Homer says ‘Doh’ to DOTAS

The recent announcement that IHT mitigation via transfers into trust is likely, in future, to be included in the DOTAS (Disclosure of Tax Avoidance Schemes) regime was received with some trepidation by advisers accustomed to assisting their clients with IHT mitigation.  In reality this proposal by the Treasury and HMRC is nothing more than was expected following the blocking in the Finance Act 2010 of two specific trust schemes which dramatically (and arguably artificially) reduced the value of assets gifted into trust.

Now that the coalition has nailed its IHT colours to the mast by freezing the Nil Rate Band (NRB) for 5 years it is backing this, much harsher than heralded, approach with supporting legislation to plug as many leaks as possible.  The consultation document introducing the DOTAS requirement does not seem unreasonable in the circumstances and certainly does not impact on most conventional IHT mitigation work using the various trust schemes which are widely available.  What is being suggested as far as disclosure is concerned?

The new rules will not require any existing schemes well known to HMRC (such as flexible and discounted gift schemes) to register because they are being ‘grandfathered’ in to acceptability.  Looking forward it will only be new trust schemes which (a) involve chargeable transfers beyond the donor’s current allowances, including any unused NRB – in other words where property becomes ‘relevant property’ – AND, (b) which involve an ‘advantage’ in relation to the IHT entry charge – an advantage being defined as the avoidance, reduction or deferral of a charge – which have to be registered.

This avoids any requirement to disclose straightforward situations where an individual simply transfers property into trust and relief or exemption is available in the same way it would have been had the property been gifted directly to another individual.  This is generally the case with most of the current crop of trust-based mitigation arrangements.  The proposals are only at the consultation phase so it is too early to be unequivocal about the requirements for plans launched in the future.  However the grandfathering facility will ensure that all existing plans of which HMRC are aware – and future plans which adopt the same principles as existing plans – will be quite safe.  In fact this is the nearest we have ever come to having a blanket approval from HMRC of all existing plans.

What does this mean for tax planners and their clients going forwards?  Well we should start by considering the position of taxpayers who have been relying on either the indexation of the NRB or, more recently, the Tory commitment to a transferrable £1m NRB, to lift them out of potential liability.  I think this is bad news for such optimists.  It is clear that a Lib-Con coalition government has a rather less generous approach to inherited wealth than that promised by the Tories.  Freezing the NRB for 5 years when the knock-on impact of ‘quantitative easing’ (printing money) is likely to be rampant inflation down the line is really quite serious.  I think most readers will agree that inflation is already rearing its ugly head no matter what interest rates are doing.  Looking further ahead there has been plenty of speculation that the coalition might well continue through until another term of government – especially if next year’s referendum delivers backing for the Alternative Vote electoral model.  This will mean a continuation of a cautious approach to raising IHT allowances.

The following chart shows the value of the NRB compared with assets starting at the same value rising with inflation.

This means that taxpayers currently on the cusp of a potential IHT liability will be severely disadvantaged by the freezing of the NRB – assuming inflation of 4% over the next 2 years followed by 8% for 3 years.  Readers may doubt such a scenario but not if they are German historians!  In the situation shown, a potential liability of nil at the beginning would become a liability of some 40% of £117,814 (tax of £47k+) after 5 years, simply resulting from inflation.

This brings me on to a favourite phrase of my IHT planning friend, Nick Chadwick, who constantly reminds taxpayers to ‘hope for the best but plan for the worst’.  This has served him well over several decades of capital tax planning and, I suspect, he will be proven right yet again!

So the message here is that all those advisers and their clients who, since 2008 when they were given false hope by the posturing of Alistair Darling and George Osborne, have put off their IHT mitigation planning, have no time to lose.  Since many of these people are relying on multiple use of the NRB, every day is important in clocking up those 7 year inter vivos periods.  Remember – hope for the best but plan for the worst – start your IHT mitigation planning today.

Paul Wilcox,
Chairman & Technical Director, WAY Group
9th August 2010

Posted on 9th August, 2010 | Tags: HMRC, IHT Mitigation, Nil Rate Band |
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As the smoke clears we begin to see the flames

So the phony campaign is now over. After four weeks of argument as to whether £6bn or £10bn of cuts now or next year would be the right way to deal with a £163bn deficit, the election delivers a government and a collection of policies that nobody voted for. Whilst the election seemed to take place in a surreal parallel universe, we now have a real, if unexpected, government and we are beginning to see the truth behind the false debates. A painful fiscal pinch is beginning, as taxes are hiked and public spending cut.

One of the first casualties of the re-emergence of the real world is the Conservative party’s manifesto commitment to increase the IHT nil rate band to £1m. The Tories had clung on to this pledge despite the best efforts of Ken Clarke, in their own ranks, and the wider weight of common sense, that said the policy was not a good or affordable priority. Mr Cameron hinted in the final leader’s debate that the increase would not be top of the agenda in the event of an outright Conservative victory. In any case, events have now moved on and the policy has been kicked firmly into the long grass. The nil rate band is £325,000 and we will either stay frozen as per the outgoing government’s plans or at best might enjoy some annual indexation.

The killing off of this policy is in many ways a good thing for financial planners. The move restores a good amount of certainty to the market: We know IHT is here to stay and we know at what level it bites. Some planners will have agreed a “wait and see” approach with clients who would be taken out of the IHT net by a £1m nil rate band. The difficulty facing clients in such a position was how long would they have to wait until they knew that the nil rate band was to be raised high enough? Well, we haven’t had to wait long and now we have seen. It is therefore time to revisit those clients and to get on with the business of planning for IHT mitigation.

Whilst the position for IHT is much clearer, we have a little longer to wait to know what changes the new government will make to lifetime taxes. We know the news will not be good, and we also know that we only have to wait until the next Budget is delivered by new Chancellor Osborne on 22nd June. The outgoing Labour government had already brought in a new 50% rate of Income Tax and we know from the coalition agreement that the new government is to make CGT bite harder upon non-business assets. At present details are scant regarding the level of the rate, the exemptions and the date of introduction, so we will have to hold our breath for a few weeks more until Budget 2010.2.

Frequent changes to the tax regimes are of course very unwelcome for long-term investors and their advisers. The current flat rate CGT regime only dates back to 2008 and the previous (taper relief) regime only survived about 10 years. Such upheaval becomes a great hindrance for individuals who are trying to put in place a long-term investment strategy. The current changes to taxation will of course mean that advisers will have to, once again, review the provisions in place. In the current climate it may be hard to find a safe haven from a demanding Treasury however. So what strategies are available to advisers upon reviewing their clients’ portfolio options?

The first thing to keep in mind is that whilst there may be choppy waters ahead, in the longer-term we may find that we just have to get through a difficult but short period where taxation rates are unusually high. One would hope that in a few years time healthy growth will have returned to the economy and the deficits will be under better control. The first option may therefore be to just ride out the storm, keep investments in place and wait until a more favourable environment allows profits to be taken with less penalty. This will suit many long-term investors who do not rely on encashment of investments to meet income needs or shorter-term objectives.

Whilst the ultimate drawing of profits may be able to be delayed, most investors will want their portfolios to be actively managed and for their portfolio asset allocations to be adjusted from time to time. It is clearly unhelpful if considerations of the tax chargeable events that would be generated have to interfere with such activity. The answer, of course, is to ensure that such activity takes place within a suitable investment wrapper. Fund of Fund portfolios will therefore be very useful where it suits the client to be ultimately exposed to CGT on the realised profits, as they deliver cost effective active management within a Unit Trust or OEIC wrapper. Where an Income Tax environment is preferred a life insurance bond will provide similar shelter.

Investors with funds in trust, such as WAY Inheritor Plan holders, will now have the forthcoming changes to the CGT regime to absorb on top of the recent Income Tax changes. Holders of the classic Unit Trust versions of the plans already benefit from the inherent tax efficiency of the nil-yielding WAY Global Portfolio funds of funds. As the choice between the CGT and Income Tax environment becomes more critical it will also be good to know that WAY, uniquely, offer access to their funds within the Inheritor Plans both as direct Unit Trust/OEIC investments and within offshore bond wrappers.

The most flexible variants of the plan such as The WAY Flexible Inheritor Plan, The WAY Gifts from Income Inheritor Plan and the WAY Duo Inheritor Plan can also perform a key role in adapting a client’s overall investment strategy to the new tax regimes. As well as the choice of tax environments identified above, these plans also allow the trustees to determine whether or not the flexible reversions take place. Thus the adviser can recommend that more or less (or none) of the client’s income needs are provided for by the Inheritor Plan and balance the reversions with drawings (or not) from other sources. This judgement can of course be made year by year and respond to changing tax regimes and client needs – an option that is not available where a typical discounted gift scheme is used.

In summary then we can present our manifesto for a new government:

• Now is the time to revisit IHT planning that was put on hold
• Review tax wrappers but don’t chase the tax tail – it may be better to ride out the storm
• Make sure investments have the best income / growth profile for the client
• Shelter active management within a suitable wrapper
• Maximise flexibility – only choose plans that can adapt to client needs as the winds change

Welcome back to the all too real world!

Yours sincerely,
Mark Benson TEP CertPFS
Technical Manager, WAY Investment Services Limited
28th May 2010.

References:
1. Preliminary Budget Report, Data & Statistics – ‘Budget 2010, UK Stationery Office, HC 451, 24th March 2010′
2. Labour, Conservative & Liberal Democrat pre-Election Manifestos – May 2010

Posted on 28th May, 2010 | Tags: Coalition Government, IHT Mitigation |
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Going for gold – 5 reasons to consider

The top performing asset class of the last decade was gold. Only toward the end of that period did ‘ordinary’ investors take advantage however, as routes to the market opened up. Now we see TV adverts every day looking for scrap gold and Harrods selling gold bullion, so is this a precursor for a classic asset ‘bubble’ prick? WAY do not believe so and here are five reasons why…

From January 2000 to December 2010 the return on gold was 277%, outstripping all conventional asset classes. Though a number of technical analysis readings suggest that the bull market will continue for a ‘second wave’, there is concern that the increasing populist aspect of the asset is indicative of a market that has run its course.

The latter is an understandable emotional response given what has been seen of some other asset and thematic cycles in recent times but the relative comparisons are difficult to match up. Consider the following:-

• GOLD AS MONEY

For centuries gold has stood as a proxy for or alternative to cash and its value has been historically reflective of that position. That descriptive changed in the 1980′s through 1990′s as disinflation became the universal goal and the returns from equities and financial assets were robust. Essentially, gold was re-classified in investment terms as a pure commodity. During this period gold fell from $850 per ounce in January 1980 to $252 in July 1999, a true bear market.

We now stand at a point where quantitative easing has been deployed by the major economies to the extent that the USA have printed more money in the last 15 months than they had run off since 1984 to that starting point. The global risk must become universal inflation of an accelerated kind and devalued paper money.

Gold’s re-rating in investors eyes as a cash alternative looks highly probable with such a backdrop, providing true support to price valuations. However probable, let’s not just assume inflation will be rife just because it supports the gold argument. Some economists are starting to forecast Japanese style deflation for the UK stating a moribund economy combined with stagnant credit conditions. Indeed there is substantial anecdotal evidence that for the first time in living memory that UK consumers are paying back debt. Here the Japanese experience is especially valuable, Japan as everyone knows has suffered the conditions described for the last decade during which time the Yen price of Gold has risen by 300%.

This is fairly conclusive evidence that Gold can also prosper in deflationary conditions as well. Furthermore a weak UK economy will tend to produce a weak sterling exchange rate (indeed it this trend has already started) and Gold & Gold assets offer UK investors a perfect currency hedge that comes without paying fancy fees associated with many structured products that attempt to offer protection against the likely decline of the pound.

• GOLD DEMAND

In recent times the supply and demand equation has been relatively simple and broadly equal. The tonnage of mined gold can be pair matched with fabrication demand, e.g. jewellery, dentistry, etc. Whilst additional supply from merchant bank and scrap gold sales has matched investment demand. The latter is increasing however, with China in particular swallowing up gold in preference to US treasury bonds. This looks certain to continue as the economy of the former continues to grow and, due to reasons mentioned earlier, the latter seem unlikely to prove attractive for some time yet.

• GOLD SUPPLY

Whilst demand grows it is unlikely that supply has the capacity to increase in line. South African fields are now 90% exhausted with, as example, the largest gold field ever discovered, Witwatersrand, now producing about 230 tonnes a year (10% of world production) down from its peak of 1,000 tonnes in 1970. Canada, US and Australia have further potential but this cannot be turned on ‘like a tap’. Additional prime to supply as in the 1980′s and 1990′s by the Western governments and banks selling off gold reserves has all but finished. The auction of half the UK’s reserves at 10% from the nadir in price – ‘Brown’s Bottom’ – being amongst the most unfortunate of disposals. So, growing demand and a supply mechanism struggling to keep pace should continue to underpin gold’s future prospects.

• GOLD, INFLATION ADJUSTED

There is twitchiness in the market about the current gold price despite the positive fundamentals. To a degree this is spawned by the wariness of commentators new to this asset class and more familiar with financial, particularly equity, markets. The $1000 threshold has been crossed and this is perceived as a neat high tide mark. However, at the peak of the previous bull phase in January 1980, gold was priced at $850 per ounce. Using the most conservative measure of US inflation the equivalent today would see gold trading at $2,300. With the current price not quite half of that figure it is easy to see why supporters eschew the notion that we are in a bubble. Rather, this is further evidence of the potential.

• RELATIVE POSITION TO OIL AND DOW JONES

To check the relative validity of the gold price it is helpful to check against other key measures. Another key commodity, oil, has had its own bull run, paused for breath, and is now moving upward again but the gold price is still sitting below its 40 year ratio of 15.1 relative to the ‘black gold’. It remains in the zone where arbitragers would be shorting oil and going long on gold. The current DOW/Gold ratio sits at 9.29. An 80 year check against the respective indices shows Gold peaking when within a 1-5 ratio of the equity index. With the DOW currently at 10,000+, this would indicate a target of $5000 per ounce! These relative comparisons are, of course, moving feasts but are a useful sanity check on the prevailing price.

For the ‘ordinary investor’ gold has seemed a little remote but the routes to investment have increased in recent years through additional fund offerings and ETFs. Inexperience will bring caution and perhaps fear that the gold race has already been run. However, with equity markets and bond markets having a far from certain near future, there does seem to be a strong case to further diversify investor portfolios and place a proportion in gold at this very juncture.

Eddie O’Gorman
WAY UK Head of Sales & Marketing
12th March 2010.

Posted on 12th March, 2010 | Tags: Gold |
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Don’t sit on the fence – you’ll only get splinters!

With at least one budget and at least one election in prospect for 2010, WAY Investment Services Ltd’s Technical Manager Mark Benson says that there is no time to delay before putting in place IHT mitigation plans for your clients. Given the average gestation period of an IHT case from agreement to settlement and with the (first) budget possibly a month away, the time to start is really today.

A recent IFA enquiry caused me to open the file of a WAY Inheritor Plan settled in February 2004 with an investment of £1,100,000. A number of thoughts sprung to mind such as how growth of over £300,000 in the investment value since then is safely out of the estate of the settlor and thus not subject to IHT on their death, and how in a year’s time the whole trust fund should also fall out of the estate at the end of the 7 year inter-vivos period. The overriding thought that came to mind however was “£1.1m transferred into a flexible trust – those were the days!” Whilst cases of such a size are unfortunately rather rare, it is interesting to reflect on how easily planning could be put in place for such amounts prior to the surprise change to the IHT rules in the 2006 Budget, which shut the door on PET based transfers to discretionary or interest in possession settlements. Nowadays unfortunately our settlor could not put much more than the amount of growth they have enjoyed into trust without breaching the nil rate band and generating a lifetime IHT charge of 20%.

There is a cautionary tale here as 2010 promises to be something of a white knuckle ride for tax planning as the political parties try to balance the challenge of dealing with the financial crisis with the desire to be generous in their manifesto promises ahead of the election. What is certain is that we must have one budget and one election this year. However, whilst May 6th remains a solid favourite for the date of the election – in particular since local elections are already scheduled for that day and cash-strapped local authorities could do without paying for two polls within a few weeks – the odds on the Conservatives as favourites to win that election have lengthened somewhat as the opinion polling shows a narrowing of their lead. With the likelihood of a change of government and the possibility of a hung parliament we cannot discount the possibility of at least one more budget and perhaps one more election this year.

When considering the dismal state of the nation’s finances and the unconvincing emergence from recession, it would seem that there is one thing we can be certain about: The forthcoming budget(s) will make the tax code more hostile to our clients’ income and capital. It is possible that the availability of trust based IHT planning might be attacked itself, akin to the changes introduced in 2006. Moreover there is also the strong possibility that an unfavourable change to the rate of income tax, CGT or IHT would dilute the savings on offer. Some may argue that the Conservatives have pledged to increase the IHT nil rate band to £1m in the first term of a prospective government, however we feel that given the fiscal challenges that lie ahead this might be a policy that remains an aspiration only. Any prospect of a first term introduction surely lies nearer the last year of the parliament.

The prospect for the next few years is that IHT will remain a challenge to succession planning, and if another aggressive attack on the use of trusts is made we might in time look back on the present as another golden opportunity that has passed. Where clients are hesitant to put plans in place due to the uncertain future, their minds can be put at ease by the recommendation of flexible arrangements such as the WAY Inheritor Plans. Our plans can adapt to the client’s changing circumstances by granting flexible powers to the trustees and also to changes to the rates of lifetime taxes by (uniquely in the market) offering access to collective investments and offshore bond wrappers. Furthermore, since clients are limited to investments within the nil rate band it is necessary to start at a younger age and (hopefully) make repeated use of the nil rate band over the years to come.

At some point in 2010 a government will face up to the reality of our financial crisis and present the bill for the remedy to taxpayers.  Those still sitting on the fence at that time will suddenly feel the splinters!

Mark Benson, TEP CertPFS,
Technichal Manager, WAY Investment Services Limited.
19th February 2010.

Posted on 19th February, 2010 | Tags: IHT Mitigation |
Comments: One Comment

IHT – avoid but don’t evade

It has been a frenetic few years for IHT mitigation.  Pre-owned assets tax (POAT) in 2004, the taxation of trusts in 2006, false promises by the Tories in 2007 and a major fall in asset values in 2008, have all kept taxpayers and financial planners well and truly on their proverbial toes.

Now Alastair Darling’s pre-budget report (PBR) has thrown yet another cat amongst the pigeons.  The double whammy this time is the removal of a previously legislated increase in the Nil Rate Band/NRB (under the Finance Act 2007, the personal nil rate band was due to rise to £350,000 in April 2010, but it will now stay at £325,000) and an attack on some specific strategies which have been using legislative loopholes relating to trusts.

Some commentators have speculated as to whether Darling’s comments in the PBR, about future legislation regarding trusts, spell the end for IHT mitigation as we currently know it.  In fact HMRC has no desire to upset conventional IHT planning using long-accepted trust-based solutions – all of which were brought into the taxable ‘relevant property’ regime in the Finance Act 2006.

HMRC and the Treasury remain fair and even-handed in their approach to collecting IHT.  All absolute gifts, at any level, remain potentially exempt transfers (PETs), whilst chargeable gifts to the full extent of the taxpayer’s NRB can be made every 7 years without any tax being incurred.  Furthermore regular gifts of any amount, from surplus after tax income, are immediately exempt.  All of these facilities remain, as do the various long-established trust schemes that have been available over the last decade and more.  It is flagrant abuse and the exploitation of inadvertent loopholes which is being attacked in forthcoming legislation.

As Nick Chadwick (well-renowned architect of some of the signature IHT mitigation schemes of the last two decades) recently explained to me “the acceptable spirit of tax avoidance has to reside within the house of fair play as secured in case law. Thereby evolving rules, where the law is inevitably silent on many issues, offer no protection from retrospective legislation at worst and swift blocking at best. HMRC will give confirmation of schemes that fall within the acceptable spirit of IHT avoidance. Failure to obtain this will be fatal for some providers, sooner or later”.

There are many conventional trust arrangements available, now and for the foreseeable future, which permit taxpayers to efficiently remove assets from their chargeable estates, whilst maintaining suitable ongoing flexibility for both themselves and their beneficiaries. There is therefore little need to seek out schemes which operate outside the confines of acceptable tax mitigation.

By far the bigger problem is the inertia suffered by many potential IHT payers who still seem to think this tax will somehow either mysteriously disappear or their estate values will be overtaken by the Tories enhanced NRB.  It should be clear to everyone at this point that for the foreseeable future there will be no appetite for either reducing or eliminating the impact of what is still seen as a wealth tax.  Not only does the ongoing budget deficit make it a non-runner but current public ambivalence toward MPs, bankers and others perceived as wealthy and privileged makes the easing of Inheritance Tax politically unthinkable.

George Osborne recently admitted on the Andrew Marr show that the Tory ambition to substantially raise the NRB was now pencilled in for later in their term of office.  But if New Labour can reverse actual enacted IHT legislation after only 2 years we surely know what expediency to expect from the Tories during their own turn in government.

With asset values likely to continue their recovery over the next year or two the business of carefully planned and executed IHT mitigation (particularly taking full advantage of somewhat depressed current values) is likely to blossom once more.  But be warned; HMRC will take an increasingly dim view of those attempting to exploit schemes operating on principles which rely on “reading between the lines” of existing tax legislation and are against the spirit of the law.

The two recently closed loopholes related to the purchase of (exempt) interests in excluded property trusts and the absolute gift (and therefore potentially exempt transfer) of retained reversionary interests within trusts. 

The first of these permitted a purchaser to buy (exchange taxable cash for) an exempt family interest in an exempt trust, thereby removing any future potential IHT charge from that value.  The second loophole involved the immediate and absolute gift of a retained reversionary interest which had already benefited from a discount to its value.  In this arrangement the taxpayer used a two step process to convert an otherwise chargeable gift into a combination of an initial small chargeable gift swiftly followed by a larger potentially exempt transfer.

In conclusion then, with the Tories recently announcing, that based on their analysis of ONS statistics in the newly published ‘Wealth in Britain’ report, some 4 million taxpayers are still likely to incur an average IHT bill of £60,000 (Guardian newspaper 29 December 2009) there is no time to lose.  Help your clients avoid this heinous tax by engaging in good down-to-earth IHT planning including, where necessary, the use of one or more of various highly-effective but conventional trust-based mitigation arrangements which remain available.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 22nd January, 2010 | Tags: IHT Mitigation |
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Still strong reasons to run adviser funds

New guidelines on distributor influenced funds are designed to ensure customers are treated fairly and should not prevent advisers from offering their own portfolio-style collective funds.

Access to financial advisers’ own portfolio-style funds can bring benefits for clients. I outlined these benefits in a previous article, which struck a chord with a number of discretionary investment managers, some of whom already run such funds and many who do not but would like to.

Several firms have expressed concerns about the cost, inconvenience and responsibilities of taking this path, as well as the imminent impact of the retail distribution review (RDR) and the alleged negative attitude of the Financial Services Authority (FSA) towards ‘distributor influenced funds’ (DIFs).

Having been involved with DIFs since 1991, I am an avid fan of delivering discretionary investment management to clients via the most effective means: collective investment. What I mean here is delivering sound, bespoke, portfolio-style management via the most cost-effective and tax-effective route by pooling clients’ assets into collective funds.

One size does not fit all, so you will have to supplement this approach by:
(i) having more than one single strategy (fund) to suit different risk appetites and possibly capital and income objectives;
(ii) being prepared to supplement such core solutions with more specialised investments to finely tune each client’s individual portfolio solution.

Two advantages of adviser funds
There are two key arguments for clients entrusting their investment funds to their advisers’ own portfolio-style funds. First, there is far more accountability: the client can meet face-to-face with a good local and personal investment team for regular reassurance about the style and substance of the management.

Second, a good portfolio manager is not the same as a good fund manager. A portfolio manager is running portfolio substitutes and therefore has a keener eye on the overall risk aspects of managing the client’s money. A specialist fund manager works to tight specifications of where they can invest and to what extent they need to maintain liquidity.

The most recent regulatory changes have allowed collective funds to mix and match underlying funds and direct equity investment, and to blend a much wider range of asset classes. This means contemporary portfolio-style funds can effectively mirror and replace virtually any bespoke portfolio.

The right firm for the job
Several firms service the third party fund market. Some are investment management firms, which tend to have more empathy with their guest managers, and others are administration companies, which focus on large scale administration activities. Either type of firm is likely to be able to guide new entrants through the steps needed to establish their own funds.

Whether a firm should embark on this is broadly down to a handful of criteria:

* Are they authorised to perform discretionary management or do they have an associate company who is?

* Do they have sufficient clients and assets under management to make the establishment of such funds a viable proposition for all parties, especially the clients themselves?

* Is there adequate understanding of the regulatory issues involved in running such funds?

* Are such funds likely to survive the commission-free/remuneration policies expected from the final guidelines to come out of the RDR?

* Do the funds comply with FSA guidelines on DIFs?

Support network is growing
A new trade association for companies associated with running their own portfolio-style funds, the Investment Funds Association, is a source of contact and support for its members and a centre of influence with the regulator. The nascent body (ifassociation.co.uk) has a growing membership that includes service providers, and many advisers who run their own branded portfolio-style funds. It may well become an essential forum for parties interested in this sector of the funds industry.

The target of regulations
The FSA has made it clear that its new guidelines on DIFs are not aimed at fund managers, collective scheme operators or private client investment managers whose investment management is central to their business proposition. These groups are already well regulated. They may be affected by the guidelines on DIFs, however, if their appointment as manager or their ongoing investment approach or accountability is under the control of the distributor of the funds in question.

The guidelines focus on several areas of responsibility that together ensure advisers are treating their customers fairly. In essence an adviser must be demonstrably competent, will be aware of, and will manage, any conflicts of interest, is obliged to be independent and deliver only suitable solutions, and must communicate all of these considerations to the client. Included in these issues will be those relating to costs and remuneration.

If this sounds off-putting then take heart: what is genuinely in the best interests of clients will undoubtedly pass muster with the FSA.

Nothing to fear
Regulation on DIFs is there to assist and protect clients and not to deny them the most effective and contemporary investment management solutions.

The regulator has an unenviable task of weeding out the incompetent, unethical or lazy among us. The competent, professional, ethical and conscientious adviser has nothing to fear.

The establishment of well-managed, portfolio-style collective funds will be a major benefit to all participants, advisers as well as clients.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 10th December, 2009 |
Comments: 2 Comments

When is a fund a portfolio?

Advisers’ own label funds are highly tax efficient
Clients who invest into IFA firms’ own-label portfolio-style collective funds can gain freedom from capital gains tax on their returns as well as keener pricing and the ability to mix and match funds.

When is a fund a portfolio?
Peter and Mary Singer are recently retired and have been taking advice on how to invest their surplus savings which, of course, includes tax-free lump sums from both Peter’s and Mary’s pensions.

Their adviser works within a major IFA firm which has its own fund management company offering discretionary investment management to clients such as the Singers. They have been advised to place a large part of their available funds within the firm’s own portfolio style collective funds with a smaller proportion directly invested in specialist funds and shares. They are concerned as to whether they are being shepherded into a fund which is as much for the benefit of the adviser as it would be for them.

This is an interesting dilemma which in some ways is part of the focus for the FSA’s current work on the much heralded Retail Distribution Review (RDR) and their recent thoughts on the merits or otherwise of ‘Distributor Influenced Funds’ (DIFs).

The answer lies in provenance
Following the 1980s scandals surrounding broker bond funds it would be lazy to simply write off ‘own label funds’ as yet another self-interested money-making idea for adviser firms. In fact in almost all cases this would be an incorrect assumption. To put these portfolio-style funds into context we need to follow their provenance from the discretionary investment services which have existed for more than a century, to their current highly contemporary manifestation.

It was traditionally the stockbroker to whom investors turned and the stockbroking community has a long history of managing individual bespoke portfolios for wealthy investors. The benefit of bespoke services was that each investor’s own requirements could be satisfied, by an individually-tailored selection of investments making up a personal portfolio. Furthermore the client was in direct personal contact with their stockbroker and was able to derive confidence from the personal nature of the relationship. Going back one hundred years or more the whole industry worked in a more leisurely and controlled manner than hitherto, commensurate with the limited speed of communications and administration of the day. In spite of increasingly volatile markets throughout the 1920s and 1930s, the manner in which these services operated continued undisturbed.

Sea change in control
It was only in the 1980s that a major sea change occurred following Margaret Thatcher’s removal of exchange controls in 1979. Investment managers then had increasing access to the international markets in order to buy shares in successful companies from across the world at the forefront of the new age of globalisation. This coincided with the information age when computerisation and global media access changed the investment scene forever. From that point on it became extremely difficult to operate effectively as a private client stockbroker whilst holding oneself out as an investment manager. Each of those jobs became so specialised that it was impossible to do both well. Either you were a client-facing stockbroker or you were a specialist investment manager. This demarcation has fed through to the typical high net worth advisory firms of today, whether stockbrokers or financial advisers, and the person you see for advice is generally the GP who within the practice employs investment specialists to actually manage client portfolios.

Own-brand portfolio evolution
All very interesting, but the relevance of ‘own brand’ portfolio-style funds is a direct consequence of this evolution and the various factors behind it. I remember managing over 700 individual discretionary portfolios back in the 1980s in the build-up to the market crash of 1987. When a change of direction was called for, my colleagues and I trawled through every single portfolio marking out the necessary re-balancing prompted by our strategic decisions. This certainly meant that every client received our individual attention but the process was fraught with stress and difficulty.

I recall many times when we worked through the night, collating all the dealing which we deemed necessary and which, in an ideal world, we should probably have done a day or two earlier had our systems allowed it. The problem was that any decision, say, to reduce exposure to Japan, which had fallen some 12%, in favour of an opportunistic exposure to Hong Kong, which had fallen more than 50%, involved a real decision on each client’s individual portfolio. This was because every single client had a slightly different Japanese exposure, depending on when they joined the service and which Japanese funds were favoured at the time. This scramble to re-balance portfolios rarely involved an examination of each client’s Capital Gains Tax (CGT) status because there just was not enough time to take that into account. This could always be justified by not allowing the ‘tax tail to wag the investment dog’.

The rise of the model portfolio
The result of that 1980s stockmarket fallout was a move by investment managers to convert these bespoke portfolios into ‘model’ portfolios, where clients with similar objectives and attitudes to risk held identical but suitably scaled portfolios. These were then deliberately managed for investment results and CGT was put to one side. With this new ‘model’ approach every single portfolio could be re-balanced in a trice because they were identical and could be managed via a simple spreadsheet.

Then in 1991 the unit trust regulations were changed, to allow collective funds which contained other collective funds to operate on a commercially viable basis. This was the penultimate step in the evolution of unitised portfolio management via portfolio-style funds. Compared with the evolved ‘model’ portfolios these new collective portfolios offered far greater economies of scale, much keener pricing (because of greater bargaining power) and complete freedom from CGT on underlying management. My firm ‘share-exchanged’ most of those 700 portfolios spread across three ‘models’ into three newly-constituted unit trusts launched specifically for that purpose.

The most recent changes to regulations have allowed collective funds to mix and match underlying funds and direct equity investment, as well as to blend a much wider range of asset classes. This means that contemporary portfolio-style funds can now comprehensively and effectively mirror and replace virtually any (far less efficient) individual, bespoke portfolio.

Trust in financial advisers
There may be very good reasons why the Singers should seriously entertain the advice of their financial adviser. The first is that a good local and personal investment management department can be met and ‘eyeballed’ by the client to offer regular reassurance about the style and substance of the management – there is far more accountability.

Secondly a good portfolio manager is not quite the same as a good fund manager. The portfolio manager is running portfolio substitutes and therefore has a keener eye on the overall risk aspects of managing the client’s money. The specialist fund manager works to very tight specifications regarding where they can invest and to what extent they can protect their funds by going liquid (the majority of specialist funds require the manager to remain relatively fully invested within their specialist area since that is the objective of the fund as specified in the prospectus).

A word of warning regarding the current obsession with performance tables. Do not be tempted to buy a portfolio-style fund based on performance tables. The job of a portfolio-style fund is to deliver safe and competitive ‘portfolio’ performance.

This means that individual constituents of the portfolio (the underlying holdings) need to be competitive within their own sectors, from a performance perspective, but the overall portfolio itself is meant simply to offer a sensible and rounded financial lifestyle solution.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 9th October, 2009 | Tags: Capital Gains Tax, CGT, IFA |
Comments: Have Your Say

Plan for the worst!

Hope for the best but plan for the worst! Most folk like just enough uncertainty to keep life interesting but not so much as to make them over-anxious. Unfortunately, the current environment puts many people in the second camp.

We are currently facing a ‘flu pandemic and whilst most of us logically know that the chances of it affecting us very badly are relatively slim, we still hate the suspense of waiting our turn at the snuffles. This feeling is exacerbated by the Press, especially when they splash all over the newspapers that yet another apparently healthy individual has (sadly) died from swine ‘flu.

In the wider world the economic and stockmarket uncertainty is also corrosive. Unemployment is rising fast and has a long way to go yet, public sector, corporate and private debt levels are testing and house repossessions and bankruptcies are likely to continue heading northwards. A prime example is the news emanating from Lloyds TSB, which is releasing all its bad employment news incrementally (hoping we won’t notice the big picture). Its recent announcement, which takes target group redundancies above the 8,000 mark, is unlikely to be its last.

And again, the Daily Mail recently reported that senior Tories are now privately admitting that the aspiration to raise the inheritance tax threshold to £1 million and scrap stamp duty for first-time buyers on homes worth up to £250,000 may be delayed because of the recession. One could say that Ken Clarke had already let that particular cat out of the bag in March but it was vehemently denied by the Cameron camp at the time. Personally, I am old enough to know that very few new governments fulfil their manifesto promises made whilst in opposition – and quite understandably so, since they construct their manifestos on grand assumptions which are often far from the subsequently discovered truth (once they actually see the books)!

This leaves investors very poorly served, especially those more elderly and wealthy individuals who should be tackling their Inheritance Tax (IHT) situation sooner rather than later. As one of my oldest and longest-standing friends likes to say: “Hope for the best but plan for the worst.” This is what I would recommend to all those taxpayers who are worrying about whether they should take action to avoid or reduce IHT.

Yes, you should take action. Take all the various steps you need to reduce your potential tax, including getting the 7 year clock ticking now and/or lending financial assets to specialist trusts at currently depressed values. If it subsequently transpires that the planning is not needed then any carefully considered planning can be effectively unwound. Using the right vehicles will incur little extra costs beyond the standard costs associated with establishing any other kind of investment strategy. This warning may sound alarmist but the uncertainty over IHT will be with us for at least another year – until the next General Election – and even then the news is likely to be negative for many years to come. And especially so at a time when there will have to be massive cuts in public services and across the board tax increases to re-balance the nation’s books.

The bigger uncertainty at the moment for most people is the state of the UK economy. Recent stockmarket rises would seem to imply that the recession is all but a thing of the past. And yet many serious pundits are warning of much worse to come. Logic does appear to suggest that the combination of sky-high debt levels across the public, corporate and personal sectors and the delayed effects of the economic slump have not fully worked through the system. With banks still re-building their balance sheets (and likely to continue to do so for some time), lending is not going to improve any time soon. Whilst many individuals and companies have been able to manage their deficits over the last year one can imagine that a continuation of the current credit and earnings drought will eventually take its toll.

My own view is that this cycle will, just as with every previous cycle, pass and we will see recovery. The uncertainty for everyone is when that is likely to happen. With the banks apparently terrified to lend to property buyers, entrepreneurs or even established companies; with southern and eastern Europe all on the verge of bankruptcy; with UK unemployment likely to sail through the 3 million mark leading to more distressed debt and property repossessions; with most stockmarket companies likely to slash dividend rates over the coming months and with the threat of a return of inflation just around the corner, the uncertainty will continue until at least the autumn and probably a great deal longer.

It seems appropriate to end by reminding you again of my friend’s apt catchphrase: “Hope for the best but plan for the worst!” And to reiterate what I’ve already said elsewhere, that this is what I would recommend to all those taxpayers who are worrying about whether they should take action to avoid or reduce IHT. In fact, I would only add one rider to all of the above: “- and do it now!”

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th August, 2009 | Tags: Financial Planning |
Comments: Have Your Say

Short-termism or short-sightedness?

On a recent trip to Devon, I stayed in a small and rather delightful hotel run by its proprietor, an ex-City currency trader. One increasingly comes across ex-City or ex-financial services folk who have left the industry for one reason or another.

Over the last year this trend has been accelerated by firms ‘letting people go’ in droves. In many cases redundancies have been across the board and highly-skilled and experienced people have been forced out of longstanding and necessary jobs. This is particularly true in the areas of sales and client servicing which, in many companies, have been left decimated.

Unlike many other sectors of industry and commerce one of the main assets within financial services companies is the skilled biped. It is these creatures which create and retain the other main asset, funds under management.

I find this distasteful British redundancy cult more than strange because as we come out of recession it is precisely those front line staff which were recently ‘let go’ that will be most important to financial services companies in the upturn.

I would go further and suggest that even before any recovery – in other words whilst still in this major and damaging equity/investment recession – investors and their advisers need as much help and support, if not more, than at any other time. And yet at the slightest whiff of a downturn companies get the knives out and slash away at sales and client support teams. This was happening as early as last Spring before the recession had really started – no doubt by companies wanting to correctly second guess the market and be seen by shareholders and the stockmarket to be doing the right thing.

One has to ask why companies do this because it seems that in most cases it is superficial and short term whilst being extremely damaging over the longer term. Being at the helm of a company which is 12 years old I would be very loathe to lose a brilliant team that has taken more than a decade to put together and assimilate into our particular culture.

I remember coming out of the 2000-2003 bear market with a full complement within sales and client servicing (the senior member of which we recruited in the middle of the downturn). This allowed us to steal a march on most of our direct competition which emerged blinking into the sunlight in the Spring of 2003 quite unprepared and without adequate resources to capitalise on the ensuing recovery.

I am pleased to say that our shareholders remain committed to our long term growth and sustainability – playing the long game – and are prepared to sit out the short term vagaries that have plagued stockmarkets over the last decade.

This time I have been and remain of the opinion that the recession will be V-shaped rather than has often been the case, U-shaped. This is even more incentive to maintain optimal service levels and retain the talented staffing which is required to make the most of the prospective market recovery.

This attempt by slash and burn management to appease both existing shareholders and the stockmarket by trying to maintain profitability when revenues fall is generally at best ill-conceived and at worst downright dangerous. Unfortunately, almost regardless of these irrational and short term measures, and any impact they might have on their P&L, their share price will generally fall with the sector anyway!
Surely the better option is to plan for the long term benefit of the company, the shareholders and the share price?

Volatility as a result of a fickle market should not distract management from their long term goals and planning. We are constantly warning investors to think in the long term and so should we.

Most highly successful and longstanding companies have not grown by adopting such short term ‘stop-go’ strategies. Of course, we all try to cut unnecessary costs during a recession but we should not cause ourselves lasting damage by permanently removing vital assets – our best people.

One of the most challenging aspects of contemporary life is the constantly increasing rapidity with which everything happens. This is largely the result of advances in speed and reach of the media as well as the continuing IT revolution. The irony is that with everything occurring at increasingly rapid speed there is little point in ‘short-termism’ because the landscape will have changed by the time the ‘short term’ measure has taken effect.

Unfortunately, we seem to be caught up in this senseless pursuit of instant but superficial gains. One of the most recent examples is the Government’s movements on higher rate Income Tax and the removal of the personal allowance for high earners.

This measure is destined to raise nothing for the country’s broken coffers in the short term, but will cause immeasurable damage to the economy in the longer term by removing the desirability of the UK as a place to do and locate business.

Looking around at the behaviour of most of the major financial companies over the last year I am at a loss to understand why they have put so many people through so much redundancy heartbreak when in very short shrift they will be recruiting once more as the markets take off.
In my view short-termism is generally better described as short-sightedness.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 26th June, 2009 | Tags: Economy |
Comments: One Comment

Is it a fair cop?

On the face of it the recent statement that ISAs are here to stay is good news for investors.  It means that savers can continue to put aside £7,000 each year into investments which are permanently exempt from Capital Gains Tax (CGT) and from higher rate Income Tax.  But how beneficial are these concessions?  Anecdotal evidence from some of WAY’s supporting IFAs indicate that a high proportion of PEP and ISA holders could easily hold and manage their investments perfectly well and effectively tax-free by utilising their existing annual CGT allowances.  Most are not higher rate Income Tax payers and so will not suffer any further tax on dividends/distributions.  So are they needlessly investing in PEPs and ISAs?

The only real beneficiaries of these tax-exempt investments are either (a) those taxpayers who invest in cash or fixed interest investments (not equities or mixed funds) and who benefit from exemption from standard rate Income Tax on those specific investments, or (b) higher rate taxpayers who are already utilising their annual CGT allowances.  For these two minority groups the continuing concessions are very good news.  WAY has many regular contribution ISA investors who are young, dynamic, higher-rate taxpayers saving into high growth funds for school fees and other medium term commitments, and doing so with the added benefit of pound cost averaging.

So far, so good.  What is rarely questioned, however, is whether these ISA savers should be taking any other considerations into account.  Is the ISA news all good or is there a potential downside?

By stealth tactics the Treasury is misleading investors into thinking there are substantial tax benefits in retaining PEP and ISA portfolios into one’s dotage, while simply ensuring that it can continue to collect large amounts of IHT from the unwitting and unprepared elderly investor.  In my view investors from their mid-sixties onwards who believe they will have an IHT liability should no longer be holding PEPs and ISAs.  What so many of them do not realise is that they will suffer a punitive IHT sting at death, whereby they and their families potentially lose a colossal 40% of their hard-earned savings.  This loss completely dwarfs the often marginal annual tax benefits resulting from the ISA wrapper.

Based on Office of National Statistics figures for holders of ISAs and PEPs, combined with our own research, WAY Group estimates that at least 165,000 elderly investors (aged 70 or older) are holding ‘tax-sheltered’ portfolios in excess of £100,000.  Based on published mortality rates this would mean that some £0.5bn, or one sixth of the annual total IHT tax take of £3bn, arises from IHT on PEPs and ISAs from this group!  This cannot be right.

I believe that there are substantially more then 300,000 investors across the country who currently hold substantial equities-based tax-free investments within their portfolios with no provision whatsoever for these funds to be transferred into alternative investment schemes which can mitigate the IHT. Over half of these investors – some 165,000 – of those with large tax-sheltered investments are aged 70 plus. This is the age group at the greatest risk of losing out on the tax-free benefits of their savings strategy.

So what can these investors do to avoid IHT on their accumulated savings?  The answer is simple, even after Gordon Brown’s Budget measures from last year.  They should encash up to £285,000 of their ‘tax-free’ savings and gift them to their chosen beneficiaries via a flexible trust.  Although gifts into such trusts now constitute an IHT taxable transfer there will be no tax so long as the gift is within the current Nil Rate Band for IHT – £285,000 per person.  Such gifts fall out of account after 7 years and so there is an opportunity for each taxpayer to make gifts up to this level every 7 years.

At age 65 the average investor still has a life expectation of some 16 years (males) to 19 years (females).  Even at age 75 these numbers are 9+ and 11+ years.  This means that any average investor has time to gift their former PEPs and ISAs completely IHT tax-free so long as they start shortly after their mid 60′s.  The real benefit of the tax exemptions associated with PEP/ISA portfolios is that when this IHT mitigation exercise becomes appropriate the targeted funds can be surrendered entirely tax-free at that point, making investment in an IHT mitigation plan that much more effective.

WAY offers a comprehensive range of IHT mitigation arrangements, uniquely offering both unit trust based and offshore bond based plans.  These are further subdivided between flexible and discounted schemes whereby trustees have a great deal of flexibility in making financial provision for both donors and beneficiaries.

A simple recent example illustrates the benefit of this approach.  The lady in question was a fit and healthy 73 year old widow.  She and her late husband had bought their ex-Council house under the ‘right-to-buy’ scheme and the rump of the mortgage was paid off from her husband’s PEPs and ISAs.  The table shows her circumstances both before and after swapping her PEPs and ISAs for a combination of flexible and discounted schemes from the WAY stable.  She has a life expectation of some 13 years but only needs to survive 7 to remove the gift into trust from her estate.  Assuming she does live those 7 years then she will have virtually removed IHT from her estate.  Even were she to live less than 7 years then her net IHT liability would be substantially reduced as a result of moving her funds.  Moreover her income is maintained and, via her trustees, she retains tremendous flexibility over the future return of funds from the flexible trust.

Paul Wilxox,
Chairman & Technical Director, WAY Group.

Posted on 19th June, 2009 | Tags: Capital Gains Tax, Higher Rate Income Tax, IHT, ISA, ISA Savers, Life Expectation, PEPs |
Comments: One Comment

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