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Savings and investment

B1. ISA CHANGES

  • No announced changes to ISAs so the maximum annual contribution limit of £7,000 (including up to £3,000 in cash) remains and can be used each year until April 2006.

COMMENT

ISAs will continue to form, for many, the first “block” of their non-pension wrapped investments. It should be borne in mind that the £7,000 contribution limit is available for each of a couple so, for them, a combined £14,000 a year can be saved – more than enough over time to build a reasonable, accessible and tax free investment fund for many individuals and couples.

For those with more to invest it is important that they are made aware of the tremendous opportunity for further tax free (or at least tax reduced) growth that can be secured through investment in appropriate growth orientated collective investments which, if held for 10 years, can qualify for full capital gains tax (CGT) taper relief. This operates so that, after 10 years, 40% of the chargeable gains will be exempt and then any available annual exemption would apply. For many investors this “combination” can operate to reduce the effective rate of tax due, possibly to nil. The maximum effective rate of tax payable, even if no annual exemption is available, for a higher rate taxpayer will be 24%.

Anyone who has a capital sum to invest in excess of the ISA investment limit, and desires to use the annual CGT exemption each year, could consider investment in an appropriate non-ISA collective investment with yearly disposals (within the annual CGT exemption) to fund future ISA contributions. This strategy can provide an attractive way of “converting” a capital sum into a non-taxable investment. Care, of course, needs to be taken over the impact of charges on the overall viability of this strategy.

B2. THE CHILD TRUST FUND AND THE SAVING GATEWAY

In April 2001, the Government published a consultation document on two new proposals to extend the benefits of saving and asset-ownership – the Child Trust Fund and the Saving Gateway. The Child Trust Fund is a proposal for a universal account, with an endowment paid to all children at birth and ages 5, 11 and 16, with children from the poorest families receiving the most help. The Saving Gateway would be an account targeted at low-income individuals, providing a Government-funded match for all money saved, up to a limit.

Responses to the consultation have been overwhelmingly positive and the Government has now announced that it is:-


  • launching a number of Saving Gateway pilot projects to assess how best to make the Saving Gateway work; and
  • publishing a follow up report, Delivering Saving and Assets, presenting detailed results from the initial consultation and presenting options for these policies for further consultation.
At the time of creating this report the Consultation report has not been read and so details not taken into account. A follow up bulletin on “Delivering Saving and Assets” will be published as soon as it has been considered.

B2.1 Child Trust Fund

The proposed Child Trust Fund will provide a cash lump sum at birth that has been entirely contributed by the Government. The Government has not yet confirmed the amounts that will be provided under the scheme. However, illustrative examples were given in the HM Treasury document “Saving and Assets for All” and we will use these figures in what follows. The initial sum is thought likely to be in the order of £250 with extra “special birthday top-ups” of, say, £50 provided by the Government at ages 5, 11 and 16. If the child is a member of a low-earning family (probably earnings of less than £200 per week) then the sums contributed by the Government to the fund at outset and at ages 5, 11 and 16 could double that under the ordinary allowance ie. £500 and then £100 at ages 5, 11 and 16.

The Government intends to permit additions to the fund to be made by anybody else for the child&#39s benefit.

COMMENT

At this stage the Treasury has not yet determined what the tax treatment of the funds should be or how the funds should be invested although it is widely anticipated that the emphasis will be on caution. The recent “Commentary 85” document from the Institute of Fiscal Studies (IFS) on the Child Trust Fund (and Saving Gateway) provides some interesting commentary on both of these proposals.

It seems that the Government is considering either:

  • An open-market model, in which the CTF would be delivered by financial service providers, like ISAs and stakeholder pensions; and
  • A preferred panel model, with a more limited number of providers offering the CTF in partnership with the Government For delivering the Child Trust Fund

For financial product providers (who may be involved in offering the Child Trust Fund) and advisers the question of what assets will be permitted within the Child Trust Fund is of some considerable interest. In the IFS document the important point that is made is that the Child Trust Fund will have a long “start to finish” time horizon and so some degree of equity investment is likely to be seriously considered. Reference is also made to some form of “lifestyling” so that as the “release date” approaches the fund is moved away from potentially risk exposed investments and into safer “bond/deposits”. This principle is well known in connection with pension funds in the years leading up to the expected or targeted vesting date.

One may not be too surprised to see some form of CAT marking implemented for these funds. It is hoped that the details surrounding the structure of these funds will not be excessive but, given their objective, one would expect to see some form of limitation on access/withdrawal in order to increase the chances of the objective of long-term saving for a “financial start in life” being achieved. With the ever increasing costs of further education showing no signs of abating and the continuing limitation on the extent to which individuals can rely on the Government to provide financial assistance, the proposed “age 18” release date might not be inappropriate. No doubt such a limitation could be contained in the trust terms – not unlike those applying when shares are held in employee share schemes.

The tax rules (when published) will need to take account not only of the taxation of the sums contributed by the Government but also income and gains arising from amounts invested by others. Where parents contribute a decision will need to be taken on the application (or otherwise) of the anti-avoidance rules which, if they apply, would operate to result in the assessment of all income on the parent if the income arises from a sum settled by the parent for the benefit of a minor unmarried child and the grossed-up income produced in a tax year from settlements/gifts by that parent exceeds £100. At current interest rates, though, one would need capital in the order of £2,500 to cause a problem under this rule which, if it were to apply, would hopefully not apply to any sums given by the Government.

Should these proposed “trusts” be excluded from these anti-avoidance rules on income they could form a tax attractive home for parental savers as well as for parental savers seeking to benefit children. But such an exemption would surely come at some cost in terms of flexibility and access.

Another issue that needs to be addressed is whether there should be any restriction on the uses to which young adults can put the funds in their Matured Trust Funds. This issue is specifically referred to in the Treasury Document referred to earlier.

A list of “designated purposes” cannot be ruled out but no doubt before going down this route management, administration, policing and cost will all be taken into account.

There is also talk, in the Treasury Document, of providing incentives for “extended family and friends to contribute” and reference is also made to providing a “limited tax incentive based on the ISA model”. We have already, of course, witnessed the introduction of tax incentivised third party contributions in connection with stakeholder pensions (see later). Particularly if such contributions are permitted, the issue of access to them before “release date” will need to be addressed.

Regardless of what may emerge in respect of the Child Trust Fund it is worth remembering that ordinary “private trusts” in bare or nominee form already offer the opportunity to use the child&#39s (beneficiary&#39s) capital gains tax exemption each year regardless of who the settlor is – parent or otherwise. The parent could also be the trustee. These trusts are however caught by the income tax anti-avoidance rules in s660B ICTA 1988 where the income exceeds £100 gross in a tax year. Under this rule, where this income limit is breached all of the income is assessed on the parental settlor. One method of avoiding this problem is to invest in non-income producing assets and focus on securing growth through capital gains.

Children cannot have stocks and shares ISAs but ordinary collectives (unit trusts, OEICs or investment trusts) held on bare trust for children can give the same capital gains tax advantages for gains up to the annual exempt amount. And, remember, taper relief also applies to reduce long-term gains.

An even easier way of ensuring that a child&#39s CGT exemption is fully used in connection with collective investments is for a parent to invest in, say, growth orientated collective investments, e.g. unit trusts or OEICs or investment trusts, that are designated for the benefit of the child. In this way a combination of taper relief and the annual exemption can ensure that over the long term no (or substantially reduced) capital gains tax is payable on gains. This could be an attractive way of funding for the increasing costs of further education. Clearly, as for all savings, the most effective results will be secured if investment can be made over a relatively long period.

Like the trust, the designated account route is one that necessitates a willingness to give up beneficial access to the investment used in the strategy from outset. The gift would normally be exempt for inheritance tax purposes or, to the extent it is not exempt, constitute a potentially exempt transfer.

Where the donor does not wish to make an immediate gift of the assets in question, perhaps because he or she wishes to maintain access to the funds, then a “deferred” gift of a collective investment will trigger a potential CGT liability on the donor when the gift is actually made, eg. when the child enters into further education at age 18 or over. The assignment of the collective investment, at that point, will be a disposal for CGT purposes with the “market value” rule imposed to determine the amount of the gain. All gains and income on the “non-designated” collective would be assessed on the investor (parent) during the period of his or her ownership, ie. up to the point of assignment.

For this type of investor, serious thought should be given to, say, a non-UK investment bond with an assignment of sufficient segments (whole policies) to the child, when aged 18 or over so as to be able to give a valid receipt, when the costs of further education are to be incurred. The assignment would be for no consideration and so would not give rise to a chargeable event and any gains arising on subsequent encashment by the student would be assessed on the student. Any available personal allowance, 10% tax band and basic rate tax band would, in most cases, help to keep tax to a minimum.

Before leaving children&#39s investments it is also worth remembering (as referred to above) that a parent can also apply (and pay) for a stakeholder pension for a child for an amount of up to £2,808 net in each tax year with basic rate tax relief added by the Government to give a total gross investment of £3,600.

B2.2. Saving Gateway

As well as the proposed Child Trust Fund the other “new” savings proposal is the Saving Gateway.

The Saving Gateway (like the CAT marked ISA and stakeholder) is aimed primarily (if not exclusively) at encouraging lower-income earners to save. While the stick of compulsion remains over pension plans, the Government appears likely to adopt the “carrot” for the Saving Gateway by offering to match savings with additional contributions paid by the State. This seems like just another way of giving tax relief or incentives but in a much more direct and obvious way and, in effect, amounts to an asset as opposed to an income distribution. No doubt the Government believes that the perception will outweigh the reality.

In their consultation document (issued last year) the Government recognised that more needs to be done to extend the benefit of saving to lower – income earners. 46% of those on household weekly incomes of less than £200 and 43% of those on less than £300 have no financial savings at all (excluding housing and pensions, but including current accounts). This is a stunning statistic especially when taken together with the fact that, according to the office of National Statistics, 65% of marketable wealth (excluding private housing) is held by the most wealthy 10% of all adults in the UK.

Perhaps as important (bearing in mind the point about the Government&#39s apparent view that a more demonstrably direct incentive to save is necessary for this market) is the fact that it would seem that tax relief alone has not been successful in encouraging those on lower incomes to save for themselves. The Saving Gateway is designed to act as a kick-start to bring these people into the habit of saving. The Saving Gateway account, which will be available only to those on lower incomes, will offer to match every pound saved in the account with a direct contribution from the State. The Saving Gateway will run for a fixed period of time, after which savers will have the opportunity to transfer their saved assets into an existing vehicle &#45 such as an ISA or a stakeholder pension or the Child Trust Fund. The Saving Gateway proposal will also provide the financial education, information and advice needed to help people make the right financial choices for themselves.

The Saving Gateway will therefore act as a catalyst towards starting those on lower incomes on the road to greater financial independence, by giving them the financial assets and information necessary to take advantage of existing measures such as ISAs and stakeholder pensions.

The Government have given some examples of how the Saving Gateway might work. A 2.5% real rate of return has been assumed in the illustration.

It has also been assumed that the Saving Gateway

    • will be open to families or individuals earning at or below a set threshold for eligibility;
    • will last three years from the time that an individual opens it; and
    • will provide for the State to match every pound put into the account, on a 1:1 basis, up to a monthly maximum of £50, the equivalent of an annual maximum of £600.

Based on all of this, if an individual who earns less than the threshold for eligibility (whatever this ends up being) opens a Saving Gateway account and saves £25 a month for the full three years of the scheme then, when the account matures, the value of the Saving Gateway will be £1,870 in real terms, adjusting for future inflation. This total will be comprised of:

    • £900 of the investor&#39s own regular contributions;
    • £900 of matching funds contributed by the State; and
    • £70 interest (which, for the purposes of this illustration, has been calculated on a monthly basis).

COMMENT

As for as the Child Trust Fund (see above)

    • taxation
    • permitted investments and (seemingly to a lesser extent)
    • limitations on what (and when) the funds accumulated in the “Gateway” can be spent on

all need to be resolved. It seems (unlike the Child Trust Fund) that the Government currently has in mind a Single Provider for the Saving Gateway.

B3. PARENTS AS INVESTORS

Parents are a “sub-group” of investors really and are touched on above in the context of the potential new Child Trust Fund. Also, the Pre-Budget Report describes how the Government is introducing a new Child Tax Credit from 2003, built on the foundation of universal Child Benefit. The new Child Tax Credit marks another step forward in tax and benefit integration, creating for the first time a system of income-related support for families with children. It is intended to be complemented by the new tax credit for work – the Working Tax Credit. Decisions on rates for the Child Tax Credit will be made in Budget 2002.

However, it is thought worthwhile to bring out the investment possibilities for parents particularly, as mentioned above, with reference to funding the increasing costs of further education on behalf of their children.

Issues to carefully consider are:-

  • Maximising use of the fact that up to £100 gross income per tax year per parental donor per donee child will not be assessed on the parental donor.
  • Maximising use of the child&#39s annual CGT exemption which, when combined with taper relief in the context of growth orientated investments, can produce substantial tax free sums to fund further education.
  • Maximisation of friendly society plan investments for the benefit of children potentially for funding further education.
  • Serious consideration should be given to the investment of up to £3,600 per annum in stakeholder pensions on behalf of a child. In order to ensure that £3,600 is invested it will only be necessary for a parent to invest £2,808 with the balance being provided in the shape of basic rate tax relief at source from the Inland Revenue.
  • Maximising the use of any child benefit available (if not immediately needed for the child&#39s welfare) to invest in either cash ISA investments (bearing in mind the £100 income threshold), collective investments to utilise the annual CGT exemption and taper relief, friendly society plans or even offshore bonds with encashments taking place after age 18 when segments or policies can be assigned without tax charge to the child to facilitate a tax free encashment within the child&#39s personal allowance.

All of this is well worth considering since, despite the general provision by the Government of funds for education at all levels, the costs attributable in respect of each child, including tuition fees and general costs of living, need to be funded by either the child (usually through student loans and part-time work) and/or parental contributions.

B4. INSURANCE PRODUCTS

Details of a new tax regime for corporate debt, financial instruments and foreign exchange are to be published shortly. The new rules will apply for company accounting periods beginning on or after 1 October 2002.

Part of the new regime will extend the scope of the financial instrument scheme to include instruments that produce a fixed return to back certain insurance products.

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