Pension Changes and Update
Writing this article soon after ‘Freedom Day’ has left me with mixed emotions: there is of course excitement and relief that life could start to return to some semblance of normality; however, there is also concern over how the country will start to rebuild itself, namely by trying to pay-back our ‘Pandemic Bill’.
There are quite a few experts at the moment prophesising that pensions will be the vehicle to drive money back into the Treasury’s coffers, so what could this mean for you? Will your retirement be negatively impacted? Will the pandemic wreak havoc on your future finances?
For generations, the Government have incentivised savers to invest into pensions, so that we don’t all end up dependent upon the State. But whilst they give with one hand, there have been many incidents where they have taken with the other; most notably with the gradual reduction in the Lifetime Allowance, Tapered Allowances and the Annual Allowance. So, what could the Government do in the coming months to fill their deficit? Whilst no-one has the definitive answers, here are some thoughts from industry experts and the financial press from the last few weeks.
Cut the Lifetime Allowance
The Lifetime Allowance (LTA) is the amount that can be saved into a pension, or grow within one, before tax charges apply. Previous governments have been renowned for slowly reducing this cap over the years, for example, from £1.8m in 2010-11 to £1.073m today, so it seems like a probable target
The good news is that the current Lifetime Allowance has been frozen this year and, generally, the limits do not affect most workers at present. However, if further cuts are made, it won’t just be the highest-earners in society who will be faced with a higher tax bill - long-serving doctors, teachers and police officers could also be penalised, due to the way that the pension growth is calculated on public sector pension funds. It could also affect anyone who is saving for their retirement in 10-20 years’ time, as the amount they will need will be considerably higher owing to inflation.
So what can you do?
If the Lifetime Allowance was reduced, the obvious step to take would be to boost your pension pot now, before you were penalised. If there was a reduction in the LTA, it would likely to be accompanied by opportunity to protect your current allowance level, but in exchange for making no further contributions. This would also mean that the fund could only increase through growth.
If you have plenty of time between now and the time you intend to use your pension, boosting your pot now and applying for future protection may be a prudent option, but you should weigh up your personal situation first, so that you don’t end up in a worse position.
Cut the Annual Allowance
Another approach that Sunak may take is to reduce the Annual Allowance, i.e., the amount that you can pay into your pension yearly before tax charges apply. If we look at trends again, this is something that former governments have done, for example from £255,000 in 2010-11 to £40,000 today, so, again, there is a fair chance that this may happen.
In line with the Annual Allowance, we’ve also seen governments hitting the highest earners with the penalty of the Tapered Allowance, which sees the Annual Allowance sink as low as £4000 for those with threshold incomes of more than £200,000.
Experts believe that Rishi Sunak is unlikely to make further changes to the Taper Allowance, as it would lead to public outcry, so it could well be that the Annual Allowance itself sees an impending reduction.
So what can you do?
Whilst none of us can change the limit on how much we can pay into our pensions, we can make the most of our ‘carry-forward’ allowances, whereby you can invest any unused allowances from the previous 3 tax years, subject to conditions. This would help to boost the amount in your pension pot, especially if the amount going forward were to be reduced.
Scrap Tax Relief for High Earners
One way to make serious savings could be to remove the tax perks for wealthier pension savers and implement a blanket tax system whereby the tax relief on contributions was the same for all investors, regardless of their marginal rate.
This would actually benefit lower earners but would be incredibly difficult and complex to implement. So, whilst it still may be a strategy that the Government choose to roll out, it would take a huge amount of time and require new legislation, so would not be a ‘quick fix’ to plug the deficit caused by the pandemic.
So what can you do?
If you are a higher-rate tax or additional rate taxpayer, you may want to consider maximising your pension contributions now, if you have the scope to do so. If you are a young pension contributor though (i.e., under the age of 40), you might want to look at other savings vehicles such as the Lifetime ISA (LISA) as a way of topping up your retirement savings now, using a scheme where the Government actually help by topping up your savings pot.
Cut the Tax-Free Lump Sum
One quite simple change that Mr. Sunak could make is to remove the tax-free lump sum limit (otherwise known as the Pension Commencement Lump Sum or PCLS), which is currently set at 25%.
Frankly, this would cause uproar! The Pension Reformation that took place in 2015 used this feature as its crowning glory, as it encouraged more people to save than ever before, with the lure of being able to pay off mortgages, make gifts to children, or splashing out on an epic trip to mark the start of retirement, all tax free. Any move to change this would certainly not endear the Tories to the general public!
Whilst I don’t believe that the Government would jeopardise future votes with such an unpopular move, they may still look to bring some restrictions onto the PCLS, for example limiting this perk to benefits already earned, so any future contributions or growth would be exempt.
So what can you do?
Don’t panic! Unless you need your 25% tax-free lump sum for a specific purpose, I would not advocate ‘cashing in’ at this point, until any pension changes are made clear in the next Budget. If any changes are made along these lines, the Government will have to give us all plenty of notice, so there will be time to formulate the best strategy for extracting funds as tax efficiently as possible.
Penalise Death Benefits
Another feature of the 2015 pension reforms was the ability to protect your pension from Inheritance Tax. The rules that were brought in enabled pension contributions to be passed tax-free to beneficiaries if the investor died before the age of 75; however, if the investor was over the age of 75, beneficiaries could still be liable to pay tax on any residual amount from the pension that they inherited.
A lot of people feel that it’s hard to justify this special tax treatment, but in truth, ripping apart the pension reformations and adding these residual pension amounts back into the deceased’s estate for IHT purposes would be complicated to legislate. The alternative may be to employ a blanket tax amount of anything inherited from a pension, regardless of what age the investor dies.
This may be a lucrative and viable option, but it would feel like a huge step backwards and could disincentivise investors from using pensions to save for their future and the future of their loved ones.
So what can you do?
If you are utilising your pension as a way of reducing Inheritance Tax and providing for your loved ones, you may need to consider some different estate planning opportunities in the future. Whilst there is no pressing need to do this now, it is always worth reviewing your estate plan on a regular basis to ensure that you are passing on your legacy in the best way possible.
Whilst no changes to pension have yet been confirmed, now is an important time to pay close attention to the Chancellor’s suggestions. At Efficient Portfolio we will be keeping abreast of all changes and making suitable recommendations to those clients who may be affected.
What Should You Consider When Selecting a Mortgage?
Whether you are looking for a brand-new mortgage or wanting to remortgage your existing property, the range of lenders and products can be confusing. So, what should you be considering? And how can you reduce your costs?
Cost of Funds
The first thing to consider is how the lender is funding their mortgages. The cheaper costs are for the lender, the lower their rates can be. The ways a lender funds its loans can vary enormously: while some will rely on raising deposits from savers, others get their funding through wholesale markets, and some go for a blend of the two. While the Bank of England base rate does play a part, there is not really a clear link between the base rate and what lenders must pay to get their funding.
The larger the deposit you have, the lower the interest rate you will be able to secure. If you are buying with a 40% deposit, then you will qualify for much better rates than if you’re buying with a 10% deposit. It comes down to a question of risk. If you are borrowing at a high loan-to-value ratio (LtV) then you won’t have much equity in the property. As a result, if you default on the loan or the property value drops, the lender is more likely to make a loss.
Another factor in the pricing of interest rates will be the level of competition in the market, and a lender’s own business targets. If a lender wants to be a dominant player in the mortgage market for that year, it will look at how its competitors are pricing their loans and use that to work out what interest rate it's comfortable lending at. Equally, if the lender feels that its lending is already ahead of schedule, then it's likely to start increasing its rates in a bid to attract fewer borrowers.
Your Credit History
Your record as a borrower in the past will have a significant bearing on the mortgages you might qualify for. For example, if you have missed payments in the past, whether on credit cards, personal loans or even your mobile phone bill, black marks will be left on your credit report. Not all lenders will consider borrowers who have these black marks in their credit history, and those that do will often charge a higher interest rate because of the perceived additional risk of lending to you.
To see what is available to you and look at the most cost effective options for your mortgage needs, please get in touch with our Mortgage Adviser Andrea Harrison, who will be more than happy to discuss your options, on [email protected] or by calling 01572 898060
Is Cash Always King?
For many individuals looking to save for the future, the ISA is generally a sensible first port of call, but what type should you consider? Cash? Stocks and Shares? Or even the LISA of JISA?
With a few choices on the market, inexperienced investors often have to take an uneducated guess and plump for the ISA that feels safest, or the type of ISA utilised by their family or friends. But is basing your savings strategy on pre-conceived notions, or the preferences of your loved ones, the best plan for your future?
Recently published statistics from HMRC indicate that in 2019-2020, over £300bn was invested in Cash ISAs, despite ultra-low interest rates. These subscriptions into cash were more than twice as high as those into their Stocks and Shares ISA counterparts.
We believe this trend indicates, at least in part, that investors are not seeking professional guidance and are instead making decisions about their wealth without knowing the full facts.
As Financial Planners, we often work with individuals who are just starting out on their financial journey and have very little experience of investing. Some are also highly fearful of ‘playing the stock market’, as they believe that it’s akin to gambling and they will lose all of their hard-earned money.
The most important message here is that investments should only be as risky as your feel comfortable with. Your preferences and tolerances should be considered before committing to any type of saving- whether that’s in cash or in stocks and shares. Ultimately, you decide what level of risk to take. Investing does not (and frankly should not) be a high-octane, nail-biting experience of panic buying and selling- it should be a long-term strategy that fits within your comfort zone and delivers what you need.
Of course, investing money isn’t riskless: market fluctuations, tax and a reduction in interest rates can all damage the return on our investments; however, it’s also important to consider how risk can also make an impact. Keeping money in cash may feel like the solution here, but in reality, cash is not riskless, and its value will also fall over time due to inflation, thus reducing your purchasing power and jeopardising your future goals.
So, how can you make your cash work harder and reduce the amount of risk you are exposing your wealth to?
Diversification is key here. Putting all of your eggs in one basket, for example one asset-class, could mean that all of your hard-earned money can be wiped out in one fell swoop. By electing to employ a diversified strategy, in this case within your ISA, you may still experience losses on some of your assets, but you could also see gains in other areas, hence your overall performance will be smoothed over time and the impact of losses is greatly reduced. However, it’s crucial to keep your investments continually under review, so that suitable adjustments can be made as required.
The same can be said for risk. An unreviewed investment will become riskier overtime, so making sure that it is calibrated to a level that you are both comfortable with, and one that will help you to facilitate your goals, is incredibly important.
ISAs are a very tax-efficient way of saving for the future, so will be suitable for most people. However, the key message is that the type of ISA that is suitable for you and your goals, whether that’s Cash, Stocks and Shares, JISA or LISA, will be individual to you and should be selected with the support and guidance of an experienced Financial Planner.
Time is our most precious commodity. But are you maximising the time you’ve got?
The world of finance is punctuated with technical terms and jargon, so I wanted to take a moment to explain some areas to you, which all share common themes of time and growth. This information can also be called the ‘rationale’ of saving, and it is the technical theory behind what factors impact your money and the approach we take at Efficient Portfolio. It’s the ‘inside knowledge’ that will explain why some people make millions and others lose it all.
Timing the Market
The great Warren Buffet said that ‘time in the market is better than timing the market’, and we couldn’t agree more. But what does this really mean, and when is the best time to invest?
Investing holds many negative connotations, mainly, in my view, because inexperienced investors have tried to guess when they should buy and when they should sell. This is when saving becomes risky. If you’re trying to guess what investments will do well, and are constantly moving money around, not only will you get yourself into a tangle, you’re likely to get burnt.
Even Mr. Buffet, who has been given the moniker of ‘the most successful investor in the world’, has not always timed the market correctly. He even said, ‘The only value of stock forecasters is to make fortune tellers look good’!
People often assume that investing is a high-octane environment of ‘buy, buy, buy’ ‘sell, sell, sell’. The very 80’s image of caffeine fuelled, overly animated people shouting down huge mobile phones may be over 30 years behind us, but this type of investing does still exist; however, it is one I would strongly warn you against.
The problem with this strategy is that people try to ‘time’ the markets, by waiting until they change in their favour. They dip in and out of investing, trying to only purchase investments when they are doing well. The truth is, when investments are performing well they are expensive, because everyone wants them!
Pound Cost Averaging
A better approach is to employ an ongoing strategy that means you don’t miss out and don’t pay over the odds. As an example, let’s say that you save on a regular basis into a Self-Invested Pension Plan. Because you make regular contributions, you will be continually invested in the market, ensuring you don’t miss out on the ‘best days. When prices are high you to go against the grain and buy fewer units, but when prices are low, you buy more. This reduces the risk that you pay too much when the price is unusually high, and benefit from buying more when the price has fallen. This is Pound Cost Averaging.
In short, the investments you ‘purchase’ actually work out cheaper than if you were to buy them in isolation, as you don’t need to time the market.
Of course, you will experience ups and downs, but a diverse, smooth and constant strategy can offset the lows and give you better returns overall. You also tailor the plan to your chosen level of risk, so you never feel that you are out of your comfort zone.
Pound Cost Averaging is a slow and steady strategy. As Paul Emerson once said, ‘Investing should be like watching paint dry or grass grow; if you want excitement, take $800 and go to Las Vegas’. Pound Cost Averaging works when you save a steady, regular sum, rather than bluing wads of cash at irregular intervals.
So, what is the consequence of investing in a slow and steady strategy? This can be best explained with the principle of compound growth, which is the growth upon the growth upon the growth that you receive from your investments. Generally speaking, the sooner you start to save, the more you will get back. More than that, the earlier in life you start to save, the less you have to regularly put away in order to achieve your desired goal.
Factors such as compound growth will work better over time and should deliver higher levels of growth, if money is invested in a suitable and diverse strategy. Financial planning offers a whole host of advantages, most importantly giving you the ability to live more comfortably and confidently, which, I’m sure you will agree, are values we all strive towards.
It may take time to start to see your goals playing out, but I hope that this explanation of some key financial concepts will help to clarify how important time is in your planning and how our approach can help to deliver your goals.
Keep CALM and Carry On
Efficient Portfolio’s chosen charity to support for this year is CALM. The Campaign Against Living Miserably (CALM) is leading a movement against suicide, and with the 18 months we have all endured, our team couldn’t think of a more important topic to help support. Every week 125 people in the UK take their own lives, and early indications suggest that the pandemic has caused a significant rise in this figure.
Charlie Reading, our Managing director lost his brother-in-law to suicide a few years ago, so was keen to do as much as possible to raise money for this amazing cause. As a result, he will attempt Ironman Tallinn (Estonia) on Saturday 7th of August to raise money for CALM.
For those that aren’t aware of what an Ironman involves, it is a 2.4-mile (3.86 km) swim, a 112-mile (180.25 km) bike ride followed immediately by a marathon 26.22-mile (42.20 km) run. I am sure you will agree, this will be a tough day at the office, however the more support he has behind him, the easier it will be from a mental perspective, even if the physical challenges remain.
If you would be willing to sponsor Charlie on this epic journey and help us raise money for a charity supporting the single biggest killer of men under 45, you can sponsor him here. Charlie, EP Team and CALM will all be incredibly grateful for your support.
Charlie’s Mini Blog
I am writing this as we drive back from Cornwall after an amazing family holiday. It seems that the rest of the UK has woken up to the fact that you don’t need to go abroad to enjoy an incredible holiday. Admittedly we’ve been spoilt with Mediterranean like weather, but when the weather is good, in my opinion you will struggle to beat Cornwall. With coastlines that would rival New Zealand or Thailand, food that rivals the Italian Lakes and activities that would give Centre Parks a run for their money, it really does have everything.
I’ve been singing the virtues of Cornwall for a few years now, and will continue to do so. I wrote a guide to Cornwall a couple of years that you can read here. Our trip this time has been a much-needed tonic, but this year it has certainly busier than ever and with restaurants fully booked, short staffed or caught by the ‘pingdemic’, knowing your options has never been more important. We didn’t get caught in traffic and we didn’t struggle to park, but we have the benefit of experience.
In order to make the most of any trip, you are wise to seek the advice of an expert as well as do research yourself and your finances are no different. We encourage our clients to learn more about their finances, so that they can make more informed decisions, while also providing them expert advice when they need it. I hope you too can enjoy a much-needed holiday to recharge after a treacherous 18 months, and when you return, if you need to refresh your finances too, please just ask.
I have previously strongly recommended that everyone read Bill Gate’s book How to avoid a climate disaster, and this month’s recommendation is from the same playbook. A Life on Our Planet: My Witness Statement and a Vision for the Future by David Attenborough is equally as brilliant as Gate’s book, and provides a different perspective to the same subject.
Whilst Gate’s book is more focused on the technology that is needed fix the climate change problem, Attenborough’s focus is more on the strategies we need to employ to save our planet. Ultimately, they are both singing from the same hymn sheet - ideally read both, but please do read one at least, all our futures depend on it.