SBA Financial - Solving the financial puzzle... ...piece by piece

Monthly Update - March 2010

The Magic of Compound Tax Relief

If you are sick and tired of the constant taxation on your pocket, then you may want to consider using Venture Capital Trusts (VCT’s) as part of your investment portfolio, to allow you to get some tax back for a change and in a very creative way. How would you like an investment that delivers a 39% increase in your investment, based upon tax relief alone? What’s more, it can be achieved by a diverse portfolio of investments with different liquidity and risk profiles, each held within structures that allow your money to grow tax free, using a combination of Venture Capital Trusts (VCTs) and an ISA.

How does it work? It has some incredible tax advantages that mean you effectively get paid by the taxman to help boost your investment returns, and is achieved by three very simple steps.

Step one: Let’s say you invest £80,000 in a suitable VCT, one that invests in a range of companies, focused on capital preservation; this will then be at the lower risk end of VCT’s, with the target of producing a minimum effective tax-free return of 50% over the life of the investment (Typically 5 Years). Part of this return is then guaranteed 30% upfront in the income tax relief you get from HMRC. In this example this would be a physical tax rebate cheque from the taxman of £24,000.

Step two: Then you invest the income tax relief of £24,000, into a VCT that looks to generate higher investment return, through tax-free capital growth from a portfolio of early stage UK companies. This will then be at the higher risk end of VCT’s, which means that you get another 30% income tax relief on the £24,000 you have just received, so in this case another tax refund of £7,200.

Step three: Now you invest the next £7,200 tax rebate into an ISA to use your full ISA allowance for the current tax year (if you have not already used it). But remember if you are over 50 then you get the new higher ISA allowance, and everyone will get this soon as we reach 6th April 2010. The ISA part of this investment may be again a bit more towards the lower end of investment risk so we balance out the risk.

What is the result? You now have a total investment of £111,200 from your initial investment of £80,000. Your portfolio includes £80,000 in companies targeting capital preservation and modest growth. You have £24,000 spread around 20 to 25 fast-growing early stage UK companies looking to archive much higher returns, plus another £7,200 in a diverse range of ISA funds. Your portfolio is worth £111,200 before you even apply any potential growth in the investments themselves, all of which is made tax-free due to the VCT and ISA structures.

Where is the catch? The initial investment is £80,000 but you will need £111,200 of liquid cash, as it will take a number of months to claim the tax relief back, so you have to create all the investment up front and then claim back in this example £31,200 of tax relief.
There are of course limits, (there always are when it’s good for you and bad for the taxman). So you can only claim up to 100% of your income tax bill, so in this scenario you would need to be paying £31,200 income tax per annum. And lastly the VCTs must be held for at least five years to qualify so although the relief is paid up front, if you do not hold them for 5 years then tax has to be paid back.

The information contained within, including references to taxation, legislation, regulation, or any other issues are correct at time of going to print.

Cash or not to Cash?

Much of the recent press has reported on the current cash ISA rates that are available. Especially in light of the recent announcement of the Retail Price Index hike to 3.7%, meaning it is now increasingly difficult to get an actual real return when invested in cash. A recent article in The Independent on Sunday reported that with cash rates reducing in real terms, many people are not going to be using their full ISA allowances in the near future despite the rise in the allowance, and the obvious benefits to taxpayers, whether they are basic or higher rate taxpayers.

With cash returns at their lowest levels in recent memory, what are the prospects for other asset classes? Well although we do not expect a repeat of the recent strong gains, the underlying conditions remain supportive of credit markets. We also expect that core inflation in the UK should remain subdued and interest rates are likely to remain near their current low level for a considerable time.

In terms of an investment strategy, we believe that some of the more attractive investment opportunities are to be found amongst higher yielding investment-grade names and better quality high-yield issuers, in a recent section in the Sunday Telegraph they highlighted Commercial Property as an option, where rental yields remain attractive following the falls in capital value of office space and factories during the recession. Our view is that when property values fell, it was indiscriminate, and this is continuing as values start to rise a little. So with values now on the up, the fall in rent should not continue as pressure builds up for rental income to increase.

That said the Financial Times recently took the side of the stock market by highlighting the Barclays Equity Gilt Study which shows that the longer an investor holds shares, the higher the likelihood of out-performing cash. The paper showed that shares outperformed cash 66% of the time over a 2 year period, but this rises to 91% over 10 years.

The information contained within, including references to taxation, legislation, regulation, or any other issues are correct at time of going to print.

Government plans to make you build a Nest Egg!

They used to call them personal pensions, and then we were told they were to be personal accounts and all employers would be phased in to have to pay eventually 3% of salary into them. Now thanks to a £363,000 makeover we now have to call them National Employment Savings Trusts. Don’t you just feel like screaming at this government to get on with real issues that will help to get our country back on its feet instead of wasting more of our taxes on yet another new name? (Frankly who cares what you call them) .

The real problem is that we have a massive pension and retirement planning problem, and it’s not going to go away, so we either do something about it now, or we follow the lead of successive governments on this issue and keep our heads well and truly in the sand.

I dread to think how confused employers must be. Even those who actually have suitable workplace pension schemes. Of course, only those firms with more than 120,000 employees will actually have to sign up or be enrolled in phase 1 by 1st October 2012 – and one wonders how many of these will not have workplace pensions well above the required minimum level? (Most of which are falling apart as I write).

For the smaller companies - those employing the bulk of workers in the UK for whom NESTs are likely to be of the greatest value - registration has already been delayed, and will be phased in over the next few years with the full employer’s contribution of 3% not hitting until 2016. For today we will ignore the highly relevant point regarding whether or not NESTs will help the lower paid at all, because of the effect of means testing on pension credits, as few of you reading this are likely to be in that sad position if you plan well now!

As regular readers will already know, I am not a big fan of personal pensions anyway but if they are to be forced on us all (and they will be) then at the very least let’s make sure we get them set up the right way. In my view it means taking into account these key issues.

Do it now don’t put it off any more it will cost you a fortune in the long run.
Make sure you use Salary Sacrifice to get back as much extra free money into the pot
Take an active interest and role in reviewing what your pension plan is doing
Look to get a low cost base in terms of plan charges (not cheap) you get what you pay for
Use employers NI rebates to help fund the cost, it ‘s better for the employer and the employees alike
Get true independent advice, only they have access to the whole market for you
Expect to pay a fee for the advice (there is no such thing as a free lunch) you get what you pay for
Make sure there is a true investment portfolio service included
You are paying the advisor so make them earn their fee with regular reviews (at least quarterly)
If you are not 100% sure of your advisor then beauty parade at least three of them before choosing.

The information contained within, including references to taxation, legislation, regulation, or any other issues are correct at time of going to print.

Cash ISA’s - The best of the best

Of course as a true independent advisor, my only focus is on what is best for my clients no matter which bank or financial institution has an offer on, but the new Santander Flexible ISA offers a triple whammy for savers with a best buy rate, a guaranteed minimum rate plus the flexibility of unlimited penalty free instant access, so it’s worth a close look.

The rate of 3.50% is guaranteed for 12 months, but because the account has been structured to pay 3% above base rate, if the Bank of England does decide to increase rates in the next 12 months then Santander customers with this deal will benefit from such a move.

Savers have really been under the cosh over the last 18 months or so, having to contend with poor rates and soaring inflation, so let's hope this attractive deal spurs other ISA providers to retaliate and come out with more attractive rates. When you weigh up that the best rate for a 2 year fixed rate ISA currently at 3.60% with Aldermore and the best 1 year fix at 3.33% from Bank of Cyprus UK, it emphasises just how competitively priced this account is.

It’s not all good news:
The major downside of this deal is that it doesn't allow transfers in (swine’s) so if you've got funds accumulated from previous tax years, you'll need to look elsewhere for those. This account is likely to prove popular and if previous ISA seasons are anything to go by, it may not be around for too long. £5,100 at 3.5% will provide a tax free interest return of £178.50 over the course of a year and £3,600 at 3.5% provide a tax free interest return of £126.00 over the course of a year.

The information contained within, including references to taxation, legislation, regulation, or any other issues are correct at time of going to print.

The REAL cost of Long Term Care

Is the recent political debate encouraging, or is it all smoke and mirrors? In an ageing society, the issue of how we pay for the care of our elderly is a key political issue now with direct consequences for millions of people. The ongoing debate around the funding of adult social care, shows that both the government and the Conservative opposition understand that current funding arrangements are not working, and that major reform is necessary (what a surprise advisors have been telling them that for years).

While the proposals are endlessly debated, there is a real need now to ensure older people entering into care every day receive the information and guidance they need on how to pay for it. Britain is undergoing a demographic transformation that will see a marked ageing of the population. We now see over-65s outnumber under-16s and by 2030 there will only be two people of working age supporting each person in retirement. This compares with a ratio of four workers per pensioner today.

The government put forward its proposals in the adult social care green paper in July 2009, and the Conservatives responded at their conference in early October 2009. As neither promised any new public money, like it or not the reality is that you will have to contribute more to fund for your own care. What is really needed is for the three major political parties to lead a complete overhaul of the nation’s attitudes towards paying for long-term care. With people living longer, and many competing claims on the public finances, the state cannot afford to fund the increasing demand.

A London School of Business report found that only 400,000 UK households, out of the 6.5m householders aged over 65, can afford the costs of long-term care. So waiting idly for the government to impose new rules is not an option. If you do then one of two things will happen if you need care.

The first is that you will have a lower standard of care if you cannot afford to pay for it yourself.

The second is that if you can’t afford it then you run the risk of losing everything you have worked for.

It is highly likely that it will be some time before a new system is introduced, and during this period over one hundred older people will continue to enter into care every day. Local authorities are legally obliged to help with the care fees for people who cannot afford to pay themselves. While the local authority pays the entire fee for those with assets beneath £14,000, in England people with assets valued at over £23,000 have to pay for their own stay in a care home,

A year’s stay in a care home costs on average £25,000 - £35,000 depending on whether nursing is required, although it is not unheard for people to be paying as much as £78,000 per year for a stay in a care home. This cost is not static, and is rising on an annual basis at a rate higher than inflation. Care last year was 5.1% more expensive than the year before. Data shows that the average stay in a care home for self-funders is four years but one in ten people will stay for at least eight years.

There is a high chance that someone may start their stay in care as a self-funder, but over time their assets will fall beneath the £23,000 threshold and leave them dependent on the state. There should be no need for this to happen, as a number of private providers offer products that ensure that the elderly do not use up all their capital.

So what can you do? There are a number of ways that you can use to shelter your wealth from this kind of attack, but the powers that be will keep looking at how they can get their hands on it, so you have to be very careful indeed, some of the solutions on offer can work very well indeed and I have seen many successes with them. But many solutions just don’t work at all. The key here is talk to a professional so that you don’t just spend money on a solution that was never going to get you the result that you wanted.

What else actually works? Like it or not, this is a risk that faces all of us, and as with all risks in life you only have three choices to take action with.
Options one is reduce the risk:
Take actions that reduce the risk to you, by using some of the solutions mentioned above or taking better care of yourself but neither of these are an absolute guarantee or completely in your control.
Option two is accept the risk:
This means that you take the view of whatever will be will be, and live with the consequences of that decision.
Option three is pass the risk on:
This means insurance, but let’s be frank all insurance is the biggest waste of money if you never need to claim, and it’s the best decision we will ever make if you do have to claim. The problem for most people is that they look at insurance as a waste of money instead of an investment to protect what is really important to them.

Would you not bother insure your home or its contents? What about your car or boat? Maybe we need to look at insurance and risk in a different light, but first accept as a given that you need to get the right type and level of insurance with a reputable company so there are no hassles come the day of the claim, remember you get what you pay for. We all have a story to tell about us or a friend that did not get paid out at claim time, and we all know some are great at claim time, you just don’t hear about the good ones on the news.

You or your money:
It is a subject charged full of emotion but to make a sensible decisions, we have to take the emotion out and look at this rationally. So putting aside the issues of providing the best possible care for you if you need it (which in my view is the most important thing) which is better value for money, paying between 5%-10% of your value to protect your assets or risking the whole lot?

If you want to spend your money before you leave this world, then protect yourself and get on with enjoying life and not have to worry about keeping hold of it all just in case.

If you don’t want to spend it but leave it to those you love then protect yourself and get on with giving it to them.

If you don’t feel on principle that you should have to provide for your own care after all the taxes you have paid, and all the promises to care for you from the cradle to the grave from every government since the dawn of tax and national insurance, I agree with you, we should not have to, but that will not change the fact that you will. You can’t have your cake and eat it, only governments and city brokers get to do that.

The information contained within, including references to taxation, legislation, regulation, or any other issues are correct at time of going to print.

Kind Regards

Steve

Previous articles

Monthly Update - March 2010

The Magic of Compound Tax Relief

Cash or not to Cash?

Government plans to make you build a Nest Egg!

Cash ISA’s - The best of the best

The REAL cost of Long Term Care