In an RDR-compliant world, advisers will need to consider the impact of tax on adviser charges. But what are the implications for investment products?
Adviser charges fundamentally differ from commission. With commission, the provider is liable for payment, under a contract between the adviser and provider. However, adviser charging means the client is liable for payment, under a contract between the client and adviser.
Clients can choose to pay adviser charges directly to the adviser or have the provider facilitate them. Where the charge is paid directly there is no tax implication for the client, it is simply a payment from the client’s money.
Where the provider facilitates the charge there are two options. Adviser charges can either be paid before or after investing the money in the product.
The fundamental difference between commission and adviser charges means adviser charges paid after investing creates a specific withdrawal of the client’s money from the product. The client is surrendering part of the investment to pay the charge.
Adviser charges paid before investing means no such withdrawal. The provider is a middle man, passing on the charge from client to adviser, outside of the product.
The implications of the two options vary by product.
Adviser charges paid from the product eat into the 5 per cent per annum cumulative withdrawal allowance – they are part surrenders.
Adviser charges paid before money is invested in the product are not a part surrender, meaning less money is invested and each annual 5 per cent allowance is lower.
However, the important consideration is cumulative withdrawals. The table below shows cumulative withdrawals for a £100,000 investment and 3 per cent initial adviser charge, comparing an adviser charge paid before and after investing the money.
|Year||Cumulative withdrawals if adviser charge is paid after investment (£100,000 into product)||Cumulative withdrawals if adviser charge paid before investment (£97,000 into product)|
Cumulative withdrawals are lower if the adviser charge is paid from the product after the investment, although each annual withdrawal from year two on its own is higher (£5,000 versus £4,850). The initial value will be the same whichever route is used – £97,000 is invested after adviser charge.
Paying an adviser charge before investing the money therefore allows greater withdrawal flexibility without detriment to clients. They could be worse-off if initial adviser charges are paid from the product.
Ongoing adviser charges also eat into the 5 per cent annual allowance. This depends how adviser charges are calculated. An adviser charge as a percentage of the fund value has a bigger impact than a flat ongoing charge. Take our £97,000 example. Assume 5 per cent per annum growth and an ongoing adviser charge of 0.5 per cent of the fund value.
|Year||Fund value||Ongoing adviser charge|
Withdrawals within the cumulative 5 per cent are potentially liable to tax on eventual surrender.
Where regular withdrawals are taken, care is needed if the cumulative 5 per cent is not to be exceeded. Otherwise, a chargeable event occurs and a small but unnecessary potential income tax liability arises.
Authorised investment funds (eg Oeics, unit trusts)
Adviser charges paid from these are disposals for capital gains tax, creating a potential capital gains tax liability.
However, CGT is payable on a gain and with initial adviser charges there is no gain.
|Adviser charge paid after investment||Adviser charge paid before investment|
No CGT liability arises with either route.
However, ongoing adviser charges differ. The following example assumes 5 per cent per annum growth on £97,000 and an ongoing charge of 0.5 per cent of the fund value.
|Year||Fund value||Adviser charge||Gain|
The gains may be covered by the annual exemption but care is needed where the exemption is being used through other disposals. Similar to investment bonds, a small but unnecessary tax liability could arise.
This may be simplified if adviser charges are below £3,000 each year. In this case, amounts realised to pay adviser charges can be added together and be taxed on eventual disposal. The client will then potentially suffer CGT at that time.
It is vital to take into account ongoing adviser charges when using the annual exemption. Cash accounts, for example, through wraps, may help alleviate this, although keeping sufficient money in cash may require the sale of investments, which itself has CGT implications.
There are no tax issues with Isas, the issue here is maximum contributions. The following table shows the effect of £500 initial adviser charge.
|Adviser charge paid from Isa||Adviser charge not paid from Isa|
|Amount in Isa after adviser charge||£10,780||£11,280|
For clients wanting to maximise Isa allowances each year, the adviser charge needs to be paid outside of the Isa.
Fundamentally, the above does not affect the advice considerations as to whether an Isa, investment bond or a collective investment is most appropriate for any particular client. Those considerations remain as they do now.
But the advent of adviser charging introduces potential pitfalls, once the appropriate investment route has been chosen. Advisers will need to be aware of these to ensure clients do not inadvertently lose out.
Matthew Stephens is head of technical product and sales at Prudential