Keeping things simple?

The Budget and its aftermath often dominate the thinking of financial planners at the start of the new tax year. As always, there was much to absorb in the detailed Budget releases from HMRC. This year this included a proposal to remove 100 pages from the current tax code by abolishing some outdated reliefs. While this is welcome, is the Chancellor missing a trick to simplify tax further by merging income tax and NICs?

As we wave goodbye to another financial year, we're still facing a good deal of turmoil around the world – economic, political and the recent catastrophic events in Japan. We touch on these later in this issue of Family Wealth Management in our regular investment outlook report on global markets.

At home, we're facing up once again to the spectre of inflation, something that hasn't been a major factor in investment decisions for quite some time. We look in detail at the UK's 'perfect storm' of inflation shocks and offer some tips to protect your assets.

Also in this issue, we look at the cost of university education and the forward planning required as fees soar. There are yet more changes to pensions to absorb and we explain what they will mean. We also look at salary sacrifice, offshore pension schemes and the new rules to end disguised remuneration. Finally, we're very proud to celebrate some more award successes for Smith & Williamson – see back page for further details.


There were few shocks in the Budget, but let's put it into context.

George Osborne's second Budget had few shocks, although the reduction in the headline rate of corporation tax seemed to have been a well-kept secret. However the annual Budget must now be seen in the broader context of tax policy making.

The Government has introduced a new way of setting tax policy which includes a timetable for changes generally to be announced in a spring Budget, followed by a period of consultation during the summer, leading to the publication of draft legislation in the autumn. The Finance Act will then be signed off by the end of the calendar year and the new rules will apply from the following 6 April.

Many of the Chancellor's announcements will become effective next year or later after a period of consultation. Hopefully the new timetable will help the Government to achieve its objective of creating a more certain and stable tax system.

Widening the tax net

It's important to remember that a number of changes in the income tax and national insurance contribution (NIC) rates for 2011/12 were announced last year, which means that anyone earning more than £42,475 a year will be paying more in income tax and national insurance from 6 April 2011.

Higher income taxpayers were already being taxed more heavily in the 2010/11 tax year. Those on £100,000 a year and upwards lost the benefit of the personal allowance, while those on taxable incomes of £150,000 upwards have also been paying 50% on income above this level. But there are too few top rate taxpayers to fill the Chancellor's coffers – hence the need to widen the net still further to those on 'middle incomes'.


Another essential ingredient in the Government's tax policy-making was the establishment of the Office of Tax Simplification (OTS). The OTS issued two important reports ahead of the Budget, reviewing 155 tax reliefs and the taxation of small businesses.

The Chancellor responded to the first report by proposing the removal of 100 pages from the current tax code by abolishing some outdated reliefs.

While the removal of reliefs which are now past their sell-by date is welcome, genuine simplification will require major pruning of the existing tax code. The OTS's report called for a complete overhaul of inheritance tax and, although nothing was said about this in the Budget, it is hoped that the Chancellor will respond on this point in due course.

Merging income tax and NICs?

The OTS's report into the taxation of small business underlined that the Government should consider merging income tax and NICs paid by individuals.

In his speech, the Chancellor noted that income tax and NICs have operated as two fundamentally different systems causing unnecessary costs for employers. He confirmed that the Government will consult on 'merging the operation of income tax and NICs'. The Budget report states that the contributory principle will continue and NICs will not be extended to individuals above state pension age or to other forms of income such as pensions, savings and dividends.

It appears, therefore, that the Government is backing away from a full merger of income tax and NICs, with a single rate of tax on earnings. Instead, it appears to be thinking of keeping the two taxes running in parallel but with identical definitions.

While this approach would improve the position slightly, the Chancellor is arguably missing a once-in-a-generation opportunity for a major simplification of the tax code by means of a full merger of the two taxes.

Putting fuel in the economy?

The Budget's main aim was to stimulate enterprise and so encourage growth and jobs. The Chancellor reiterated that he wanted the UK to appeal to global businesses as a location of choice. Positive signs have come from the chief executive of WPP who indicated that the company will consider relocating its headquarters to the UK, but it remains to be seen whether the reduction in the headline rate of corporation tax, and other reforms now underway, are sufficient to tempt more businesses to relocate here.

The Treasury published a supporting Budget report of almost 200 pages, but this was short on detail and will no doubt be followed by a flurry of consultation papers in line with the new policy structure.


A look at the options available under new drawdown rules.

2010 was a busy year for changes to the pensions regime. Last October, draft legislation was introduced limiting tax relief on pension contributions from 6 April 2011, and reducing the lifetime allowance from £1.8m to £1.5m with effect from 6 April 2012.

At the time, the Government indicated there would be consultation on the issue of individuals being forced to take an annuity from the age of 75. As an interim measure, the age of 75 was extended to 77 until new rules had been finalised.

In December 2010, new rules were announced to take effect from 6 April 2011. These change the options for generating pension income, and deal with the issue of taking an annuity at age 75. They also include changes to inheritance tax (IHT) on pension fund death benefits. There are no changes to the ability to take a tax-free pension commencement lump sum (PCLS).

The first major change is that there will no longer be a requirement to take benefits by a specified age. The tax free PCLS and pension benefits can be taken at any time from age 55. Secondly, the unsecured pension (income drawdown up to age 75) and alternatively secured pension (income drawdown from age 75) will be scrapped, and replaced with capped drawdown and flexible drawdown.

Capped drawdown

This will operate in a similar way to the unsecured pension. There are three main differences.

  1. Individuals will be able to continue in capped drawdown throughout their lifetime.
  2. The maximum limit on annual income will still be calculated by reference to government tables known as 'GAD rates', which broadly reflect the rate of a single life, level annuity at a given age. The limit will, however, be set at 100% of the relevant GAD rate for an individual's age. The maximum unsecured pension was previously based on 120%, while an alternatively secured pension was based on 90% of the rate for a 75 year old. The change will restrict the maximum income prior to age 75, compared with current rules, but is more generous thereafter.
  3. The maximum income will be reviewed every three years. At present, this takes place every five years in an unsecured pension and annually in an alternatively secured pension.

Flexible drawdown

Flexible drawdown offers a new approach compared with current options. As long as an income of £20,000 per year is secured, flexible drawdown will be available. Examples of secured income for this purpose are state pension, pension annuities and scheme pensions, provided the scheme from which it is paid has at least 20 members. Purchased life annuities and investment income, for example, cannot be included. Subject to securing this minimum income, there will be no restriction on withdrawals from the rest of the fund. Indeed, it will be possible to take the whole of the fund, subject to payment of income tax.

The flexible drawdown option may appeal to some who can secure the £20,000 income. It remains to be seen how many people will wish to withdraw the whole fund, particularly bearing in mind that:

  • there is potentially an income tax charge of up to 50% on funds withdrawn
  • it is very likely that, after income tax, the income generated from the capital withdrawn will be considerably less than that available through capped drawdown
  • funds held within the pension fund grow free of capital gains tax (CGT) and virtually free of income tax, whereas they will potentially be subject to both taxes if held personally
  • while tax at 55% will be due on the residual fund in the pension on death, funds held by the member will be subject to IHT at 40%, having already been subject to income tax when extracted from the pension.

Death benefits

If there is a residual pension fund on death, it can be paid out as a lump sum. In this case, the position will be:

  • if no benefits have been drawn and the member dies prior to age 75, the fund may be paid out without any tax
  • if no benefits have been taken and the member dies after age 75, the fund may be paid out to nominated beneficiaries, subject to a 55% tax charge; any tax-free lump sum entitlement that has not been taken will be lost, or
  • if the member dies while drawing the benefits through capped or flexible drawdown, the fund can be paid out to nominated beneficiaries, subject to a 55% tax charge; current tax charges are 35% for unsecured pension prior to age 75, and a combination of taxes totalling up to 82% of the fund on death after age 75.

Inheritance tax

The Government has simplified the current system, where IHT may be payable in certain circumstances. As long as arrangements have been set up correctly, IHT should no longer be payable on pension funds.


Most individuals with relatively small funds will still find purchase of an annuity the most appropriate option. Those who have built up larger funds will have some additional flexibility, and the decision to remove the obligation to take an annuity at 75 is to be welcomed.

While the tax increase from 35% to 55% if the fund is paid out on death of the member prior to age 75 is disappointing, financial dependants will still have the option of taking income from 100% of the fund, and the charge reflects the fact that pension funds are intended to provide retirement income for the member and financial dependants, rather than an inheritance.

There are still advantages and disadvantages to each option, so the decision on how to generate pension income from a fund continues to be complicated and requires consideration of personal income needs, provision for financial dependants, attitude to investment risk and tax. Professional advice to help make the right choice will therefore be key.


A look at reasons for the recent rise in inflation and some tips to protect your assets.

The latest figures show UK inflation as measured by the Consumer Prices Index (CPI) at 4.0% and this could rise further. So how can you avoid the erosion of cash deposits and maintain the real purchasing power of invested capital?

Before attempting to devise an investment strategy to mitigate inflation, it's critical to take a step back to understand its underlying causes.

Bank of England governor, Mervyn King, attributes the rise in the UK rate to three factors over the past four years – a 'perfect storm' of inflation shocks.

There has been the rise in import prices – 20% over the past four years – compounded by a weak pound. Secondly, energy costs have soared – since the start of 2007 the oil price has increased 110% and gas is up 130%. Finally, VAT has distorted CPI. Excluding indirect taxes, inflation was 2.3% in January, well below the 4% headline figure.

These three factors, taken together, account for the 12% increase in price levels over the past four years. Therefore 'domestically generated' inflation over this period, according to King, is close to zero.

Divided opinion

However, the Monetary Policy Committee (MPC) is clearly divided into two camps.

The 'hawks' claim that the UK economy has lost capacity permanently and that the output gap – the difference between actual and potential GDP – is much narrower than previously assumed. They say that if this is the case, as the economy recovers, the rise in headline inflation will translate into rising inflationary expectations. Hence their belief in the need for an early increase in interest rates.

The 'doves', led by Mervyn King, argue that the current spike in inflation is temporary and that the UK economy is too fragile to absorb an increase in interest rates with the economy still recovering from deep recession. The labour market is in no position to kick-start a wage cost spiral. Consequently, real disposable incomes are likely to remain under pressure. Also, with a very fragile housing market, now is not the time to impose higher mortgage rates, they say. A tight fiscal policy needs to be counterbalanced by a loose monetary policy.

So, according to the doves, the rise in CPI is temporary and is forecast to subside later this year. Following this logic, we should not be positioning ourselves for a long-term structural shift in inflation. This view appears to be supported by the bond markets where 'breakeven inflation' (the difference between gilt yields and inflation-linked yields) has stabilised at 2007 levels rather than increased significantly.

Clearly, determining whether inflation is temporary or structural is a key question in terms of monetary policy response.

Temporary or structural?

A 2009 International Monetary Fund (IMF) study, Inflation Hedging for Long Term Investors, emphasises that differentiating between short-term and sustained or persistent inflation is not only important in terms of monetary policy, but also in terms of asset returns. The report shows that hedging over a one-year period is difficult, whereas the long-term return response is much more significant.

When considering inflation hedging it's important to differentiate between the temporary price level and structural inflation shifts. If inflation is undergoing a structural move, US data shows that the 4% level seems to be an important pivot point in terms of the real performance of assets.

So, rather than a knee-jerk reaction to inflation, it may be wise to step back and consider the possible impact of the different possible levels of inflation on an investment strategy.

Investing when inflation is heading upwards towards 4%


Inflation rising towards 4% could see equities benefit from both rising prices and unit growth and possible PE expansion. Highly indebted companies will benefit as inflation reduces their liabilities and this may favour small cap stocks.


Bond yields are closely correlated to nominal GDP, which incorporates both prices and volumes. So, if rising inflation is pushing the trend in nominal GDP higher, expect an upward shift in yields – hence lower prices.

Inflation-linked bonds

As one would expect, these should do well. Even though real yields have fallen, there is scope for them to fall further (after all, in the 1950s-1970s negative real interest rates were the norm). Medium-dated UK index-linked bonds are only factoring in around 1.5% Retail Prices Index accrual rates, which we see as far too low.

Gold and silver

Gold and silver are traditional inflation hedges. The 1980 peak in gold in terms of 2010 dollars was $2,251, which compares with a current price of $1,400.


As inflation rises real interest rates eventually need to turn positive. At that point cash offers a real return.

Commercial real estate

Over the long run commercial real estate has been a reasonable inflation hedge. However, because rents are renewed at fixed periods, commercial property can incur time lag penalties.

Investing if inflation surpasses 4%


Equities tend to under-perform because of the double whammy of margin compression (due to rising input costs) and PE contraction (the market is not prepared to pay up for poor quality earnings). Also, rising real interest rates will eventually slow demand.


As inflation persists we would expect to start to see a 'bear flattening' of the yield curve as the long end of the yield curve starts to decline (prices rally) in response to the downturn in the economy while short rates continue to rise.


The salary sacrifice process can produce worthwhile savings for employees. Here's how it works.

The concept of salary sacrifice remains an attractive way to reduce income tax bills for employees, as well as NICs for both employees and employers. Changes introduced on 6 April 2011 for workplace canteen subsidies have eliminated one of the benefits that gave both tax and NIC savings when used in conjunction with salary sacrifice, but there are still many others that can be used.

Salary sacrifice – a contractual agreement between employer and employee to adjust the mix of salary and benefits in kind provided – can serve to reduce tax and NIC payable. If taxable salary is replaced with one or more exempt benefits in kind, the employee avoids tax and employee's NIC on the salary forgone, and the employer avoids employer's NIC on the same amount.

Potential rates of saving

Although the top current rate of income tax (the 'additional rate') is 50%, for some the actual marginal tax rate can be 60% because their total income falls within the range where personal tax allowances are withdrawn (at £1 for every £2 of income). The rate at which employees could save tax and NIC varies according to total annual income and employed earnings, but the range, for 2011/12, lies between 32% and 62% if tax-exempt benefits in kind are involved. The employer's NIC saving from such an arrangement will be 13.8% of the salary converted into benefits in kind.

Employer pension contributions (into a registered scheme) are probably the most familiar 'vehicle' through which salary sacrifice savings are achieved. However, they are not necessarily the most effective, because an employee would obtain tax relief if they made the same contributions personally. This is actually an example of a benefit substitute that achieves NIC savings alone (12% or 2% for the employee, depending on salary level, and 13.8% for the employer, at 2011/12 rates). Benefits such as qualifying childcare vouchers, an employer-provided mobile phone or settlement of congestion charges for an employee who commutes into central London using a company car all produce the full tax and NIC savings described above.

Caution required

Choice of the substitute benefits in kind is important because some produce no savings whatsoever. For instance, vouchers that could be exchanged by the employee for goods, services or cash would be fully liable for tax and NIC through the payroll, and neither employer nor employee would be better off through the process. If taxable benefits in kind are used in the salary sacrifice context, provided they are not specifically brought into charge for employee's and employer's Class 1 NIC (like non-cash vouchers), they will provide a saving, but only to the employee and only at his/her NIC rate.

The salary sacrifice process is not without its pitfalls but, operated correctly, can produce worthwhile savings for employees, especially where the employer will share some or all of the NIC savings achieved.


Anti-avoidance measures confirmed in the Budget have shut the door on so-called disguised remuneration involving structured vehicles including EBTs and EFRBS.

The disguised remuneration changes, from 6 April, aim to prevent avoidance or deferral of income tax payments and NICs through the use of these structured vehicles.

Income tax and NICs chargeable

The new legislation is designed to treat as income loans from employment benefit trusts (EBTs) and employer financed retirement benefit schemes (EFRBS) to employees from 9 December 2010. This means that income tax and NICs will be chargeable on the employee, while the employer will have to account for PAYE and employer's NICs, but would be able to claim a corporation tax deduction.

HMRC has attempted to quell fears that the new legislation would catch other types of employee loans from the employer by confirming that it is not the Government's intention to charge loans that were commercial or "otherwise innocent".

There is currently no relief for beneficiaries who are taxed on the receipt of any loans made on or after 9 December 2010, but who subsequently repay the loan. However, there is a specific exemption from a charge for loans paid out by 5 April 2011 that are subsequently repaid by 5 April 2012.


The legislation also introduces the concept of earmarking to prevent the perceived abusive use of sub-funds in EBTs. From 6 April 2011, should trustees earmark or allocate funds for beneficiaries in any way, then the beneficiary will be taxed as though they had use of those funds, even though in practice they might not.

HMRC also stated that specific types of arrangements, such as approved employee share schemes and bonus deferral plans that satisfy certain specified conditions, will be protected from a charge on so-called earmarking.

The Treasury estimates that 5,000 employers and 50,000 staff, will be affected by the new rules for EBTs and expects many such schemes to be "discontinued".


Some forward planning may be required as university fees are set to soar.

With many universities announcing plans to set fees close to the new £9,000 a year limit, some families are facing a huge bill for their children's education.

If you're planning ahead to put your children through university you need to be aware of investment and tax issues, while keeping an eye on the economy and the potential impact on investment choices and returns.

Cash returns are unlikely to keep pace with university fees, so you need to invest wisely. You might consider the role that an effectively managed, diversified investment portfolio can play in aiming to achieve the required returns. This can be designed to meet specific requirements and invested in a mix of longer-term growth assets and shorter-term assets, which will allow for payment of fees at the relevant time.

In spite of the well-publicised ups and downs, shares (which would be a typical component of the portfolio) remain an attractive asset for longer-term university planning and combating inflation.

Making a portfolio work as tax efficiently as possible is also a key part of the planning process and there are a number of tax-saving investments and savings vehicles that can be used, depending on personal circumstances and attitude to risk. Here are some options to think about.

National savings

These include Premium Bonds, National Savings Certificates and Children's Bonus Bonds, which are completely tax-free investments that can be cashed in when required. They are also Treasury-backed, so may be attractive to the risk-averse investor.

Individual savings accounts

You can accrue substantial ISA portfolios over time. Ideally, both parents should open ISAs to maximise tax-efficient saving – the new limit is £10,680 for this tax year – and they can be used as a source of capital or income. Cash ISAs are available to anyone over 16 provided they are UK residents, so consider investing on behalf of youngsters.

The Government announced in the Budget that it is launching new junior ISAs, which replace the Child Trust Fund, although they will not benefit from Government contributions. These will be available from autumn this year and allow tax-free savings for children of all ages.

Qualifying investment plans

These are regular premium insurance policies, providing individuals with both an investment and life assurance element, normally established for ten years. You select the underlying investment funds, which are collectives managed by fund management groups.

Offshore investment bonds

These are single premium non-qualifying insurance policies which receive special tax treatment. You can make 5% withdrawals without being taxed on underlying income and gains, as well as benefiting from 'gross roll up'.

Venture capital trusts and enterprise investment schemes

These are at the higher end of the risk scale and while they can form part of an overall strategy, should not be used in isolation as a means to save for education.

VCTs provide capital to small and expanding companies with the aim of growing the business and generating a profit for the VCT. You can invest up to £200,000 per tax year and benefit from 30% income tax relief. In addition, dividends are tax-free and there is no CGT should the VCT be sold. There is, however, a minimum holding period of five years to qualify for the 30% tax relief.

EISs invest in individual small businesses. Income tax relief is now 30% for EIS investments up to £500,000, with a minimum holding period of three years. This is due to increase to £1m and further changes are due to be introduced in April 2012. EISs also enable you to defer CGT.

Don't forget about tax

From a tax point of view, the first thing parents should do is minimise their combined tax bills by making full use of their tax allowances and lower tax bands. Assets held by married couples can be gifted from one to the other without incurring a CGT charge.

It can be worth putting some income-producing assets such as shares or cash deposits into your child's name; however, parents are taxed on the income from such investments if this exceeds £100 per year.

If assets are gifted by others, for example grandparents, the child can now receive income up to £7,475 a year tax-free, making this a valuable tax mitigation opportunity. It may also result in IHT savings.

Additionally, if grandparents pay fees on behalf of grandchildren or make regular gifts to children in anticipation of university expenses, they escape a future IHT liability, provided the grandparents are left with sufficient income to live on. Anyone can give away up to £3,000 per year without giving rise to IHT.

Don't overlook the current difference between the rates of CGT (28%, or 18% for basic rate taxpayers) and income tax (40% or 50% for higher rate taxpayers) as this can be a major influence on the choice of investments.

Helpfully, everyone, irrespective of age, has an annual tax-free capital gains allowance, now £10,600. Even if parents gift or buy assets in their child's name which aim to generate capital gains rather than income, the child could sell them, making a capital gain each year of up to £10,600 without incurring tax on those gains.

There are many tax issues to consider and we strongly suggest that you take professional advice on this.

There is no guarantee that VCT and EIS investments will qualify for, or continue to qualify for, tax relief. Tax breaks can be withdrawn and you may be required to repay any tax relief which you have received. VCTs and EISs can also prove difficult to sell. For these reasons, be sure to consult an adviser before investing.

The value of investments can go down as well as up. Investors may not get back the amount invested


We examine whether enthusiasm for these complex pension arrangements is justified.

Offshore pension schemes known by their various acronyms – QROPS, QOPS, QNUPS and EFRBS – have been embraced enthusiastically by many financial advisers since their introduction in 2006. Is there good reason for this? The rules relating to overseas pension schemes in their various guises – see our quick guide opposite – were generally introduced as 'relieving provisions' and HMRC has made it clear that it will come down hard on schemes that abuse the rules.

For example, QROPS can be established in any country with which the UK has an appropriate double taxation agreement. However, shortly after the new rules were introduced, it is understood that Singapore was removed from the list of those countries whose pension schemes were able to apply for recognition because of alleged abuses by some of its scheme administrators.

Reporting window

While most QROPS comply with the rules, certain providers will, after the UK reporting window has closed once the member has been non-UK resident for five tax years, allow transfers to offshore pension schemes which allow benefits to be taken as a lump sum, or change their rules to the same effect. Such transfers or rule changes within the five-year window would have to be reported to HMRC by the QROPS administrator and would attract UK tax charges.

This might be seen as an abuse of the rules, but these only require that benefits should be provided in a particular manner "at the time of a transfer of sums or assets" to the QROPS.

Whether members of such schemes find that HMRC seeks to charge tax under the unauthorised payment rules as well as withdrawing the scheme's QROPS status post the five-year reporting window is a moot point, assuming that HMRC becomes aware of changes after that time.

UK resident investors will find that QROPS are generally an expensive alternative to a UK registered scheme and it is those UK residents who do not fully understand the rules who might be tempted to transfer overseas when staying put is the best alternative. It should be made clear at this point that transferring a scheme overseas does not take it out of the UK tax net.

After the five-year reporting window has closed, QROPS can offer tax advantages over UK schemes but not generally beforehand.

Having said this, some pension jurisdictions have tax approved schemes which qualify for QROPS status and which offer more generous benefits than UK schemes to its own residents, for example, Australia and New Zealand. As a result, earlier transfers to such schemes might be an option in the right circumstances, particularly as the Australian authorities will tax growth and income in UK pension funds on Australian resident members of the scheme as it arises.

Tax efficiency

EFRBS will be generally less tax efficient where the various limits on pension contributions and lifetime allowances have not been breached. Over these amounts the position is far less clear. The new rules for EFRBS to counter 'disguised remuneration' (first published in December 2010 and broadly confirmed in the Budget) indicate that where a third party (such as a trust) makes any provision for what is in substance a reward or loan in connection with an employee's employment, there may be a tax charge based on the cash sum or the value of the asset made available. The cash sum or value will be deemed to be a payment of employment income and the employer will be required to account for PAYE. These new rules can extend to EFRBS.

It is also worthy of note that the predecessor to EFRBS, funded unapproved retirement benefits schemes (FURBS), continue to benefit from IHT protection provided no further contributions have been paid into them post 5 April 2006.

We strongly recommend that individuals considering transferring to or investing in an offshore pension scheme of any description take proper advice to make sure that they understand them and their costs. Furthermore they should be mindful that HMRC will not tolerate any abuse that it becomes aware of.

Offshore pension schemes – a quick guide

Qualifying recognised overseas pension schemes

QROPS were introduced to allow individuals who had either left the UK or are intending leaving to transfer their UK registered pension scheme into an overseas pension scheme without suffering unauthorised payments or scheme sanction charges. However it is also possible for individuals who do not intend leaving the UK to transfer their UK registered pensions to QROPS.

Qualifying overseas pension schemes

The QOPS rules were introduced to enable individuals coming to the UK to continue to get relief for pension contributions paid into overseas pension schemes of which they were members before they became resident in the UK. A QOPS cannot receive transfers from UK pension schemes unless it has QROPS status.

Qualifying non-UK pension schemes

The QNUPS rules were introduced to correct an anomaly which potentially brought overseas pension schemes into charge to tax under the UK's discretionary trust rules and also granted relief for the estate on death.

Employer financed retirement benefit schemes

EFRBS were generally established by employers who wanted to provide pension benefits to top up those provided by registered pension schemes and became a popular way of avoiding NIC and income and CGT on investment growth.

Some pension planners also advocate the IHT advantages of overseas EFRBS under the QNUPS provisions should the member die before he/she has received benefits.


Selected highlights from some of the world's markets.

Global equities – admirable resilience but more tests to come

Considering the array of events encountered in the first quarter of 2011 – North African turmoil, Allied intervention in Libya, surging oil prices and the Japanese earthquake and tsunami – equity markets have displayed remarkable resilience.

The principal driver behind this resilience has been liquidity. At a corporate level, strong balance sheets and free cashflow generation have delivered a pick-up in dividend payouts, stock buy-backs and merger and acquisition activity. At a macro level, negative real interest rates and steep yield curves have also been supportive of risk assets. Also, the Federal Reserve has been very explicit in acknowledging that the generation of equity wealth effects was the cornerstone of their second quantitative easing (QE2) programme.

Obstacles ahead

Looking forward, the markets have to contend with several obstacles. One of the key issues will be gauging the impact of a potential cessation of US QE2. While it is extremely hard to predict the precise consequences of the removal of substantial liquidity support, it will undoubtedly add to overall market uncertainty. While QE2 will probably end in June, headline US interest rates are unlikely to change for quite some time.

By contrast, the European Central Bank (ECB) appears to be on the cusp of tightening. Markets often find it difficult to calibrate to a world where the central banks of the two key reserve currencies have divergent monetary policies.

The third potential headwind for markets lies with the risk of a compression in margins as corporations find it increasingly difficult to pass on rising input costs. We are at the stage of the cycle where value traps emerge. The rising oil price is also a deflationary shock to global growth.

The sustained rally in global equities that ran from September last year to mid- February 2011 has now entered a period of consolidation. This is likely to persist until we get greater clarification over the outlook for corporate earnings and margins post the second quarter earnings releases.


Fiscal austerity starts to bite

Despite forecasting higher net borrowing over the next five years, the Government has maintained its commitment to eliminate the structural budget deficit by 2014-15. While the markets have attached credence to the Government's commitment to cut public expenditure, they are less confident about the growth assumptions used to calculate future public sector revenue streams. The estimates compiled by the Office for Budget Responsibility (OBR) assume GDP growth rebounds from 1.7% this year to an above trend 2.9% in 2013 – this looks ambitious.

Consumer confidence

The combination of public sector layoffs and negative real earnings growth is already impacting retail sales and consumer confidence. This is likely to be a recurring theme as the year progresses. The latest MPC minutes disclosed a need to assess the impact of the rising oil price on the economy over the next few weeks. This emphasises the significance of the May inflation report in determining the direction of monetary policy.

While interest rate futures are discounting tightening starting in July, we think economic data will remain sufficiently weak to see this time horizon extended.

Even if the MPC decides to tighten, it is likely to make a couple of symbolic hikes (what Mervyn King referred to as 'futile gestures') and then pause. Much of this is already factored into markets. The UK clearly requires a loose monetary policy to counter a tight fiscal policy. While equities still offer the potential of real total returns, near-term performance is likely to be driven by news surrounding corporate margins and US QE2. It is worth remembering that the UK market remains highly correlated to the US market.

Europe – not such a 'grand bargain'

While the EU leaders have just agreed a 'grand bargain' aimed at providing a permanent crisis resolution mechanism, the provisions of the agreement fell some way short of what was initially indicated. The principal shortcoming is that, due to intense domestic euro scepticism, the German chancellor has pushed for a substantial watering down of capital commitments to the European Stability Mechanism. Also, a key signatory for the mechanism, Finland, has to await an election in mid-April where the 'True Finns', an anti-euro party, has been gaining support. It is hard not to reach the conclusion that the conflict between EU-level crisis resolution and national politics has yet to be fully resolved.

The ECB has indicated that it is close to lifting interest rates as inflation has moved above its 2% target. The widening of interest rate differentials with the US has contributed to the almost 9% appreciation of the euro relative to the dollar in Q1. Ironically, once the ECB starts tightening, the focus of the currency market could switch from interest rate to growth differentials which could see the euro start to weaken relative to the dollar.

Japan – triple whammy

The triple whammy of an earthquake, tsunami and nuclear reactor meltdown came as a heavy blow for an economy that was showing tentative signs of recovery. It now looks as though GDP will contract 1% to 3% in 2011. For 2012 the rebuilding stimulus should then produce between 2% and 3% growth. Initial concerns that supply chain disruption would be significant now look overdone. In the immediate aftermath of the quake the yen appreciated significantly (in anticipation of capital repatriation). The G7 subsequently initiated a concerted intervention to weaken the yen, which has been a partial success.

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.