UK: Family Wealth Management - Winter 2011

Last Updated: 5 January 2012
Article by Smith & Williamson

Foreword

KEEP CALM AND CARRY ON

2011 has been a year marred by continued economic and political turmoil, the most recent development being the Prime Minister's decision to veto EU treaty changes in an effort to protect Britain's financial services. There are concerns that the country could now be left out in the cold when it comes to future negotiations with the remaining 26 EU member states, as unanimity is only needed in the case of taxation.

At home, the Government has published various consultation responses and much of the draft legislation that will appear in the 2012 Finance Act. The new framework is intended to give us better tax legislation, but this doesn't necessarily mean tax simplification given the proposed new rules, overview and explanatory notes amount to 1,405 pages. What it does mean, however, is that there are fewer opportunities for the Chancellor to introduce unexpected tax legislation, which is welcome news when planning for the future.

Also in this issue of Family wealth management, we look at options for saving for your children and grandchildren, including the new Junior ISA, as well as opportunities to invest for your own future. In particular, we examine the enduring appeal of gold and its relevance in asset allocation in the current economic environment.

Elsewhere, for those facing restrictions on their pension contributions, we review the tax-efficient alternative investment options available. We also provide some top tips on pension drawdown to help individuals get the best out of their schemes. Finally, we celebrate more award success for Smith & Williamson – this time for investment performance and in recognition of some of the rising stars in our private client tax team.

PREPARING FOR THE FINANCE ACT 2012

Earlier this year, the Government published a Tax Consultation Framework which promised a new way of introducing tax legislation. Objectives will be set out each year in a spring Budget, followed by a period of consultation, culminating in the exposure of draft legislation at least three months before it becomes effective. The hope is that this will lead to better legislation.

Making progress

In keeping with this timetable, on 6 December 2011 the Government published various consultation responses and much of the draft legislation that will eventually appear in the 2012 Finance Act. In addition, the Chancellor made a couple of tax-related announcements in the Autumn Statement on 29 November 2011. While the new framework may give us better legislation, the proposed new rules, overview and explanatory notes totalled 1,405 pages – even before taking into account the ancillary reports. It's likely then that the Finance Act 2012 will put us in the lead when it comes to producing 'the longest tax code in the world' – not an accolade to be proud of.

A by-product of this new policy framework is that there are fewer opportunities for the Chancellor to pull any rabbits out of the hat. In fact, there were few unexpected tax shocks contained in the Autumn Statement or the 6 December package.

Residence test

It was disappointing to learn that the new statutory residence test will be delayed for 12 months to April 2013, bearing in mind that the current residence tests have caused considerable confusion over recent years. On the other hand, it is perhaps better to wait for improved legislation that reduces the need for taxpayers to fight their case in court.

Personal allowances

In 2010, the incoming Coalition Government pledged to work towards a personal allowance of £10,000 during the lifetime of this parliament. In the March 2011 Budget, the Chancellor announced that the allowance for 2012/13 will be increased to £8,105, which is a step closer to that goal. This is a welcome move as it makes no sense for the Government to take tax from low-paid individuals with one hand and give them back by way of benefits with the other. However, the Budget documents also included a note that the tipping point where taxpayers start to pay the higher rate of 40% will be the same for 2012/13 as it is this year (£42,475). As a result of 'fiscal drag', i.e. the effect of inflation-linked wage increases, this is likely to mean more people will be paying the higher tax rate next year based purely on wage inflation.

Child benefit

Some families will suffer a double whammy from April 2013 given the Chancellor's previous announcement that child benefits will be withdrawn from this date for higher-rate taxpayers.

CPI-linked

In the March Budget, we were warned that in future, allowances and thresholds will be index-linked to the Consumer Prices Index (CPI) rather than the Retail Prices Index. The necessary legislation is being put in place to achieve this for the IHT nilrate band and the CGT annual exemption. This is academic for IHT given the nilrate band is frozen until 2015. Similarly, the CGT annual exemption for 2012/13 has been frozen at the 2011/12 level of £10,600. However, we should be grateful for small mercies. The Liberal Democrat manifesto called for the exemption to be drastically reduced, so freezing it seems to be the lesser of two evils.

ARE YOU READY FOR THE NEW TAX YEAR?

Use our handy checklist to find out

At this time of year, many readers will be galvanising themselves into gathering the information they need for the 31 January tax return deadline. This is a great opportunity to also think about structuring your finances more tax efficiently.

Avoid penalties

It's particularly important this year to submit your online tax return by the end of January, as the late filing penalty regime has changed. Missing the deadline by just one day will trigger a penalty of £100, whether or not any tax is outstanding. Further penalties will be charged if submission is more than three months late.

There are notification obligations on starting in business, or on becoming a partner, and you need to keep a constant eye on the amount of actual and projected turnover for VAT.

Make use of allowances and lower-rate tax bands

It's common to find married couples where one has a substantial income, while the other has spare lower rates or even personal allowances (currently £7,475). Are there any income-producing assets that could be transferred and held in a more beneficial way? HMRC seems relaxed about the transfer of certain assets into a spouse's name, such as property and quoted investments, but is much stricter about shares in private companies, so care needs to be taken here.

The 60% trap

The personal allowance is taken away from individuals whose total taxable income falls within the band £100,000 to £114,950, at the rate of £1 for every £2 of excess income. This gives an effective tax rate of 60%. So any tax reliefs achieved in this band, for example by a gift aid payment or a pension contribution, are magnified.

Sole traders and partners

Most business owners are familiar with the concept of claiming capital allowances on plant and machinery actually used in the business. It is less well known that capital allowances can also be claimed on certain embedded fixtures within the building itself, such as air conditioning, toilets, electrical or cold water systems.

Stringent new rules for claiming relief will come into force in April 2012 and this is an area where great care will be needed, particularly with the documentation for the sale of second-hand buildings.

Also, watch the timing of expenditure qualifying for the annual investment allowance, as the limit reduces from £100,000 to £25,000 with effect from 6 April 2012 (1 April for companies). Care is needed for pro-rating these amounts for accounting periods spanning this date.

Pension planning

From April 2011, the annual allowance for pension savings was reduced to £50,000, but with some scope to make use of unused allowances, based on this figure, from the three preceding years. The opportunity to make use of any unused allowance from 2008/09 will be lost if not used by 5 April 2012.

From April 2012, the lifetime allowance for the value attributed to benefits being crystallised before incurring a charge reduces from £1.8m to £1.5m, so think carefully about taking benefits and/or registering for the fixed protection of the £1.8m limit before 6 April 2012.

At the other end of the scale, anyone can invest up to £3,600 a year into a pension scheme, whether or not they have taxable income, and obtain 20% tax relief. So assume that a father is making maximum pension contributions, but his wife has no earnings and they have two children. The father could invest the net sum of £2,800 a year into separate pension plans for his wife and each of his children, and the pension plans would each receive £3,600.

CGT annual exemption and losses

Husband and wives both have annual CGT allowances of £10,600 for 2011/12, which can be used with simple planning. At 28% the annual exemption is worth £2,968 per person (£5,936 per couple), so it's not to be sneezed at.

The timing of disposals could be critical, especially near the end of the tax year; and husband/wives and civil partners should consider transferring (unconditionally) between them any shares with in-built gains or losses prior to a disposal.

CGT entrepreneurs' relief

The entrepreneurs' relief lifetime limit is currently set at the very valuable sum of £10m, so it's important that the qualifying conditions are met in advance of any disposals. In order to qualify for entrepreneurs' relief on the disposal of shares in an unquoted company, an individual must have been an officer or employee for the 12 months prior to the sale and must have owned at least 5% of the ordinary shares and voting rights during that time.

IHT planning

The frozen nil-rate band means that individuals should take advantage of the full range of exemptions and reliefs. Most lifetime gifts are exempt, provided the donor survives the date of the gift by seven years. Regular gifts made out of excess income are exempt, for example, a grandparent paying for a grandchild's school fees.

A reduced IHT rate of 36% will be introduced for deaths on or after 6 April 2012, provided certain conditions are met regarding the level of charitable legacies. Thought needs to be given to what this might mean for your estate and the effect of obtaining the reduced rate. Based on the new rules, where the proposed charitable legacies in an estate exceed 4% of a 'component' part of the estate, increasing them to 10% could lead to more funds passing to the other beneficiaries.

"SAVING IS A VERY FINE THING...

...especially when your parents have done it for you" Winston Churchill

Junior ISAs Available since 1 November 2011, Junior ISAs are a welcome addition to the range of investment options available for children. As a tax-free savings vehicle they're likely to be attractive to parents as a way of helping to fund future university fees or a deposit on a first property. It's possible for eligible children aged 16 or over to open a Junior ISA themselves, but we expect that most subscribers will be parents or grandparents.

Junior ISAs allow parents, family members and friends to make savings on behalf of a child up to the annual subscription limit. This has been set at £3,600 for this and the next tax year. From 6 April 2013, it will be adjusted in line with the CPI.

They are available for children resident in the UK who were born:

  • on or after January 2011, or
  • before September 2002 and are under 18, or
  • between these dates and do not already have a Child Trust Fund.

Withdrawals from a Junior ISA cannot be made until the child's 18th birthday, when it will be converted into an adult ISA (except in exceptional circumstances).

National Savings

Children's Bonus Bonds from NS&I, the Government-backed savings organisation, allow you to invest for a child's future in their own name. There is no tax to pay on the interest or bonuses. The current 34th issue guarantees a compound rate of return over five years including the fifth year's anniversary bonus of 2.5% AER. The bonds can be cashed in early if necessary, but they should really be viewed as a fiveyear investment. No interest is earned on bonds cashed in during the first year.

The maximum investment is £3,000 per issue and anyone aged 16 or over can invest for anyone under 16. So, bonds cannot mature beyond the child's 21st birthday.

Another option through NS&I is Premium Bonds. The maximum investment is £30,000, but with odds of 24,000 to 1 and a current rate for the prize fund of 1.5%, this may not be a gamble that those investing on behalf of children are willing to take!

Stakeholder pensions

For much longer-term savings, stakeholder pensions for children are an attractive option to help build up a pension pot over time. Funds cannot be accessed until age 55 so clearly this a very different time horizon, but it's worth bearing in mind that the State is unlikely to provide very much in pension terms in the future, so the earlier pension savings starts the better. Starting such a pension for children or grandchildren can be a good way to start them on the savings path, although it must be appreciated that the value of the pension fund can go down as well as up, depending on the actual investment fund that is used.

Up to £3,600 per year gross can be invested on behalf of a child in a stakeholder pension. Tax relief at source is available at the basic rate of 20%, regardless of whether the person paying is a taxpayer, so the amount actually paid is £2,880.

Remember that pension funds are virtually tax exempt as far as the underlying investments are concerned and it's sensible to consider this type of arrangement if you want to make regular payments each year. Over time, this should accrue to a meaningful sum.

Offshore investment bonds

These bonds can be a useful way of providing funds for university fees or a gap year. They can also be used to help fund school fees prior to age 18 by using the annual tax-free withdrawal allowance of 5% of the initial investment. This involves the investment of a capital sum through the medium of an offshore investment bond run by insurance companies, normally based in Dublin or the Isle of Man, and can be in the parent's name. Depending on the investment funds chosen, the value of the investment can go down as well as up and there is a risk that the investor may not receive a return of all the capital invested.

The capital is invested in underlying investment funds selected by the investor. Investments are largely free of tax, other than withholding taxes, which are nonreclaimable. Once the child is 18 the bonds can be assigned to them and, as long as they are non-taxpayers at the time, in most cases it's possible for them to surrender the bonds without any tax liability.

Grandparental gifts

Another very useful way of saving for future school fees, particularly for younger children, is through grandparental gifts.

A capital gift from a grandparent is extremely tax efficient compared to parental gifts, where income above £100 is taxed on the parents. Grandparental gifts, on the other hand, can be invested in the child's own name or within a bare trust as the capital is treated as the child's, so that any income is taxed on the child and any gains are subject to the child's own individual CGT allowance (£10,600 in the current tax year).

Bearing in mind a child will also have a personal tax allowance (currently £7,475), it is unlikely that he or she will in fact pay any tax on investment income unless substantial capital gifts are involved.

GOLD – STILL A CORE ELEMENT OF INVESTMENT PORTFOLIOS?

We continue to live in uncertain times. The global economy is facing significant structural 'headwinds', with developed economies tracing out worryingly anaemic growth trajectories, and emerging economies confronting inflationary pressures. The eurozone debt crisis has added an additional tier of concern over the systemic risk being posed to the global banking system.

When thinking about asset allocation in an investment portfolio, we think it is important to maintain exposure to an asset class that offers not only protection against heightened uncertainty (a 'risk-off' trade), but also protection against the eventual debasement of fiat currency (i.e. currency that cannot be converted and therefore has no intrinsic value). Gold is that asset class.

Impact of interest rates

The emergence of negative real interest rates and yields has been an important driver behind the rally in the gold price. As gold pays no income (it is classified as a zero-yield asset), the significant decline in the opportunity cost of holding gold (real rates) has been very supportive.

We think real rates are likely to remain extremely low for an extended period, given the economic backdrop. In addition, the fact that central banks (particularly the US Federal Reserve and the UK Bank of England) are having to counter economic slowdown by creating substantial sums of additional liquidity via quantitative easing (QE) programmes raises the risk that they eventually debase fiat currency by overdoing the supply of money. In this respect, gold seems to offer protection against both deflation and inflation risk. Gold also offers a haven against other 'tail risks' such as the unravelling of the euro.

Supply and demand

The supply and demand characteristics of gold have also improved significantly due to the growth in Asian jewellery demand, central banks seeking to boost their gold reserves (having spent 30 years reducing them), and the emergence of physical gold exchange traded funds (ETFs). The World Gold Council (WGC) estimates that, over a relatively short period, ETFs have acquired in excess of 2,000 tons of gold, making them the sixth-largest owners.

Will the gold bubble burst?

Given that the gold price has appreciated fourfold since 2005, a legitimate question is whether it constitutes a bubble? We argue that this is not the case for several reasons. At US$1,775, the price is still a long way short of the inflation-adjusted 1980 peak of US$2,200. As a ratio of the S&P index, the gold price is also significantly below the level seen in 1980. Gold is still relatively under-owned, constituting around 1% of global asset allocations (WGC data). The trend dynamics for gold remain supportive. The 200-day weighted moving average remains upward sloping and has provided numerous support levels over the last few years. More importantly, analysis of prior asset bubbles (such as Japanese equities in the 1980s and Nasdaq in the 1990s) shows that they experience a parabolic move upwards after a period of steady appreciation. We think gold has yet to enter this latter bubble phase.

The key risks to gold reside in a reversal in real yields and a sharp appreciation in the US dollar. As both of these outcomes look unlikely for the foreseeable future, we remain positive about gold and would use any pull-back to the 200-day moving average as an opportunity to top up positions.

INVESTMENT OUTLOOK

Eurozone impact on the UK

Equities have registered a sharp decline following mounting concerns over the eurozone. A possible referendum in Greece, the rise in peripheral bond yields to unsustainable levels, the removal of administrations in Italy, Greece and Spain plus technocrat-led governments with a remit to impose strict austerity programmes have all raised legitimate questions over the viability of the euro. There is a growing sense that unless Germany sanctions aggressive QE by the European Central Bank (ECB), the end game is fast approaching.

The UK's veto of the EU treaty on 9 December had little initial impact on UK markets. But the treaty itself will impose more austerity on the eurozone, delaying the UK's recovery further.

Gilts and bonds – a silver lining

In the UK, waning economic momentum is down to turmoil in the eurozone and domestic influences, such as a deteriorating labour market (unemployment has increased to 8.3%) and negative real incomes.

UK growth estimates for 2012 have fallen from 2% to 1%. Indeed, the Organisation for Economic Co-operation and Development has forecast growth of just 0.5% and warned that there is a greater risk of contraction in gross domestic product over the coming quarters.

Amid all of this, UK gilts and index-linked bonds have achieved safe-haven status, registering strong returns in November. This is partly down to the Bank of England making bond purchases and a decline in both growth and inflation expectations.

Slow and steady

In his Autumn Statement, the Chancellor acknowledged that it will be almost impossible to eliminate the structural budget deficit by the end of this parliament. But, as long as the Government continues to make spending cuts and doesn't do anything rash in response to these new growth forecasts, the markets are likely to remain relatively sympathetic.

Recent announcements of credit easing, increased infrastructure expenditure and a second installment of QE support the view that, on a relative basis at least, the UK is doing the right things to try and confront the economic headwinds. But corporate earnings appear to have peaked and are vulnerable to the impact of negative operating leverage. Moreover, market volatility remains extreme and is likely to persist for some time, taking its toll on the equity risk premium and valuations.

Investment strategy

The best equity investment strategy is therefore to remain focused on compounding reinvested dividend income and identification of the handful of stocks that have competitive advantage, robust business models and global franchises (The New Nifty Fifty).

What next?

A signal that the ECB is embarking on unconstrained QE would trigger a significant 'risk-on' rally. But this is unlikely as the systemic risks posed by the unravelling euro justify maintaining a cautious stance.

As 2012 unfolds, there will be greater focus on stopping the shortfall in demand. This will require co-ordinated and sustained policy responses from the Monetary Policy Committee and the UK Treasury.

BEYOND PENSION CONTRIBUTIONS – ALTERNATIVE INVESTMENTS

Many people are now unable to make further pension contributions, or their contributions are more restricted, due to recent pension changes. So alternative investments, which will also provide tax relief and/or tax efficiency, are now of more interest than ever.

The investments covered here are not appropriate for everyone because of their higher-risk profile (often involving a significant risk of loss of the original capital sum invested), minimum holding periods and potential lack of liquidity. But while these risks should be taken into account, tax-efficient investments can still have a place as part of an overall strategic financial plan.

Venture capital trusts

  • Maximum investment: £200,000 p.a.
  • Income tax relief: 30%
  • Tax-free dividends
  • No CGT on sale
  • Minimum holding period: 5 years

Venture capital trusts (VCTs) are designed to provide capital to small and expanding companies, with the aim of growing the business and generating a profit for the VCT. By virtue of its investment in smaller companies, VCTs are considered as higher risk and are generally regarded as longterm investments.

Individuals can invest up to £200,000 per tax year and benefit from 30% income tax relief, which is claimed via their selfassessment tax return. Dividends are tax free and there is no CGT should the VCT be sold. There is, however, a minimum holding period of five years.

Given that many small businesses are finding it difficult to raise capital through the traditional bank route, VCTs are ideally placed to strike attractive deals with these businesses and will normally take a seat on their board to provide expertise in decision making and to guide the business forward.

Enterprise investment schemes

  • Maximum investment: £500,000 p.a.
  • Income tax relief: 30%
  • No CGT on sale
  • IHT exemption: after 2 years
  • Minimum holding period: 3 years

Similar to VCTs, enterprise investment schemes (EISs) also invest in small businesses. However, while the VCT is likely to have several investments, an EIS will only invest in one company, which increases the element of risk for the investor and could result in failure to recover the amount invested.

Following a change in legislation in 2011, EISs now provide the same level of income tax relief on investment as a VCT, at 30% (increased from 20%) for investments up to £500,000. There is a minimum holding period of three years, and EISs also allow CGT deferral.

Any capital gain realised on sale is not taxable, provided income tax relief has been received and not withdrawn. Losses may also be allowable for income tax purposes. After two years, the EIS investment is exempt from IHT.

It is now possible to carry back all of the income tax relief to the previous tax year.

Changes to VCT/EIS restrictions from 6 April 2012

As things stand, a VCT or EIS can only invest £1m into an individual company, which must not have more than 50 employees. But with effect from 2012/13, the investment limit increases to £10m, with the employee threshold raised to 250, and the investee company must have no more than £15m of gross assets. The annual investment limit for an EIS also increases from £500,000 to £1m, while the annual limit for VCTs remains at £200,000.

Business premises renovation allowance

  • Income tax allowance: up to 100%
  • Writing-down allowance: up to 25%
  • Minimum holding period: 7 years
  • Qualifying capital expenditure by: 11 April 2017

The business premises renovation allowance (BPRA) was introduced in the Finance Act 2005. It came into force on 11 April 2007 and initially ran for a period of five years; this period was extended by a further five years in the Finance Bill 2011, meaning that all capital expenditure must be incurred by 11 April 2017.

BPRA is available in certain areas of the country for capital expenditure when converting, renovating or repairing and bringing back into use certain commercial buildings or structures that are no longer being used. The premises must previously have been used for the purposes of trade, and must have been unused for at least 12 months.

The expenditure must be incurred to make the property into qualifying business premises. 'Premises' means any building or structure, which must be used, or available and suitable for use, for the purpose of a trade, profession or vocation, or an office or offices, and will typically be structured around hotel developments. It should be borne in mind that any investment in commercial property can be vulnerable to a general downturn in price and value and there is no assurance that the scheme's investment objectives will be met.

BPRA benefits from an initial income tax allowance of up to 100% of the sum invested, with a straight-line-writing-down allowance of up to 25% of the qualifying expenditure on any remaining balance. The premises must be retained for a period of seven years after completion.

'Qualifying expenditure' is capital expenditure incurred on or after 11 April 2007 and before 11 April 2017 involving the conversion, renovation and repair of such premises.

Schemes will be structured so that, in addition to the initial investment, a nonrecourse loan will also be taken out to help gear the prospective returns. Borrowing can increase the risks of an investment.

Seek advice

These types of investment may not be suitable or appropriate for everyone and, while aiming to achieve the mitigation of tax, they carry the risk that an investor may not get back the amount invested. Specialist advice is therefore necessary when considering these tax-efficient investment opportunities, their suitability for individual circumstances, and the associated risks and benefits.

Enterprise zone trusts

  • Capital allowance: up to 100%
  • Minimum holding period: 7 years
  • Rent can be offset against loan interest
  • CGT payable on sale

The Government introduced enterprise zones (EZs) in the 1980s as a way of encouraging businesses developed in designated areas, with London's Docklands being one of the most successful examples. In August 2011, new EZs were announced, including areas in Essex, Kent, Cornwall, Oxfordshire and Cambridgeshire.

EZ trusts invest in commercial property within these designated zones and will typically involve a cash deposit of between 35% and 40% of the gross investment by the investor, together with a limited recourse loan, which is secured against the property.

As with BPRA schemes, the minimum holding period is seven years from the date when the building is first used; and capital allowance of up to 100% qualifying expenditure is available, although normally this ranges from 75% to 95%. EZ trusts, like BPRA, face the same risks associated with investment in commercial property.

During the holding period, any rent received is taxable, but this can be offset against the loan interest. In the event of a sale, any gain is subject to CGT.

TOP TEN TIPS FOR PENSION DRAWDOWN

Getting the best from your scheme

Pension drawdown – taking a regular income from your pension savings without buying an annuity – has become very popular in recent years.

Drawdown schemes can offer valuable flexibility. But investors need to be careful about the amount they draw because the size of the overall pension fund may decline, depending on how the monies are invested. In other words, you may get the same monthly income, but the return on your investments and the size of your capital fund may fall substantially. As a result, the capital remaining to generate future income could be depleted earlier than anticipated.

Here are ten things to consider if you have a pension drawdown arrangement.

1. Remember the risks

It's essential to understand the relationship between your total return on your underlying investments and the income being taken. If your income is greater than the total return at any given time, your capital may be depleted earlier than anticipated.

2. Understand the importance of maintaining the capital sum

Try not to drawdown more than the natural income yield from the assets during the first few years of drawdown. You need to try to ensure that the underlying capital keeps up with inflation, so that the income which that capital can generate also has scope to rise in line with the cost of living.

3. Remember the GAD rate is higher than the current annuity rate

If you draw the maximum Government Actuary's Department rate (e.g. 6.1% for a male aged 65), it's unlikely to be sustainable as you'll almost certainly be subsidising the income on your investments by taking a significant amount of the capital each month.

4. Compare any drawdown rate with index-linked annuities

If you draw substantially more than the index-linked annuity rate, the capital in your fund is unlikely to be maintained in real terms, i.e. adjusted for inflation over an extended period. You may need to fall back on other funds to sustain your retirement.

5. Ensure the fund remains well balanced

As your drawdown arrangement needs to provide you with a regular income, it can be tempting to liquidate incomegenerating investments, for example, in preference to other holdings which may be less liquid. This may create a good income flow in the short term, but you need to ensure the remaining investments remain well balanced to support you in the future.

6. Get an estimate of the full charges before signing up

This includes checking the underlying costs of specific investments within your fund. For example, investing heavily in pooled or bond funds may spread risk but can also increase your underlying costs.

7. Review your fund regularly

If you want your pension fund to last for a certain number of years, you need to have a clear understanding of the nature of the investments within your portfolio and the ability of those investments to generate a reliable stream of income.

8. Keep an eye on annuity levels

Drawdown has many benefits, but it's possible to transfer at any time to an annuity, which gives you certainty by providing a guaranteed income for the rest of your life.

9. Drawdown is as good as your investment manager

Ultimately, the performance of your investments and the amount you can draw depend on the success of your investment manager. If you're unhappy, you can always change your investment adviser.

10. Don't forget about tax

Despite the above, there can of course be good reasons for stripping the fund quickly, depending on circumstances, such as poor health. As a result, some people are keen to draw out as much as they can each year to deplete the fund, to avoid an ultimate 55% tax charge on death.

Some people are also taking maximum income and then gifting it, to take advantage of the rule allowing regular gifts from surplus income to fall outside the IHT net. However, bear in mind that unvested pension funds can be passed on IHT-free on death before the age of 75. Therefore, a pension fund is very tax efficient if income from this source is not required. Also remember that, once you begin to draw income down, that income is taxable at your marginal income tax rate.

REMINDER! FIXED PROTECTION DEADLINE LOOMS

From 6 April 2012 the lifetime allowance for pension funds will fall from £1.8m to £1.5m. Higher earners have until 5 April 2012 to register for fixed protection of £1.8m. If the value of pension benefits exceeds the lifetime allowance, a tax charge will be levied at 55% of the excess.

Action points

Look at benefit projections to determine whether you might be affected and then consider ways to deal with it.

  1. Election for fixed protection of £1.8m must be with HMRC by 5 April 2012. No further contributions or membership of a pension scheme will be allowed. From October 2012, a requirement for employers to enrol employees into a pension automatically will be gradually introduced. You must opt out of the pension within one month of enrolment or fixed protection will be lost.
  2. If you are aged 55 or over, consider drawing benefits before 6 April 2012 while the current £1.8m allowance exists. If you take benefits through drawdown rather than buying an annuity, consider electing for fixed protection as well, because a further lifetime allowance check will take place at age 75.
  3. Consider making extra contributions before 5 April 2012 to maximise the fund and then register for fixed protection or take benefits. You can potentially get tax relief on contributions of up to £50,000 per tax year and carry forward unused contribution allowances from the previous three years.
  4. If you are going to stop accruing benefits within pensions earlier than originally planned, you will need to consider alternative strategies to build up your retirement funds.

THE UK/SWITZERLAND TAX AGREEMENT - NET TIGHTENS ON SWISS BANK ACCOUNTS

The tax authorities are convinced that the long-awaited UK/Switzerland tax treaty will enable it to collect billions of pounds it considers due in respect of hidden Swiss money.

The UK and Swiss Governments have now signed the long-awaited UK/ Switzerland Tax Agreement.

The Agreement, which was signed on 6 October, still needs to be ratified, but is expected to be fully effective from January 2013 and represents another step forward in HMRC's fight against tax evasion.

Who is affected?

The Agreement will apply to all holders of Swiss accounts with a principal address in the UK. In addition, where the account belongs to a UK passport holder, they will be treated as UK resident unless a certificate of tax residence issued by another jurisdiction is provided.

What assets are affected?

The Agreement provides for a tax deduction to be applied in respect of any banking assets, including cash balances, precious metals accounts, all forms of stocks, shares and securities, options, debts and forward contracts, and other structured products.

Excluded assets are the contents of safety deposit boxes, real property, chattels and some insurance contracts.

Regularising the past

The Agreement provides for a significant deduction of between 19% and 34% of the capital held in a relevant account at 31 December 2010. The actual rate will be computed in accordance with a complex formula, taking into account the length of time that the funds have been held.

This one-off deduction will be treated as full settlement of prior years' tax, interest and penalties arising on the assets concerned. The tax withheld by the Swiss authorities will be handed over to the UK Treasury without identification of the account holders. Therefore, the one-off payment option preserves anonymity.

The alternative to paying the one-off levy is to authorise the Swiss paying agent to disclose personal details to HMRC including account balances and asset statements for the ten years to 31 December 2012. Compliant UK resident and domiciled taxpayers will opt to disclose because they have already paid the tax arising.

What are the options?

UK resident and domiciled individuals have two options. They can opt to permit details of the Swiss income and gains to be disclosed to HMRC. Alternatively, annual withholding taxes will be deducted from Swiss accounts at specified rates.

These are:

  • 48% on interest and other non-dividend income
  • 40% on dividends
  • 27% on capital gains.

Again, payment of these taxes to the UK Exchequer will be made without identification of the account holders, so preserving anonymity.

Foreign domiciliaries

Foreign-domiciled individuals who have been taxed on the remittance basis in past years can choose to self-assess previously unreported remittances. The self assessment of taxable remittances has to be given to the Swiss bank, which will then make a deduction and payment of 34% of the remittances to the Swiss paying agent. The funds deducted will, again, be paid to the UK Exchequer on an anonymised basis.

Where a foreign-domiciled person has been taxed on the remittance basis and is satisfied that they have no unreported liabilities from past years such that they are fully compliant, they can give notice to opt out. Going forward the non-domiciled account holder need only disclose, or suffer withholding, on UK source income and gains and on any remittances to the UK.

To be eligible for these special rules, the person must provide the Swiss paying agent with a certificate.

The certificate must be provided by a lawyer, accountant or tax adviser who is a member of a relevant professional body. The following must be verified.

  • (Where required) that the UK tax return for the relevant tax year contains a claim or statement that the relevant person is not domiciled anywhere within the UK.
  • (If appropriate) that a remittance basis claim has been made.
  • To the best of the knowledge of the professional signing the certificate, the domicile status of the relevant person is not formally disputed by HMRC.

Options available for previous non-disclosure

Where liabilities have not been previously disclosed, there are other possible courses of action.

Past liabilities can be disclosed but since HMRC can assess such tax liabilities for up to 20 years, the total cost of tax, interest and penalties has the potential to be very high.

A much more advantageous settlement may be achieved through use of the Liechtenstein Disclosure Facility (LDF), which also includes various built-in guarantees. Disclosure under the LDF will often result in the total settlement being significantly less than 34% of the capital. The LDF provides certainty of settling past tax issues, with immunity from prosecution. However, it will be necessary to demonstrate a long-term and significant asset invested or managed in Liechtenstein.

Summary

For anyone who has correctly disclosed liabilities arising on Swiss-held accounts, this Agreement should not cause any difficulties, as permission to the Swiss authorities to disclose their accounts to HMRC will prevent the need to apply withholding taxes.

However, for those whose tax affairs have not been fully compliant, the net has been tightened once again.

Voluntary disclosure of any previously unreported liabilities must be the way forward in order to avoid the threat of prosecution. In this regard, disclosure under the LDF may well provide the best solution to wipe the slate clean.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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