Cheshire IFA — Acumen Investment Partnership. Independent financial advice on investments, tax, pensions and assurance.

INVESTMENT BULLETIN : NOVEMBER 2004

ARE YOU READY FOR PENSIONS REFORM?
THE FUTURE OF ISAS
INVEST FOR CHILDREN NOW

PRE BUDGET STATEMENT

This year’s Pre-Budget Report was widely viewed as the last before a general election next May. Gordon Brown sprinkled his announcements with several sweeteners for particular groups, including increased lump sum payments for older pensioners, a minor improvement for ISAs and a substantial rise in the upper limit of working tax credit childcare payments.

The Pre-Budget Report includes a further raft of measures against tax avoidance, taking advantage of the new rules in the Finance Act 2004 that require the disclosure of schemes.

Read full article

IN PREVIOUS ISSUES :-

THE PRIVATE RESIDENCE & INHERITANCE TAX

The massive rate of increase in the value of property has had many effects. One particularly unpleasant downside is that more property owners will now be caught by inheritance tax when they die.

TRADED ENDOWMENT POLICIES

In the first of a series of features and articles, Nick Cosby of the Acumen Investment Partnership answers your questions on Traded Endowment Policies.

1. ARE YOU READY FOR PENSIONS REFORM?

On 6 April 2006, the Government will be introducing the new simplified pensions tax regime, which arguably represents the most radical change to private pension provision ever made in the UK. All the existing pension tax regimes for occupational pensions, personal and stakeholder pensions, and retirement annuity contracts will be swept away and replaced by one new tax regime.

What are the key changes?

One new pensions tax regime will apply to members of all approved schemes (henceforward to be called registered schemes).
All existing approved schemes (occupational, personal, stakeholder and retirement annuity contracts) will be subject to the rules of the new tax regime
A single Lifetime Allowance limiting the total amount of pension savings that can benefit from tax relief will be set. In tax year 2006/07 this will be £1.5 million. This will be increased in each subsequent tax year as indicated by the Treasury.
Where the value of an individual’s retirement benefits exceeds the Lifetime Allowance a charge of 25% will be levied (55% where the excess is taken as a lump sum).
Special transitional rules will enable members, where appropriate, to protect their entitlement to pension and tax-free cash benefits secured prior to 6 April 2006.
There will be an annual limit of inflows of value to a member’s pension funds. As at 6 April 2006 this will be £215,000. This amount will be increased each tax year as indicated by the Treasury.
The maximum member’s contribution in each tax year will be limited to the greater of £3,600 gross and 100% of earnings.
Up to 25% of the capital value of a member’s benefits within the Lifetime Allowance may be taken as a tax-free cash sum. The balance will be used to provide taxable annuity or income benefits. There is no specific limit on the maximum pension/income that can be provided other than that available from the capital value of the member’s fund within the Lifetime Allowance.
Where a member dies before drawing benefits a lump sum of up to the amount of the Lifetime Allowance can be paid free of inheritance tax to one or more beneficiaries. Where a lump sum exceeds the Lifetime Allowance, the excess will be subject to tax at 55% on the recipients of the death benefit.
Provision may also be made for a spouse/dependant’s pension/income payments in the event of the death of the member before or after drawing benefits. Any such spouse/dependant’s benefits will not count against the Lifetime Allowance of the deceased member or the receiving spouse/dependant.
Benefits may be drawn from age 50 onwards (age 55 from 6 April 2010). A member may be able to draw their benefits in full or in part without having to retire from their employment.
Employer contributions will normally be allowable as a business expense in the accounting period in which they are paid. Tax relief will be available on the member’s own contributions at the member’s highest rate(s).

The introduction of the new regime raises many questions. These include:

What capital value will the Inland Revenue place on retirement benefits when determining the Lifetime Allowance?
Will it be advantageous to maximise pension contributions prior to the introduction of the new regime?
Is somebody likely to receive a higher tax-free cash sum under current rules and, if so, how can he or she protect this higher tax-free cash entitlement?
If a person is due to retire before 6 April 2006, and he or she is able to defer retirement, would it be advantageous to do so? In particular, would it enable somebody to take a higher tax-free cash sum, to take more flexible retirement benefits or to secure a higher post retirement lump sum death benefit?
Will it be advantageous to elect for transitional protection of an individual’s retirement benefits? And, if so, would he or she be best advised to opt for primary or enhanced protection?
As all schemes will, in the future, be subject to the same rules regarding benefits and contributions would this be a good opportunity for a person to consider whether their current pension plan is the most appropriate for their circumstances?
If somebody is a member of a small self-administered scheme or a self-invested personal pension scheme will there be any advantage in that person bringing any investment forward to before 6 April 2006?

top

2. THE FUTURE OF ISAS

The Individual Savings Account (ISA) has been a massive success with many individual investors. There is little doubt why ISAs have been so successful and that is because of the tax breaks they offer. Granted there is no tax relief on contributions made, but investment income and capital gains building up inside the ISA are totally tax free, although it is no longer possible to recover the 10% tax credit on UK dividends.

With such tax reliefs at stake, it is very understandable why people would wish to invest, especially as there is no restriction as to when benefits can be taken and in what form.

This means that ISAs can represent a very flexible and tax efficient method of financial planning as they can provide an equity investment with no worries about CGT, and, unlike a bank/building society account, paying tax free interest. For example, consider the following ways in which ISA investments can be used: -

Tax free augmentation of the investor’s pension benefits
Tax free provision of funds to meet school fees or university cost
Tax efficient repayment of a mortgage

Of course, an ISA investment cannot be placed inside a trust for inheritance tax purposes, but a married investor could always leave the investments (outside the ISA wrapper that falls away on death) to a nil rate band discretionary trust as a means of inheritance tax planning.

But all good things come to an end. The Government, concerned at the Treasury tax leakage that is attributable to ISAs, has decided to restrict their benefits. The first stage of this occurs on 6 April 2006, when the maximum ISA investment that can be made in a tax year reduces from £7,000 to £5,000. We do not know yet but clearly this change may pave the way for future restrictions or even removal.

The moral is clear. Investors should invest as much as possible in ISAs whilst they still can. As a form of tax-free investment in a collective investment, they are very attractive. Investors may later kick themselves if they miss this investment boat now.

top

3. PENSIONS FOR CHILDREN

With income tax relief on contributions, virtual tax-free growth of the fund and the ability to take a large chunk of the proceeds as tax-free cash at retirement, pensions remain a highly tax-efficient investment.

Until fairly recently a person needed earned income to take advantage of these tax breaks, and could only contribute for himself. But under the rules for personal and stakeholder pensions introduced in April 2001, a person can contribute up to £3,600 gross each year on behalf of himself or other people, including children and grandchildren.

When a person makes a contribution on behalf of another person (the member) the Inland Revenue grants tax relief at the basic rate only, even if the investor is a higher rate taxpayer. This means that for every £2,808 net the Inland Revenue will add £792. The limit of £3,600 applies to the member, not the investor, so contributions can be made for more than one child. Contributions can be made from the child's birth until the child starts to make his or her own contributions (the child cannot take legal responsibility for the fund until age 18). From 6 April 2006, the contribution limit will be £3,600 gross each year or 100% of earnings if greater.

Before proceeding it should be borne in mind that pension tax reliefs do not come unfettered. The fund is locked away, currently until the individual is at least aged 50, so if the chief concern is saving for school fees or perhaps for a first property, then a pension is the wrong choice.

It is thought that there are two good reasons for taking out personal pensions for children: -

The effects of compound interest. Making an investment over such a long time span gives the child a massive head start on his or her long-term savings.
Inheritance tax planning. Provided the plan is established with the intention of paying the contributions on a regular basis and out of income, the inheritance tax normal expenditure out of income exemption may apply. The establishment of a pension plan for a child is ideal for older investors who want to do something worthwhile for their grandchildren. The fact that the grandchildren have no access to the money at age 18 or 21 (and so can't misspend it) is an added benefit. Instead, the money gives an excellent kick-start to the grandchild's own pension planning.

This planning can therefore be attractive but how do you choose a pension plan for a child or grandchild? This is a surprisingly tricky question because one is looking at comparatively small annual contributions but with an investment horizon of 50 years or more. By carefully selecting a stakeholder scheme, under which the annual management charge cannot exceed one per cent, it should be possible to achieve the right asset allocation at the right price. The investment objectives should focus on capital growth.

top

ACTION:
Contact us for further information and advice on any of the above

The Acumen Investment Partnership is authorised and regulated by the Financial Services Authority.

The Acumen Investment Partnership • Southlands • Buxton Road • Bosley • Macclesfield • SK11 0PS
Tel: 01260 223115 • Email: