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Budget 2011: Financial planning opportunities

Having inflicted substantial pain on the electorate through the introduction of a number of austerity measures in the June 2010 emergency Budget, Chancellor George Osborne offered the 2011 model as a Budget for economic growth – and that was particularly the case on corporate taxation, where he signalled a progressive reduction in tax over the next few years.

As regards income tax, capital gains tax and inheritance tax, there was little change other than that we already knew about.

On the basis that the higher the rate of tax a client pays, the greater their need for financial advice, the continued high level of personal taxes announced in the two previous Budgets and the significant changes to the pension rules announced in the last quarter of 2010 mean the financial adviser should still have a number of high-net-worth clients interested in tax-efficient solutions and, where relevant, financial products.

Income tax
Little change was made to income tax at the top end. Previous Governments had laid the foundation for the tax changes by increasing top-rate tax to 50 per cent. Reassuringly, the Chancellor told us he still sees the 50 per cent rate as “temporary”.

We were already aware of the stealth tax attack on people on the cusp of higher-rate tax. With effect from April 6, the personal allowance rises by £1,000 to £7,475 but the taxable income figure at which higher-rate tax begins reduces to £35,000 a year.

The impact is that increasing numbers (the Institute of Fiscal Studies estimates up to 750,000 people) will be “fiscally dragged” into higher-rate tax because of the reduction in the basic-rate band in 2011/12, resulting in more needing advice to minimise its impact. These people are all likely to be interested in pensions, Isas, venture capital trusts and other tax-efficient investments and strategies.

The Government’s announcement it will raise the personal allowance by a further £630 from April 6, 2012 will not, in itself, create more higher-rate taxpayers because the higher-rate tax threshold will only be reduced to such an extent that nobody pays additional income tax and, indeed, most are better off.

The increase in National Insurance contributions by 1 per cent from April 6, 2011 means more emphasis will need to be placed on NIC planning.

An effective form of NIC planning for genuine (non-shareholding) employees would be to consider a salary sacrifice arrangement in conjunction with employer contributions to a pension plan. Contributions could be boosted by payment of the saved NIC costs as additional pension payments. There are other important implications to consider with a salary sacrifice scheme.

A shareholder/director of a private company would likely lean towards dividend payments as a means of NIC planning.

Capital gains tax
Since June 23, 2010, there have been two main rates of CGT – 18 per cent and 28 per cent. These replaced the previous flat rate of 18 per cent. The 28 per cent rate will apply to those gains that, when added to an individual’s taxable income, fall into higher-rate income tax.

While CGT rates have inc-reased, they are still lower than higher rate income tax. This means it will still pay higher rate taxpayers to invest for capital growth, particularly as they can then make encashments so that capital gains fall within their annual CGT exemption – set to increase from £10,100 to £10,600 in 2011/12.

For investors on the cusp of the higher-rate tax threshold who are realising capital gains that exceed their annual exemption, they will be interested in pension strategies to extend their basic-rate tax band and so reduce the amount of capital gain that suffers 28 per cent tax.

Independent taxation planning strategies between couples will become even more important, as will the alternative bed and breakfast strategies – bed and Isa, bed and Sipp and bed and spouse. Tax-efficient investment strategies can also be used to mitigate CGT. These will include the Isa and VCT, which both offer tax freedom.

There was little in the Budget that affects the big debate over the tax benefits of collectives versus investment bonds. As a generalisation and all other (no tax) things being equal, investment bonds deliver a better home for income portfolios and collectives for capital growth. Of course, much will depend on the precise circumstances – not least the amount and term of investment, the investor’s tax position and the make-up of the underlying portfolio. Advice is essential to making the right choice.

For the person running a business, the level of entrepreneurs’ relief (10 per cent CGT rate) is to be doubled to £10m from April 6. However, business owners should not rely solely on realising their business for retirement provision as a sale may not then be possible. It is always best to put some independent retirement provision in place via a registered pension plan or tax-efficient investments.

As far as savers are concerned, especially higher rate taxpayers and those lucky enough to have taxable income of more than £150,000, there is a continuing need to consider tax-efficient savings. For these people, mainstream tax-efficient investments such as registered pensions, Isas (the annual limit of which will increase to £10,680), offshore bonds and new-style qualifying savings plans are very important. Indeed, these are the type of people who will probably be interested in the particular tax benefits of the VCT and enterprise investment scheme.

Provisions announced last year on the underlying investments of VCTs take effect on April 6, 2011 and are designed to ensure VCTs are truer risk investments. However, on a positive front, the rate of tax relief on EIS investments will increase to 30 per cent from April 6, 2011, with the permitted maximum investment doubling to £1m from April 6, 2012.

From April 2012, certain restrictions will be relaxed for VCTs and EIS, in particular the number of permitted employees and permitted gross annual value of the company concerned.

We await details in the near future on the new junior Isa, which will be available to investors under the age of 18 who do not have a child trust fund. We can expect an investment limit at least equivalent to that permitted under the CTF.

While on the subject of investments for children, many parents and grandparents will be worried about the future cost of a university education. In such circumstances, and provided they are happy that only the child in question will benefit, the early implementation of a bare trust to hold growth collectives or offshore bonds will offer a mechanism to provide for the tax-efficient funding of the costs of educating children/ grandchildren and helping them through university. With tuition fees of up to £9,000 a year, the earlier a start is made on planning the better.

We have had some important changes here but we knew about them way before the Budget. Confirmation of an annual allowance of £50,000 for 2011/12 was well received. Contributions within the allowance will qualify for tax relief at the investor’s marginal rate(s).

The ability to carry forward unused annual allowance (based on the notional £50,000 limit) from tax years 2008/9, 2009/10 and 2010/11 will help many pension scheme members to maximise contributions. This will be particularly relevant for those who were caught by the anti-forestalling rules in tax years 2009/10 and 2010/11, many of whom will only have paid a contribution of £20,000 for each of those years and so have unused annual allowance available for carry-forward. It should be remembered that in order not to lose carry-forward annual allowance from 2008/09, the full £50,000 plus an amount in respect of carried forward ann- ual allowance from that tax year will need to be paid to pension arrangements with an input period ending in 2011/12.

With the lifetime allowance set to reduce to £1.5m on April 6, 2012, clients with pension funds approaching that value will need advice on whether to elect for fixed protection or not. The downside is that, having made the election, no further contributions can be made to a registered pension.

Employee benefits
Employee benefit arrangements such as employee benefit trusts and employer-financed retirement benefit schemes have taken a hit. The Government’s disguised remuneration rules will mean that with effect from April 6, income tax will apply to a number of arrangements (set up for a tax-avoidance motive) where an employer makes a payment to a third party for the benefit of an employee.

In light of this, it is imperative that such employees should maximise permitted contributions to a registered pension scheme (that is, based on the new permitted annual allowance of £50,000, together with carried-forward annual allowance from the previous three tax years).

Estate planning
Things continue to look better for financial advisers in relation to inheritance tax planning. The freezing of the nil-rate band at £325,000 until April 5, 2015 means that for most couples with assets of more than £650,000, they will need to consider the impact of IHT on their death.

It is also important to note that the freezing of the nil-rate band dilutes the effective value of a transferable nil rate band from a deceased spouse to a surviving spouse. For this reason we may see a re-emergence of interest in the nil-rate band discretionary will trust, which will enable the first to die to put assets in trust that will accrue in value outside the taxable estate of the surviving spouse.

The financial services industry has a number of solutions. For those with cash/investments who want to make a gift yet control the destination of the benefits, a discretionary gift trust works well. For couples who want to gift yet enjoy some form of income, the DGT and loan trust can work well; and for those who want to cover the IHT liability on a property – say, a private residence – a joint- lives, last-survivor policy in trust can work well.

Also, do not forget the use of spousal bypass trusts for death benefits under pension schemes – an easy way to keep assets outside the surviving spouse’s taxable estate, yet still give the surviving spouse access via the trustees.

A new provision was announced that, following consultation on the detail, should see taxpayers who are prepared to making a substantial bequest to charity (equal to at least 10 per cent of their net estate) qualify for a 36 per cent IHT rate on the rest of their estate.

Overall, not a bad Budget for the financial adviser.

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