UK: Family Wealth Management: Personal Financial Planning, Tax And Investment - Spring 2013

Last Updated: 20 May 2013
Article by Smith & Williamson

History lessons: What do the lessons of the past tell us about long-term equity returns?


Back on track?: The economy finally gets a spring in its step

Although spring seemed to be a long time coming, we have seen some green shoots of recovery with the economy witnessing a resilient equity market, despite a gloomy economic backdrop. The first quarter of 2013 saw positive investment returns from equities, which looks set to continue. Against this backdrop, in this issue of Family wealth management we take a fascinating look at the longer term trends in different investments and what history tells us about the likely future projections from investing in equities over the long term. Back in the present, we have a special investment feature on the retail sector and its prospects.

Recent events in Europe have only caused more uncertainty and heightened fears for the year ahead. There was nothing radical and little in the way of tax news in the Budget but there were positive announcements including significant changes to help individuals on and up the property ladder, an increase in personal allowances and the introduction of an employer's national insurance (NI) relief of £2,000 per year from 2014, which will go some way to help smaller businesses. There were also unexpected inheritance tax (IHT) proposals, such as restricting business property relief. This could result in potentially significant extra IHT liabilities for business owners. It was also confirmed that the freeze on the tax-free, nil-rate band for IHT will be extended until 2018. We look at the impact of some of these Budget changes in this issue.

With the Government introducing changes to the lifetime allowance, which takes effect from 6 April, we explore alternative ways to complement your pension pot. New government rules emanating from the Budget around qualifying life assurance policies, often used to fund IHT, are complex and need careful consideration. We encourage you to seek specialist advice if you have or think you have a qualifying policy. We also cover the positive impact of changes affecting pension drawdown and the benefits of offshore investment bonds.

A balancing act: A look at what history tells us about the likely future returns from investing in equities over the long term.

What long-term returns should you expect from equity investments?

In the short term, financial markets move in strange and often unpredictable ways. Equity markets in particular are much more volatile in practice than, with perfect hindsight, the most important fundamental determinants of share prices, such as earnings, dividends and cash flow, appear to justify. When asked what the stock market would do, the banker J.P.Morgan gave the definitive reply many years ago: "it will fluctuate".

Health warning

However, when it comes to assessing the potential medium and longer-term returns from different asset classes, it's possible to make assumptions that are more firmly based in both theory and historical experience. While any projection has inevitably to carry a health warning – the 20th century showed that you can never rule out revolution and natural disasters – forward- looking return assumptions do provide a useful framework for financial planning and investment strategy. A number of different techniques including valuations, macroeconomic data and historical experience can be used to produce a realistic set of assumptions.

Historical perspective

One well-tested approach is to rely on historical experience to provide suitable parameters. Three academics at the London Business School – Dimson, Marsh and Staunton – compile an authoritative history of global investment returns in more than 20 different countries all the way back to 1900. Their expectations for long-term real returns (after deducting expected inflation), according to their latest annual update published in February, are summarised above.

Macro Research Board, a consultancy, is one of several independent firms that carry out a similar exercise on a regular basis. In October 2012, it came up with the following medium- term projections for a balanced portfolio consisting of 50% in global equities, 35% in ten-year government bonds, 10% in global commodities and 5% in cash.

Learn your lesson

The key messages to take away from this type of analysis are as follows.

  • Future returns on average, while positive, are likely to be lower than in the golden period of 1982-2000. It's hard to justify more optimistic assumptions on either valuation or historical experience.
  • Unless the developed world enters a severe deflationary period, the bulk of balanced portfolio returns is likely to come from equities rather than from conventional bonds (whose value is primarily downside protection at current yields).
  • As a direct result of government and central bank policy, yields on many asset classes have fallen to historically low levels after taking account of inflation and this will hold down the potential for above average returns across most asset classes for some time.

Investors do, of course, need to balance the potentially higher returns from equities against the associated risks. It's important however to distinguish between the risk of intermediate price fluctuations (volatility) and the risk of permanent capital impairment or loss. The former can be unsettling, but the latter does the most damage.

Budget 2013 highlights

What was in the Chancellor's box of tricks?

We had been told to expect a "boring Budget", particularly bearing in mind that much of the headline news had been included in the Autumn Statement last December. Clearly the Chancellor had very little cash to give away, but nevertheless there was some good news.

The 'tom-toms' were certainly quieter this time around, with less leaking of news – until the Evening Standard got ahead of itself. We did have Liam Fox calling for a capital gains tax (CGT) holiday to kick start the economy, which left us wondering whether as a former cabinet minister he had the Chancellor's ear.

And then the day before the Budget, the Treasury announced an extension to the childcare scheme to autumn 2015 (after the next election). That sounded expensive and so immediately raised the question of where the cash would come from to pay for it.

Tax changes – devil in the detail

There was little in the way of new tax news in the Budget speech, but as always the devil is in the detail. The Overview of Tax Legislation published by HM Treasury itself contains 185 pages of proposals.


Significant moves are afoot to assist homebuyers to get onto and move up the property ladder, at least when the home is worth less than £600,000. These initiatives will hopefully provide a boost to home ownership and new build projects.


The headline measure on jobs was the introduction of an employers' NI relief of £2,000 per year from 2014 for all businesses. This will help smaller businesses in particular and as a result many will pay no employers' NI at all. However, there were some worrying developments, with a consultation proposed on how members of limited liability partnerships are taxed. This could result in yet more complications for firms to wrestle with.


The one-off CGT exemption for a capital gain reinvested in a seed enterprise investment scheme (SEIS) made in 2012/13 has been extended for 2013/14, but only up to one-half of the gain. This will give a boost to the SEIS, a relief that started slowly but is now beginning to take off. In addition, an individual can still obtain 100% relief against a capital gain realised in the 2012/13 tax year by making a SEIS investment in the current tax year 2013/14 and electing to carry it back to the previous tax year.

Personal allowances

The increase in the basic personal allowance to £10,000 has been brought forward one year and is a welcome move for those on lower incomes, although the increase will be tempered for higher-rate taxpayers. As previously announced, the personal allowances for those born before 5 April 1948 remain frozen. This begins the phasing out of age-related allowances to bring them in line with a universal personal allowance.

Unexpected IHT changes

Having had a fairly stable regime for IHT for some time, this was the year for a number of significant changes.

The first change concerns the ability to offset loans against the assets chargeable on death. It came out of the blue and will not be subject to consultation. It has been common practice for many years for the borrowing used to acquire assets that will qualify for IHT business property relief or agricultural property relief to be secured against other assets that will be liable to IHT in full. For example, when making a loan to an individual for the purpose of buying a new business, the bank may prefer to take a charge against the family home. The new rules require the borrowing to be matched with the asset acquired, resulting in potentially significant extra IHT liabilities for farmers and business owners.

Secondly, it was confirmed that the freeze on the tax-free nil-rate band for IHT will be extended until 2018. This freezing is part of the Government's package to fund a cap on care costs for older people and is expected to drag approximately 5,000 additional estates into the clutches of IHT by 2017/18.

Non-dom changes get the go ahead

The Budget papers confirmed that a number of matters that have been subject to consultation are going ahead.

One important area concerns the statutory residence test. Decisions on an individual's tax-residence status have previously been decided by reference to case law going back well before the jet age to the early 1900s. This created uncertainty for individuals regarding their residence status and that uncertainty was a deterrent to businesses and individuals considering investing in the UK. The new statutory rules became effective from 6 April 2013 and will enable residence status to be determined more easily, although it will still be necessary to keep detailed records.

In addition, the Government has confirmed that the current £55,000 limit on IHT-free transfers from a UK domiciled individual to a non-UK domiciled spouse or civil partner will increase in line with the nil-rate band, currently £325,000. This is a welcome move since the limit of £55,000 had remained unchanged since 1982.

A non-UK domiciled spouse or civil partner may also elect to be treated as domiciled in the UK for IHT purposes. The election will enable a non-UK domiciled spouse to claim the spousal exemption in full, but will bring their worldwide assets within the scope of UK IHT. Consequently, this will need to be thought through carefully in case a short-term benefit is outweighed by long-term consequences.

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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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