Last week I led with the observation that there seems to be some momentum behind the attraction of growth stocks among some fund managers. This is against a background of caution over demand for income stocks, some of the ratings for which, according to some commentators, may be looking a little stretched.
Since the falling out of love with growth stocks following the dotcom crash, some believe that there are a number of growth stocks that now look undervalued. Apparently, even some value stock devotees are commenting that growth stocks look cheap.
It is the latest expressed enthusiasm for growth stocks that leads me to consider the importance of selec-ting the right wrapper for a growth stocks’ portfolio.
If the growth stocks are ones that declare no or small dividends, then the tax-deferring qualities of a UK investment bond will not be of great relevance. That is not to say that the investment bond does not have other qualities – it clearly does, simplicity being one of them. However, the value of taper relief and the annual exemption (applied year on year or left until realisation or both) could be highly attractive for UK taxpayers and especially those who would not otherwise use their annual exemption.
Even the most simple example would reveal that, for a couple who made a shared capital gain of £40,000 over 10 years, with the available annual exemption at £12,000 each, at the end of that 10-year period it would be possible to realise the gain free of capital gains tax based on current legislation. Taper relief would reduce the gain for each investor to £12,000 and this would be exempt within the annual exemption.
It may well be possible for the taxable gain to have been reduced by yearly rebalancing. This would have the effect of uplifting the base value so that while the gain would still be realised at the end of the investment period, less of that gain would be treated as a capital gain realised at that time. Rebalancing exercises – unlike many bed and breakfast exercises of the past – should, of course, be investment and not tax-led.
Rebalancing typically takes place where there is a need to adjust the portfolio to stay within an asset allocation framework that is deemed to be suitable for that particular investor, taking account of his or her attitude to risk. As a by-product, if this facilitates the use of the annual exemption to uplift the base value of the investment, then so much the better in respect of final gains.
Of course, to the extent that the investments are disposed of and reacquired, the taper relief qualifying period for those investments will cease and a new one will begin. However, overall this ought to make good tax sense – a perfect example of the tax tail not wagging the dog but nevertheless providing investor benefit.
Those choosing a collective wrapper for these excellent tax reasons will also be heartened to know that it gets even better on death. That is because, on death, all past capital gains are wiped out and the base value of the investment uplifted for the purpose of calculating future gains. This is so regardless of who inherits under the will (or intestacy) of the deceased investor.
This capital gains tax wipe-out is an added bonus for would-be users of the nil-rate band through will trust planning but who prefer to use collectives rather than bonds, for whatever reason. The beneficiaries under a nil-rate band trust would then inherit free of inheritance tax and capital gains tax.
The value that an adviser can add by recognising the right choice of investment wrapper for a particular portfolio should not be underestimated. Naturally, on relatively small investments, the impact of wrapper choice and tax consequences will not be appreciable. Where, based on a particular portfolio being considered, the wrapper that is chosen does not make an appreciable difference to the end returns, then other factors will be more relevant in determining wrapper choice.
These other factors will also be relevant where the wrapper choice does make a tax difference. In this case, it will be necessary to effectively weight up the relative importance of the tax and financial consequences of the wrapper choice and other factors, such as administrative simplicity and the capability or ease of holding the portfolio within a particular wrapper subject to trust. It may be that there is a good case for splitting the portfolio among different wrappers to minimise the risk of choosing the wrong wrapper.
To date, the combination of financial products and trusts in inheritance tax planning has largely been the domain of insurers, UK and offshore. There seems to have been no end of innovation, especially since last year’s Budget.
The development of platforms and increasing recognition that the open architecture that serves investment planning so well may also have a place in estate planning will be worth watching. While it is well known that it is usually more difficult to hold income and capital gains-producing assets in trust, this does not necessarily mean that where the potential investment and tax gains are significant enough, it will not be worth bearing the extra cost in terms of trust administration. Advice will be absolutely essential in making this call.
The golden rule is that where the investment is big enough, it will be worth spending the time helping the client to make the right choice and documenting how that help was given and how the choices were made. Now that really is treating your customer fairly.