We all knew it was going to be a tough Budget – we had been forewarned. But for investors and retirement planners, it could definitely have been worse.
On the basis that the higher the rate of tax a client pays, the more he needs financial advice, the tax increases announced by this Budget (combined with the Labour Government Budget two months ago) means that the financial adviser should have an even bigger audience interested in tax efficient products. Let’s look at some of the opportunities.
(1) Income tax
The Liberal Conservative Coalition made little change to income tax at the top end.
The Labour government had already laid the foundation for the tax changes in their April Budget. As well as increasing top rate tax to 50 per cent, many of the provisions introduced were based on the “stealth” tax principles of freezing personal allowances and the higher rate tax threshold which, when combined with fiscal drag, will create a new army of higher rate taxpayers over the next five years. These people will all, hopefully, be interested in pensions, Isas, VCTs and other tax efficient investments.
From 23 June 2010, there will be two main rates of CGT – 18 per cent and 28 per cent. These will replace 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.
It was widely thought that the CGT rate would be aligned with rates of income tax and go to 40 per cent or even 50 per cent. The lower 28 per cent rate is a compromise which reflects the fact that the Government will not introduce taper relief or indexation allowance. The increased rate applies immediately – ie. to gains made on a disposal after 22 June 2010. The good news is that the annual exemption will remain at £10,100 and will increase annually in line with inflation.
To combat this tax increase, clients will want to maximise the use of losses (“same year” and carried forward) and the annual CGT exemption. For those on the border of the higher rate tax threshold, 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, namely – “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. Whilst the EIS offers scope for tax deferral, with CGT rates going up, investors will need to think twice about such action.
The big debate over the tax benefits of collectives versus insurance bonds has, of course, resurfaced. Previously, as a generalisation, investment bonds were a better home for income portfolios and collectives for capital growth. Now, with CGT rates increasing, the pendulum may have swung slightly in the direction of bonds, even in the case of some capital growth portfolios. However, the retention of the full £10,100 annual exemption should keep most investors out of charge to CGT, especially if they are able to crystallise gains on a regular basis. 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.
As far as the saver is concerned, apart from the hike in CGT rates and the phasing out of the Child Trust Fund, there is not much to report from this Budget although the Coalition Government have confirmed that the previous Labour government’s measure to charge tax at 50% on those lucky souls with income of more than £150,000 will remain in place. Tax efficient investments, such as Isas and offshore bonds, become more important in such a climate. As a substitute (and addition to existing Child Trust Funds), bare trusts holding growth collectives or offshore bonds will offer a mechanism to provide for the tax efficient funding of the costs of educating children/grandchildren.
Trustees of discretionary trusts have been hammered over the last couple of months. First a 25 per cent increase in main income tax rates to 50 per cent (42.5 per cent for UK dividends) quickly followed by an effective 55.5 per cent increase in CGT rates (18 per cent to 28 per cent). This represents a good opportunity for IFAs to engage with trustees of such trusts to discuss tax efficient investment using collectives and investment bonds (UK and offshore) to improve the lot of the trustees and the beneficiaries.
The Government’s proposal to consult on measures to improve the flexibility with which a person can withdraw pension benefits was well received. As a transitional measure the maximum age at which a pension annuity has to be bought has moved to age 77. It was also reassuring that there was no mention of further restricting the income level at which there is a restriction of higher rate tax relief on pension contributions. Instead, the Government have announced a consultation process on the proposal to limit tax relievable pensions saving each year with effect from 6 April 2011. They have a figure in mind of somewhere between £30,000 and £45,000 and this seems a sensible and much less complex alternative to the high income excess charge that is due to start on 6 April 2011.
In the meantime the anti-forestalling rules will remain for tax year 2010/11. Those with high incomes but not caught by the anti-forestalling rules may decide not to wait for the outcome of the consultation and make substantial higher rate tax relievable contributions while they still can in case the limit drops still further.
(6) Estate Planning
Finally, things look much better for financial advisers as regards inheritance tax planning. The failure to announce that a £1 million nil rate band will be introduced probably means this idea has now been rejected. This means that for most couples with assets of more than £650,000, they will need to consider the impact of IHT on their death. 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 wish to gift yet enjoy some form of income, the Discounted Gift Trust and Loan Trust can work well; and for those who want to cover the inheritance tax liability on a property – say a private residence – a joint lives last survivor policy in trust can work well. Also don’t forget the use of spousal by-pass 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.
All in all not a bad Budget for the financial adviser.
John Woolley is a director of Technical Connection