Bowden: The Budget announcements on income tax will see an increase in all types of tax-efficient investments including offshore bonds. The deferment of income tax in an offshore bond has obvious benefits for individuals who anticipate a reduction in their income tax status at encashment. It is not just the increase in tax rates that will drive this market, the restriction on higher-rate pension tax relief will also mean retirement planning will encompass a wider range of tax-efficient vehicles.
In addition, investors will seek other investments where increases are taxed as capital gains rather than income.
Schofield: The instant answer from the life industry to any change in tax legislation always seems to be bonds, so an increase in interest is likely. There will certainly be advantages to be gained by investing in the gross roll-up of an offshore bond and taking advantage of the 5 per cent withdrawal facility, especially for those who are investing for income. However, for growth investors, the use of capital gains allowances and 18 per cent capital gains tax will still be attractive.
Hall: There are some obvious attractions in being able to shelter future income from the 50 per cent tax rate until a time when an individual’s level of income might bring them below the threshold. However, there might be additional scope to transfer assets into a spouse’s name, even if the spouse is a higher-rate taxpayer but not a 50 per cent tax-payer.
I would perhaps be more tempted to look at some of the offshore money market funds where income is treated as dividends and would be taxed at the new dividend rate.
Although the proposed dividend rate is 42.5 per cent, it would remove the layer of charges that offshore bonds would impose. It depends on what assets are being held in the bond as to whether this is an effective tax wrapper.
If the assets are predominantly growth-oriented, then this would not be very helpful as the returns, when finally realised, would be treated as income and taxed as such rather than being treated as capital gain which has its own allowance and a lower tax rate of 18 per cent.
Do you expect to see a surge in interest in venture capital trusts due to the reduction in higher-rate tax relief on pension contributions for anyone earning more than £150,000?
Bowden: VCTs took a knock when the income tax relief was reduced to 30 per cent. Current market conditions have also made investors wary of the risks involved in these investments with regard to both returns and liquidity. Of course, VCT tax relief of 30 per cent starts to look more attractive if only basic-rate relief can be obtained on pension contributions.
For this reason, VCTs will become more popular but investors must consider the risks involved. There is a danger that investors lose out by allowing tax considerations to blinker the overall merits of the investment.
Schofield: From a tax perspective, VCTs will certainly hold some appeal and there may well be increased interest. However, as with all investments offering tax advantages, our duty is first of all to ensure the underlying investment fits with the client’s attitude to investment risk. The underlying investments have not significantly changed and VCTs still represent a higher-risk investment. Our view is that they remain suitable only for those clients with a matching risk profile.
Hall: I think there will be greater focus on these investment areas but the investment story must stack up at all times and the decision should not be driven by tax savings first and foremost. There is little point in getting a tax break of 20 per cent if you stand to lose 40 per cent.
However, with a potentially increased demand, we may find specialist managers become more creative with their offerings to find ways of reducing the risk. Managers such as Triplepoint tend to get creative around this. However, there is a danger that products will be pushed on to the market if there is sufficient demand and that these will be bought by less sophisticated investors who will not fully appreciate what they have invested in.
Was the increase in the Isa annual allowance to £10,200 sufficient? Would you have liked to see any other measures introduced to encourage saving?
Bowden: The increase in Isa allowances to £10,200 has helped encourage a higher level of saving but the complicated staged manner of its introduction is ridiculous.
One of the biggest barriers to saving is the complexity of the schemes on offer. The manner in which this has been introduced does nothing to help with this. To encourage saving, the product needs to be easy to understand, have the words “tax exempt” in the title (a return to Tessa) and be easy to subscribe to on a monthly basis as well as by lump-sum investment.
Schofield: The increase in the Isa allowance was certainly a simple way to encourage increased savings. However, the change is piecemeal with part in October and part next year and the new allowance of £10,200 only brings the level up to where it should have been if the allowance had been increased properly over time. We would have liked to have seen more measures that reward savers, especially those who have been hit hard by the fall in interest rates.
Hall: Isa limits, like many other things, have not kept pace with inflation. However, raising limits does not encourage savings except for those with surplus capital to invest. There is little to encourage people to save out of income.
The Chancellor has hit pensions at the higher-earner end of the scale but he did nothing to encourage pension savings at the lower end. One of the barriers to long-term pension investing is that people are unable to access the money earlier. The Government could have considered making pension funds accessible at an earlier date on a loan basis, similar to how certain pensions work in the US where 401(k) loan rules seem realistic enough and, as a last resort, would possibly help when money is desperately needed, with borrowing for specific reasons – including house purchase. This might be useful in the current economic environment.
Financial stocks have led the FTSE surge in early May. Do you think the worst has passed for the financial sector?
Bowden: The worst for the banks may be over, in that the threat of full nationalisation has diminished in the short term. This allows investors to believe they may share in at least some of any future profits. This possibility will provide a floor for the share price but there will still be shocks along the way.
Speculators will have done well if they invested during the lows of March but they must be seeking to take profits. A more fundamental share price recovery will not occur until banks can demonstrate a robust and secure trading model and the Government can find alternative investors to enable it to reduce its stake.
This will take many years and if any news reignites the fear of total nationalisation in the meantime, all gains will evaporate.
Schofield: Financial stocks have indeed risen strongly in May but it has to be recognised that this recovery has come from rock-bottom lows. There is nothing about the state of the economy and the sector to suggest financials are healthy or that the worst is over, even taking recent rises into account.
Hall: It is still too early to be able to say with certainty that the worst has passed. We have not yet seen whether the financial stimulus packages are actually going to work. The bounce in stocks may well be a result of them being oversold in the first place but is the sector now a safe bet? I don’t think so. The volatility in the market is still high and it is not inconceivable that there will be other failures or problems to undermine the financial sector. By all means dip your toe in the water, but no more than that.
The Association of British Insurers and the Investment Management Association are both looking at the criteria for money market funds with a view to amending the rules or even creating a new sector to avoid confusion as to what these funds can and do invest in. Do you think the classifications need to be reviewed?
Bowden: The classification for money market funds definitely needs to reviewed. Investors use these funds for one of two purposes. First, to provide a safe home for money (normally for the short term) or, second, to try to achieve a greater return than from normal bank or building society deposits.
The two aims are entirely different and investors need to be absolutely sure what the fund is trying to achieve and hence the relative risks it is taking. Funds should be categorised depending on whether they have security of capital as their aim or whether they aim to outperform deposit accounts.
Schofield: The end result of any financial crisis is someone locking the stable door after the horse has bolted and this is equally true in terms of the money market sector. Having said that, we welcome the proposal to introduce a more cautious sector but we do think the classifications are in serious need of a full and proper review, if only to ensure this particular error is not repeated.
Hall: Yes, they do. The spectacular own goal that Standard Life gave us with its fund earlier this year merely highlights how potentially toxic these funds can become.
It may well result in additional sectors and classifications but investors and their advisers need to be able to deal in these funds with absolute certainty that there is no potential for “drift” by the fund and that it cannot turn into something else.
At the same time, the two organisations should look across their range of classifications and start to provide some conformity when using similar terminology. Balanced, cautious, etc, should broadly be the same, whether ABI or IMA.