Financial planning in the current landscape
Martyn reviews the changing pension environments and outline the proposed changes to the taxation of non-domiciled UK residents.
Most people would agree that the last few months have created deep feelings of uncertainty, and in politics and financial markets uncertainty does not make financial planning any easier. However, this should not negate the concept of following a sound financial plan. Although each person’s objectives will reflect their own personal situation, financial planning is intrinsically about dealing with those things that will occur: such as the need to cease work at some point, the need to protect against unforeseen events and, in the words of Benjamin Franklin, “the twin certainties of death and taxes”. In this article, we will cover a wide range of issues which have been affected (to varying degrees) by recent events.
Reviewing the changing pension environment
Probably the biggest impact of recent events has been felt in the area of pensions, namely pension deficits and significantly reduced annuity rates. Pension deficits on many final salary pension schemes have increased on account of the fact that falling gilt and AA rated corporate bond yields have increased pension scheme liabilities by more than the increase in asset values. Around 80% of the UK’s final salary pension schemes are believed to have deficits and this situation has worsened since the EU referendum vote.
For those interested in transferring out of a final salary scheme into a personal pension however, the latest sharp fall in gilt yields may be good news, as cash equivalent transfer values are likely to increase.
Saving for a pension has not, as yet, been directly impacted by this summer’s uncertainties. It is not difficult to imagine higher rate tax relief again coming under threat, particularly if there is a risk of a downturn in the UK’s public finances. Indeed, for some higher earners, a reduction in pension tax relief has already occurred. This is because legislation was introduced this tax year to restrict the annual pension savings allowance for those people earning in excess of £150,000. In addition, the lifetime allowance also reduced to £1 million on 6th April 2016 and the net effect of these changes has resulted in a number of people deciding to cease saving into pensions altogether.
Despite this, we believe that pension saving up to the lifetime allowance should still form a central part of a financial plan. Should a higher rate tax relief become unavailable, this strategy will need to be revisited, but in the meantime, pension saving provides the most tax-efficient way of building up fund for retirement.
The complexity of the UK tax system has also increased the need to plan efficiently. One way to do this is to make sure that assets and investments are held in the most tax-efficient way. For example utilising the annual tax-free dividend allowance – which was also introduced on 6th April.
Most people are familiar with the tax advantages of protecting income from taxation via an Individual Savings Account (ISA). From this tax year, the change to dividend taxation means that it is also possible for each person to receive £5,000 of tax-free dividends. Assets may therefore need to be rearranged in order to take advantage of this allowance.
Creating £5,000 of annual dividend income should be relatively simple for larger investors and indeed, the new basis of dividend taxation will cause many investors to pay more tax on their dividends so the incentive to use the allowance is therefore greater. On the other hand, there will be situations facing married couples where virtually all of the investments are held in the name of one spouse, typically the lower rate taxpayer, which has been a traditional strategy in previous years. If the £5,000 dividend allowance is not currently being used by both partners, assets will need to be transferred so that both have enough dividend income to utilise this allowance.
Using the dividend allowance need not increase overall equity exposure. If there are various structures to choose from, it should be possible to rebalance assets so that the overall asset allocation does not diverge from the agreed mandate.
We often write about tax advantaged investments, such as venture capital trusts (VCTs) and shares which qualify for relief under the enterprise investment scheme (EIS). The tax legislation backing these investments has not been affected as yet by market uncertainty and there remains strong demand for viable investments. Demand is also expected to be boosted by those who are no longer saving into pensions and are seeking an alternative tax-efficient savings arrangement.
An EIS offers a whole range of tax reliefs. There is income tax relief at 30%, inheritance tax (IHT) relief after two years and the ability to defer capital gains tax (CGT). Non-domiciliaries can also consider investing previously untaxed offshore funds into an EIS: this is because EIS tax reliefs can be combined with so-called business investment relief (see the later section on non-domiciliaries).
Inheritance tax planning
There is a natural desire to leave valuable assets to future generations and IHT will reduce many inheritances unless efficient planning is carried out.
There are many potential strategies available for IHT planning such as gifting, using trusts and owning assets that qualify for IHT relief. Individuals should consider the value of their taxable estates and take a view on whether the potential IHT liability can be reduced. It may also be possible to add further tax efficiency through improved will planning. If planning is likely to prove difficult, protecting the estate via life cover can prove an effective strategy.
Pension assets are becoming more of a factor following the improvement to inheritability. At present, the value of a personal pension will not form part of an individual’s estate and will not incur IHT. The financial plan should therefore consider which assets should provide income after retirement, and which funds should be encouraged to build up outside of the estate. It currently looks entirely logical to leave the pension fund untouched while drawing down on the assets that are within the taxable estate.
The government has now confirmed that its proposed changes to the taxation of non-domiciled UK residents and offshore trusts will be introduced in April 2017. There had been mounting speculation that the extra work and uncertainties created by the EU referendum vote would lead to these reforms being delayed however this has not been the case. The last major reform of non-dom taxation occurred in 2008 and many of those changes were introduced very quickly with little time to react. This led to negative sentiment and it was hoped that this would not reoccur. Thankfully, the latest changes have been announced at an earlier stage and with greater consultation; however the proposed changes are radical and once again create the need for immediate planning.
Although the announcement is still part of a consultation process (with responses allowed until 20th October), it is prudent to assume that the changes, as outlined in the summary, will come into effect. Whilst there may be some revisions, a strategy to deal with the changes needs to be developed.
The changes will also affect people planning to move to the UK, particularly those who were born in the UK with a UK domicile of origin but who subsequently acquired a non-UK domicile status by living abroad for an extended period. One area where the government is seeking to increase the use of a tax relief is business investment relief (BIR). Broadly speaking this relief enables UK resident non-doms to bring untaxed funds into the UK in order to make certain types of investment. The relief is targeted at increasing investments into unquoted UK trading companies. Non-doms can use BIR to fund investments (such as EIS companies) which offer various tax reliefs in their own right. The effect is that valuable UK tax savings can be achieved by using offshore funds, some of which may have been regarded as ‘trapped offshore’ because of their tax history. As part of the consultation, the government is now looking for suggestions as to how BIR may be improved and it will be interesting to see how this develops.
Above all however, it is absolutely vital that non-domiciled individuals obtain professional advice on the proposed changes so that they avoid any pitfalls in the new regime, and do not miss out on potential opportunities.
Summary of the main non-dom changes
- UK residential property held by non-doms via offshore structures, such as offshore companies, will be brought within the scope of UK IHT.
- Non-doms who have been resident in the UK for 15 out of the last 20 tax years will be ‘deemed domiciled’ for general tax purposes with effect from 6th April 2017.
- There will be CGT rebasing provisions to help transition non-doms into the new regime. Curiously this relief will only apply to those non-doms who become deemed domiciled in April 2017 and will not apply to those who be deemed domiciled in future years.
- There will also be a one year window, starting next April, to enable non-doms to rearrange offshore portfolios and accounts in order to separate the original capital from any income or capital gains. These can therefore be reorganised into the most tax-efficient series of accounts. This will apply more widely not just to those who become deemed domiciled next April.
- Non-doms who were born in the UK with a UK domicile of origin, who subsequently acquired an overseas domicile of choice, will not be able to maintain their non-UK domiciled status if they become a UK resident again, other than for a short period. The future tax treatment of benefits received from offshore trusts has been made clearer than it was when the proposed changes were announced last year.
Wealth Planning Director
Martyn joined in 2001. He focuses on providing holistic wealth planning advice to clients and works alongside our Portfolio Managers. Prior to joining Cazenove, Martyn worked in banking for 13 years and then worked for 9 years in a City based role for a leading insurer. Martyn has a degree in European Studies from the University of Bradford. He is a Chartered Financial Planner. Martyn has 25 years' financial planning experience.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
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