management charges in the region of 2% to 3% and around 3.5% in terms of total costs strip out considerable upside, and that is before any form of performance fee is deducted. Don’t forget that there are often arrangement fees representing around 2% of each transaction. In the end, investors only receive returns net of costs. When costs are high as they are in this case, intermediaries take an unjustified share of the upside. The proof of the pudding is in the eating.
The risks of EIS and VCT investments are varied and considerable as they both invest in very small unquoted companies. It is our belief that many investors do not have a clear insight into the risk they are taking on. These range from the risk of failure, to owning minority stakes in illiquid private businesses and the risk of changes in the tax regime that may affect the attractiveness of the tax breaks on offer.
The conclusion that we arrive at is that we would not recommend EIS and VCT investments in the event that a client’s other tax reliefs (e.g. pension, ISA, CGT) have not yet been fully utilised. When it comes to investing, diversification, keeping costs low and only taking risks supported by evidence is what matters, yet EIS and VCT products don’t tick these boxes!
These high-risk, tax planning products should only be considered and recommended in very client specific circumstances where all other avenues have been explored, and only for those clients who meet stringent net worth and investor sophistication criteria.
Is the tax tail wagging the investment dog in the UK? From what we can see the answer is yes.