Once in a lifetime IHT planning opportunity

Anecdotal evidence seems to indicate that few advisers are working on Inheritance Tax mitigation at the present time and yet in reality the credit crunch has generated the most ideal environment for such planning for many years.  Whilst it is true that the transferable Nil Rate Band has taken a number of more modestly wealthy individuals out of the IHT trap, the number of taxpayers likely to pay this tax still appears to be substantial.  Of course, advisers are saying that their wealthy clients are more taken up with repairing their personal balance sheets (after the hits they have taken from the credit crunch and stock market rout) than they are with mitigating tax.  This is, however, a foolish approach since the credit crunch and its impact is temporary whilst the prospect of gifting one’s hard earned wealth to the Government is permanent.

I have been looking at house prices in London to get an idea of the temporary impact of the wealth destructive effects of the mortgage famine (which I believe is the real culprit in house price falls).  Looking at terraced houses, which represent the modest living accommodation of average Londoners, it seems that those living in suburbs like Camden, Fulham and Islington (even after recent substantial falls in values) still have properties worth in excess of a couple’s Nil Rate Band.  Meanwhile a couple living in Wandsworth have seen their terraced house fall from £620,000 down to £500,000.

 The other disincentive when considering IHT planning has been the dramatic falls in equity values.  During 2008 a massive 31% was wiped off the (FTSE 100) value of shares, a reversal not seen in any other year since the FTSE 100 was launched in 1984.

 These falls in personal asset values beg the question as to whether it is correct that taxpayers have become distracted from considering their potential IHT positions.  In my submission, whilst I understand the current concerns about rebuilding assets, there are very many reasons why taxpayers should be focusing on IHT mitigation at this very moment.  The main three, which I will cover individually are: (1) the seven year clock necessary to remove assets from one’s estate should be started as soon as possible; (2) the depressed value of personal assets at this time offers a ‘once in a lifetime’ opportunity to supercharge any such planning, and; (3) the availability of highly flexible schemes based on both unit trust portfolios and bonds means there is no reason to not put IHT mitigation in place as an additional benefit of normal portfolio planning.

The Seven Year Clock
Recent research (from WAY Group) indicates that taxpayers adopting IHT mitigation are doing so much later than they perhaps should to get best value from the seven year period it takes for asset transfers to fall out of one’s estate.  Men typically start planning at age 69 and women at age 72.  That leaves the average person with only one complete seven year period between starting IHT planning and when they are likely to die.  So the earlier one starts IHT planning the better to make sure one survives the seven year run-off period or even to enjoy more than one set of gifts (more than one seven year period).

Once in a lifetime opportunity
There is little doubt that today is a great time to be doing one’s IHT planning.  Why?  Because:

•         Proportionately one can remove far more from one’s estate today than a year ago, and probably in a year’s time, because of depressed values. Transfer now whilst prices are cheap.
•        There will inevitably be a recovery and assets will substantially increase in value.  Whilst nobody really believes the Halifax statistics for house price rises in January it does give some indication that there will soon be a bottom and then a recovery.  This is linked far more to the availability of mortgages (which disappeared for several months in 2008 and under Government pressure are now reappearing) than to sentiment.
•        We have seen the early green shoots of stockmarket recovery since the lows of last year and no-one should doubt the potential for a worthwhile recovery this year.
•        By moving assets into trust now, the resulting change in beneficial ownership will trigger a Capital Gains Tax (CGT) point, BUT at current depressed levels very few people will have to pay any CGT.
•         Any recovery in values, once assets are transferred, will conveniently occur outside the donor’s estate thereby saving substantial IHT on that extra value (IHT savings at 40% far outweigh any future CGT at only 18% on gains above the allowance).

With Government finances in a mess there are unlikely to be further cuts in IHT for the foreseeable future, regardless of which political party is in Government.  So there is an extremely strong case for those potentially liable to IHT to get the seven year clock ticking.

 No reason not to plan
Until a few years ago IHT planning involved putting on a financial straitjacket whereby putting assets beyond the reach of the tax man normally involved putting them beyond one’s own reach (other than possibly a fixed future ‘income’).  In addition, most traditional IHT arrangements were based on life assurance bonds and their often inconvenient attendant Income Tax status. 

 Those restrictive days have long gone and the IHT mitigation market has moved on very much in line with other contemporary developments in the investment management arena.  It is now possible to engage highly flexible trust arrangements in which trustees have extensive flexibility in passing benefits to the donor and/or beneficiaries as dictated by circumstances rather than simply by prescription.  In addition these arrangements can now contain the kind of managed portfolios investors would have held, in any case, had they not been planning for IHT.  It is now even possible for IHT-shielded portfolios to be managed on the most contemporary of investment platforms.

 The trust flexibility and investment options available today mean that the only argument for not placing an IHT mitigation trust around a client’s portfolio is the marginal extra cost of doing so which, even with trustee fees, normally works out at less than 1% per annum.

Advisers would be well advised to look afresh at contemporary IHT planning which is no longer a ‘magnum opus’ and simply represents a best practice ‘add-on’ for any portfolios managed on behalf of wealthy clients.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 13th February, 2009 |
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A tale of IHT mitigation

John and Frances Greening are facing a major dilemma regarding the death of Frances’ widowed mother in January 2008. Frances is the sole beneficiary of her mother’s Will and she was left a substantial inheritance which has unfortunately fallen in value very dramatically in the intervening period. John and Frances have been working their way through the probate process and suddenly realise that they are caught out by the credit crunch from settling the estate in the most effective manner. They are having difficulty raising funds to pay the Inheritance Tax in order to achieve the very probate which will allow them to sell assets to pay the tax. The assets in question have fallen so much in value that the effective rate of tax they could finish up having to pay is much higher than the 40% normally payable upon death. Frances’ father died nine years ago and utilised the whole of his Nil Rate Band.

There are three different problems here which combined are putting this couple in a very difficult position indeed. The challenges are:

• Mum lived in the suburbs of London in a house valued (at the date of death) at about £1.3 million. In addition she had other, financial, assets totalling a further £0.4 million. Based on a Nil Rate Band of £300,000 (as at January 2008) this would incur IHT of £560,000. So they have to find a lot of cash to pay the IHT in order to be able obtain probate to sell any assets.
• The value of the house has probably fallen by some 30% since her death and the value of the share portfolio (which was weighted towards banks with a generous exposure to builders and mining stocks) has fallen by nearer 50%. The theoretical values are therefore now £910,000 for the house and £200,000 for the shares. The house is unlikely to be saleable since similar properties in her area are just not moving. The IHT based on these lower values would be £324,000 – a huge £236,000 less than on the death values.
• There is an HMRC concession whereby falling asset prices can be re-based for probate purposes but only if they are sold by the executors within a specified period after death – 48 months for property and a challenging 12 months for other assets. To sell, the executors must have obtained probate. This is only achievable if the full tax is paid in advance and a re-base claim then made later when the assets are sold at lower prices.

The Greening’s have less than 2 months to sell the shares to establish a lower re-base value. If they manage to achieve this they will probably be well advised to re-invest any proceeds in Frances’ name straight away, to make sure they do not miss any subsequent recovery. But this assumes that they achieve probate and to do so they must pay any tax due. With Capital Gains Tax now at 18% it is better for any recovery to happen in Frances’ name rather than with the executors where any recovery will fix the IHT on the gain at 40%.

Fortunately, there is also the property instalments concession which they can use to avoid paying the full tax on Mum’s house immediately. They will have to pay 10% of any tax due to achieve probate and can then pay the remainder in another nine annual instalments with interest. This means that they can take their time selling the property and to claim any re-basing (if the house does not climb back above January’s value) so long as they sell by January 2012.

So what does this now all look like in terms of what they must do before January to achieve the optimum results – remembering that probate can take some time even once the application is in and the tax is paid? They will have to pay the full tax on the ‘other assets’ and the first instalment of tax on the property (plus a little bit of interest which becomes payable from 6 months after the date of death) before they can have access to the shares to sell them before the 12 months is up. They must work very fast to get the probate application in to make sure they get probate in time.

The calculation looks something like this:
Total Assets (£1.7m) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (the £560,000 mentioned above). This gives a marginal rate of IHT of 32.94%. This rate is applied to the separate assets, so they will have to pay £131,765 on the ‘other assets’ (32.94% of £0.4m) and £428,235 on the house (32.94% on the £1.3m) but need only pay 10% of this immediately. So to obtain probate they must submit the necessary forms and make a payment of tax on account of £174,588 (£131,765 plus £42,823).
They have to find this cash from somewhere and in the present climate that will not necessarily be easy because there are no assets available to charge to a bank (until after probate). Assuming they can raise this cash, obtain probate in time and sell the shares before the first anniversary of Mum’s death, then they can ask for the share valuations to be re-based onto an actual basis. They will then be able to obtain a partial refund from HMRC following a new calculation, as well as being able to repay the bridging finance from the share proceeds.

The new calculations will then look like this:
Total Assets (£1.5m now that the share values have been re-based) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (£480,000). This now gives a marginal rate of IHT of 32%. This rate is applied to the separate assets, so they should have paid £64,000 on the ‘other assets’ (32% of £0.2m) and £416,000 on the house (32% on the £1.3m) of which only 10% was payable immediately. So their initial tax bill should have been £105,600 and not the £174,588 they actually had to pay on account. So they should receive a refund of almost £69,000 at that point.

These potential calculations are repeated all over again if and when Mum’s house is sold for less than the original probate value. Again, there is some sense in pursuing this because John and Frances will receive an IHT refund at 40% on any reduction whilst only suffering CGT at 18% were they to reinvest and enjoy an increase in property prices.

This whole scenario simply underlines the benefit of removing assets from one’s chargeable estate early enough to avoid all of these probate challenges, quite apart from the general benefits of avoiding as much of this heinous tax as possible.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: IHT Mitigation |
Comments: One Comment

IHT and the Glenrothes effect

Labour’s surprise victory in the Glenrothes by-election (7th November 2008) has rekindled that party’s hopes of achieving re-election sometime in 2010. The reasons for the unexpected vote of confidence in Labour probably include Gordon Brown’s new reputation as financial crisis Superman as well as the apparent policy vacuum from Cameron and his front bench colleagues in relation to the current banking and economic chaos.

There has recently been some question about the future of Inheritance Tax (IHT) planning for Mr and Mrs Average. For a brief interlude the combination of falling house prices, falling stockmarket values and the promise of a couple’s £2 million Nil Rate Band from the Tories seemed to make IHT planning for all but the very wealthy somewhat less urgent.

This view is completely misplaced and has to be challenged because taxpayers need very little encouragement to be completely complacent about a tax which they will never suffer but which brings great difficulty to the next generation. An interesting and extremely difficult by-product of the recent fall in asset values, particularly house prices, is that many taxpayers that have died over the last year or two left taxable assets which have subsequently fallen dramatically in value before they were able to be sold to pay the tax.

Imagine someone having died early this year with a sizeable share portfolio focused on banks, builders and mining companies. They may be required to pay 40% tax on assets which have subsequently fallen in value by 90%. To put that into context the tax on an investment portfolio of, say, £300,000 might be £120,000 (at the full 40% assuming their Nil Rate Band was exhausted elsewhere) and yet the related portfolio may have fallen to only £30,000 in value after the dramatic market falls of the last few months. How can you realise £120,000 of tax from a portfolio worth only £30,000 – what a horrendous side effect of the recent market debacle.

This has been exacerbated for tax on properties where beneficiaries are faced with a market which has not only tumbled but in many cases has become completely static so that properties cannot be sold at all. In both of these cases there is an HMRC concession to re-base the value but it requires a sale of the assets in question by the executors within a set time period (12 months for shares) and only after the full tax has been paid to facilitate probate – so a major cash flow challenge especially in the current banking climate.

This whole new scenario is an added incentive to make sure that assets are transferred outside a taxpayer’s estate more than seven years before their demise to remove the relevance of pre and post death values. If the whole value is beyond the reach of the taxman then no tax will have to be found and therefore there will be no forced sale of assets.

So what chance is there that IHT is a thing of the past for most of us? Shadow Chancellor George Osborne was recently compromised into a confirmation of the impact of Alistair Darling’s moves on transferability of Nil Rate Bands between spouses and civil partners. Transferability combined with the Tories’ Autumn 2007.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: Glenrothes by-election, IHT Mitigation |
Comments: One Comment

Far too clever, cobber

We had left for Australia early on Boxing Day and in the rush had forgotten to buy any adaptors to convert from UK to Australian electrical sockets.  So our first stop on the way from Brisbane airport to our relatives’ house was at an electrical store to buy the necessary.  I was slightly taken aback at the cash desk when the young man asked me what on earth had happened in the UK to lead to the failure of such a great name as Woolworths.

 Little did I know that the electrical store I visited was owned by Woolworths and run by passionately loyal employees of Woolworths (Australia).  The following day we were taken to a large and very impressive supermarket – Woolworths – looking amazingly like one of our best Tesco stores in the UK.  Whilst Woolies in the UK has gone to the wall, the giant and very well-managed Australian version is actually the 22nd biggest retailer in the world, according to recent global research by accountants Deloitte.  The top three are Wal-Mart in the US, Carrefour in France and Tesco in the UK, but Woolies Australia, at almost half the size of Tesco in terms of turnover, is a real star bearing in mind the very much smaller market in which it operates.

I later learned that Woolworths, Australia, a major supermarket group, whilst owning a number of large speciality chains (such as electrical and wine stores) is also a leading brand in petrol stations, hotels and casinos.  What a very different story to their UK counterparts.  Unfortunately it all comes down to vision and quality of management.  Tesco had the vision 30 years ago to raise its game and play to the future whereas Woolworths UK remained in its post-war time warp.

 A few days later we were doing the obligatory river cruise through the beautiful and modern city of Brisbane when our attention was drawn to a massive and extremely artistic neon sign on the main wall of the Brisbane Gallery of Modern Art about half a mile away.  It gave out one huge message, the title of their current multi-media exhibition – OPTIMISM. 

 These sentiments were prevalent everywhere we went around Australia.  On a subsequent trip up the coast to an ocean resort at Noosa the local newspaper was full of opinions about the threat of recession.  Tex Pipke, head of the Cooroy Chamber of Commerce, suggested that “this community is opposed to the idea of recession in Australia, to the point that we might not participate.”  Speaking about local developments in trade and tourism over recent years he went on to say “Why would we be depressed?  We have a lot to celebrate, so let’s not go out there and participate in this recession.”

 Whilst I have been away on this antipodean trip I have had plenty of time to read the endless analysis both by competent and less competent journalists, business people, financiers, bankers and intellectuals, attempting to explain how the crazy explosion of inappropriate credit over the last decade led to the inevitable credit crunch which in turn is leading to a massive global recession.  All of this intellectualisation is fine but it fails to address the missing ingredient – what to do now.

 We have had massive sell-offs before, often following major financial dislocations in the market place.  These have involved various different sectoral difficulties over the years, the most recent being the bursting of the ‘tech bubble’ in 1999.  Each time we have managed to overcome the challenges and move forwards.  Unfortunately this time the credit crunch symptoms (in essence a sectoral difficulty) were immediately identified with the 1930’s depression and as a result we have ‘apparently’ moved directly from healthy economic world growth to a self-induced and completely unnecessary recession. 

Obviously the tightening (and often unavailability) of credit has had an impact on personal and corporate capital spending but, as an example, I needed to upgrade my own car in August 2008 and had no difficulty whatsoever in getting extremely inexpensive terms from a finance company owned by one of the big four banks (as was).  So why has the sale of motor cars fallen so dramatically over the last year?  Not just in the UK or the United States but virtually everywhere in the world (car production in France was down 8.1 per cent in November after October’s 22 per cent plunge according to Insee, France’s national statistics agency).  The knock-on effects of a slowdown in the car industry have affected many other connected industries.

 It appears to me that the whole world has gone mad.  Yes unemployment has risen but spending reductions have not been limited to those unfortunate to be out of work, everyone seems to have completely stopped spending.  As a result manufacturers have stopped ordering raw materials and retailers have stopped ordering finished goods.  Most capital spending has stopped or is stopping and everyone is cutting revenue spending.  Trade is falling off a cliff. 

 The strange thing is we are all accustomed to a certain standard of living.  With interest rates now on the floor, oil prices at almost a quarter of what they were early in 2008 and various other prices becoming competitive (Australia is now over the drought of recent years and is heading for a bumper harvest) the panic will surely ease.  Then we will be spending again, probably as early as later in 2009.  Many UK consumers have seen their disposable income rise by between £5,000 and £15,000 per annum net over the last year.  So, suddenly consumption will be up – relative to now – but everyone in business will be completely de-stocked!  There will then need to be a dramatic resumption of manufacturing/production.  So there will be a resumption of the classic ‘go’ part of the age-old ‘stop/go’ cycle and off we will go again!

 I believe Gordon Brown, Barack Obama, the Chinese Government and all other sensible thinking people wishing to prime-start their economies are absolutely correct, BUT without the consumer, who accounts for a huge proportion of overall global economic activity, normalising consumption, these other measures will take forever to work.  Intellectual discussion and actions by central governments are all well and good but what the world needs now is a return to normality. 

 The last time there was a widespread call for normality from the public was immediately after 9/11 when New York mayor, Guiliani, went public with a plea for New Yorkers to ‘carry on as normal’ (go shopping, go to the theatre, go to the restaurants).  His motive was more by way of a message to Osama bin Laden that the West would not be compromised, but his call was answered by the people.

 The current situation is not related to terrorism, but it is nevertheless extremely serious.  Whilst we do not want anybody to spend above their means nor to borrow money they can ill afford to borrow, it is important that we normalise our consumption patterns RIGHT NOW, if we are to avoid a short sharp and damaging recession.  If you are due to trade up your car, if you are due to take a holiday, if you are due to spend money on an habitual basis then do so, now.  If we all do this then we can avoid this imminent recession.

 So, cobber, stop intellectualising about the credit crunch and the subsequent chaos and get back to living your life as per normal – just like the Australians want to.  That way we can all survive this man-made disaster that the Press are constantly talking us into.  As Nike says ‘just do it’ and I suggest you convince all your friends and family to ‘do it’ too.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th January, 2009 |
Comments: Have Your Say

Sell, sell, buy, buy!

We all know that markets and share prices are governed by fear and greed whereby bull markets are characterised by greed and bear markets by fear.  We also know that markets overshoot on both the upside and the downside – often within a short space of time.  Surely this is exactly what we are seeing right now.  If the banks were overvalued just a few months ago, surely they are undervalued now, similarly with builders and miners.  Most of us remain in a state of hung over trauma having seen a buoyant market and economy fall off a cliff in very short order.  Of course the falls have not been consistent across all sectors, as implied above, and the trick now is to determine what sectors should be backed if, and when, we can anticipate the pendulum swinging back into more positive mode.

 Not that the investing public is feeling any more positive yet.  Presently all news seems to be bad news, even when it is good!  Inflation falling would normally be considered good news but currently it is a harbinger of the dreaded deflation.  Interest rates falling would normally be considered good news but because up to a half of mortgage payers will not receive the full benefit then it is considered bad news.  Falling Sterling making our exports more competitive would normally be considered good news (look what it did to stimulate our economy in the early nineties) but because our imports will cost more and overseas investors will have less confidence in the UK then it is considered bad news.

 All this ‘bad’ news makes our market fall.  When interest rates fall, when inflation falls and Sterling becomes more competitive the market falls.  When Gordon Brown announces there will be substantial fiscal measures to stimulate the economy the market falls.

 This does not make any sense.  The fact that RBS spent more acquiring ABN Amro recently than the total current market capitalisation of Barclays, Lloyds TSB, HBOS, Marks & Spencer, J Sainsbury and WM Morrison defies logic.  Sure they may have paid too much but not so much that realistically they could have bought all those other major UK companies instead!  Many companies today are ‘dirt’ cheap. 

 The fact that many shares can be purchased at less than last year’s earnings defies logic.  The fact that our own natural everyday consumption habits will underpin the financial future of most major UK companies means that there are some terrific bargains out there.

 In managing a broadly based portfolio, managers will normally have an eye to combining undervalued assets (to achieve competitive performance) with a wide diversification (to harness and restrict volatility).  The current environment makes this task particularly important and exciting over the months ahead.  WAY Group is unusual in having its portfolio funds managed by a selection of external managers.  Not surprisingly its three main, but entirely independent, managers agree on the prospects for the next market phase.

 John Husselbee at North Investments, manager of the WAY MA Cautious portfolio which has recently been moving from cash back into the markets warns “There is no doubt that the past few weeks have given investors a white-knuckle ride that would test anybody’s faith in financial markets. There may be some who want to get off now, some who are concerned but will stick it out and even those fully prepared to take more. What you need to avoid being is the investor who gets off near the bottom, taking a large loss and giving up any potential for recovery and future growth.”

 Meanwhile Jason Britton of T. Bailey, running the more adventurous WAY MA Growth portfolio, is already working out a broad strategy going forwards.  He agrees “Returns may be volatile but one of the most important factors in relation to equity investment is when one invests and when one sells, and if you are investing for the long term then equities appear to be offering good value at the current time.  A lot of bad news has been priced in from recession, through to the financial crisis and the de-leveraging of hedge funds.  There may be further to go as the consequences of the financial crisis filter out and create ripples in even more unexpected places, or as the recession proves deeper than currently envisaged, but there is a real danger of looking back in a few years time and kicking oneself for not taking advantage of recent falls, even if markets may yet be cheaper next month.”

 On strategy Britton says “Currently we are weighting the equity portion of the WAY MA Growth Portfolio to the US and Japan.  The US was the first into a slowdown and is likely to emerge first too.  Outside of financials, the earnings reporting season is generally providing good news and whilst the outlook may be deteriorating corporates are coming from a position of strong cash flow and low-ish leverage.  But investing in the US also comes with a safety net for UK investors, namely a rapidly strengthening Dollar.  Whilst the extreme moves of recent months may not continue, we anticipate there being a bit further to run here.   Japan is also providing a mix of buy-signals none of which in isolation would be sufficient to get excited about, given its propensity to disappoint, but the weight of data suggests that Japan may move more quickly than other markets when things settle down globally.”

 Meanwhile Paul Kim of IMS Fundquest, who manages the WAY Global Portfolio range, reminds us of the benefits of the managed portfolio style adopted within WAY,
“I believe funds of funds provide a good spread for investors, with a variety of expert managers ‘at the coal face’ picking stocks that should weather the storm and emerge stronger. This diversification avoids having too much specific risk, in any one stock or sector. However, many very well-managed companies have been tarred with the same brush and have seen their share prices knocked disproportionately and now represent excellent long term value.  We seek to back those managers best likely to identify and run with undervalued companies and sectors.”

 The message is pretty clear.  There may be more downside yet to come in the market but attempting to finesse timing to hit any such further fall is far too dangerous.  The general market represents excellent value right now but for the talented manager there are some real gems out there where performance of hundreds of percent are on the cards over the next couple of years.  The clear message then is to be committed to the market right now and to get in while you can at these bargain basement prices.  Not only will we all make money (including recouping some of our recent losses) but we can bring much-needed confidence back into the market and into the economy – you could say it is our duty!

In any case and in spite of rumours to the contrary, the property market, which was allegedly the initial cause of this fall-out, is actually not dead.  Recent figures from the National Association of Estate Agents indicate that sales per agent are up from 5 per month in August to 6 per month in September, climbing again in October to 7 sales per agent.  Unless one is mistaken that seems to represent an increase of 40% from the bottom.  Is this good or bad news?

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th November, 2008 |
Comments: Have Your Say

Cash and the Fourth Dimension

Until recently the consensus view in the retail press and amongst many of the investing public was that cash, and only cash, constituted low risk investment.  However, following the failure of the Icelandic banks and fears about the solvency of banks generally, both here and virtually everywhere else worldwide, such an assumption suddenly seems rather shaky.

 We recently launched a cautious equity-based fund which was held largely in cash until mid-October.  Against a background of tumbling equity markets imagine our surprise that all enquiries by prospective investors and their advisers about the security of the fund focused purely on the cash holdings!  Investors seem well acquainted with the perceived risks within the equity markets (the memory of 2000-2003 is fresh in their minds) but suddenly are worried about the security of their cash holdings.  This brings me on to consider risk in the wider context where I see two distinctly different categories of risk – absolute risk and price risk. 

 Absolute risk is related to losing one’s stake in its entirety – as one generally does on the gaming tables.  In investment terms this normally only happens when the entity in which you have invested, primarily as a shareholder or sometimes as a depositor (think Icelandic banks), goes bust.  It can also happen when a company is nationalised, such as Northern Rock, when shareholders also lose everything. 

 Price risk, on the other hand, is where an investor buys an asset for which the price is determined by the market forces of supply and demand.  If you buy RBS shares today, will the price rise or fall between the point of investment and any subsequent sale?  Having fallen some 90% or so from its peak and now that its future has been underwritten, RBS should have zero absolute risk and, probably, a very low price risk (the FT website was recently quoting a prospective running dividend yield of 33% – we know this wont happen but it puts the current share price into context compared with recent profit and dividend levels).

 There is little to say about absolute risk other than to emphasise that it is sensible for investors to do adequate due diligence before investing in any company that is vulnerable to currently deteriorating economic conditions.  There is plenty to say about price risk and it is here that the fourth dimension of time, and of course timing, comes into play.

 Both Warren Buffett and Bill Mott have gone on record recently to say that all the risk is currently in cash.  This is not because of prospective bank insolvencies but because interest rates are going to fall to very low levels so that real returns from holding cash are likely to be negative, even if one allows interest to roll-up.  On the other hand equity investment at this historical point in the market is likely to offer both decent yields and substantial capital growth, so long as one follows the basic rules of investment – of which number one is diversification and number two is to invest for the medium to long term (the fourth dimension).

I believe that equity value in the markets is greater than at any previous point in my lifetime and likely to be greater than at any point in the rest of my lifetime.  Of course prices could go lower (although I doubt they will go much lower) but in years to come this period will be looked back on as a once in a lifetime opportunity to make big money from equities – especially in the sectors which have bombed so badly in recent days and weeks.  Personally I am borrowing what I can to buy banks, builders and miners right now, many of which are down 90% or more from their recent peaks.  Even a recovery to only 25% of previous levels equates to a performance of several hundred percent from this point!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th October, 2008 |
Comments: Have Your Say

HMRC plays the ageism card on IHT planning

The value of a gift for Inheritance Tax purposes is calculated not by reference to the value of what you have given away but by reference to the diminution of your estate as a result of making the gift.  This subtlety avoids evasion by making small gifts which dramatically reduce the value of one’s estate – for instance by gifting away a minor 5% shareholding which removes voting control from the donor!

 In the case of a traditional discounted gift trust the value of the gift into trust is discounted by the value of benefits retained by the donor.  So if a taxpayer gives away a £200,000 investment (normally an investment bond but in some cases unit trusts) but ‘carves out’ and retains an annual reversion of 5% or £10,000 per annum, then the value of the gift is £200,000 less the value of the retained ‘income’ rights.  The value of those rights at the point of making the gift obviously depends on how long the donor is likely to live and on assumptions about interest and inflation rates.  If the donor is likely to live 20 years (and will therefore likely receive a return of £200,000 over that period) then the discount will be very large.  The older the donor is at the time of making the gift the lower the discount will be.

 This process and valuation model is totally logical and actually reflects the accepted means of calculating the discount on such mitigation schemes.  In spite of this generally practical approach to discount valuation the technical definition is somewhat different and is enshrined in Section 160 of the Inheritance Act 1984, which puts an ‘open market value’ on any rights carved out and retained by a donor in such schemes.  Since an open market value is largely a theoretical concept – donors never actually wish to sell their ‘income’ rights – HMRC are happy to rely on the actuarial model described above.  So happy are they that they have spelt out, in guidance notes, precisely how the calculations should be made and what mortality tables should be used.

 The problem with the elderly has arisen over the last 5 years or so since when the HMRC has imposed its own interpretation of what constitutes an open market value.  They have been claiming that no discount is applicable to elderly donors because no potential open market purchaser would be able to ‘insure’ against the failure or potential loss resulting from their purchase, by taking life cover on the donor’s life (due to lack of demand there are very few opportunities to insure the lives of those aged 90 and over).  They suggest that an inability to insure means that the rights would have a nil open market value – they would be unsaleable.

 Last year a case went before the Special Commissioner because HMRC had once again disallowed an actuarial discount to a lady of 90 who had invested in just such a scheme and died several months later.  The challenge to HMRC had been sponsored by AXA Isle of Man whose scheme was involved.  There was a collective, albeit premature, sigh of relief in February following publication of a ruling by the Special Commissioner granting a compromise discount to the donor.

 On 7th February 2008 Special Commissioner, Howard Nowlan, ruled that the derisory £250 nominal discount offered by HMRC to an elderly DGT client was unreasonable. The case, the evidence presented and the ruling were all extremely important for those of us working within Inheritance Tax mitigation. 

For me the crunch here is that the legislation talks of ‘open market value’ but makes no reference to insurability.  The HMRC have been relying on standard practice of specialists like Foster & Cranfield who deal with the valuation and sale of second hand annuities and insurance policies.  Commissioner Nowlan, I am pleased to say, approached the whole issue from a more common sense perspective and noted that regardless of her potential insurability, or otherwise, there would be plenty of theoretical investors who would be prepared to take a ‘punt’ on her life at the right price – including himself!  To suggest that the lady’s retained lifetime ‘income’ stream could be valued at the final and derisory HMRC offer of £250 when that ‘income’ stream yielded a net return of £304.16 per month was nonsense.  She would only have to live for a month for the purchaser to be left in profit and whilst she was certainly of impaired health she could reasonably have been expected to live at least one month!  He did comment that a 90 year old in normal health would be expected to have a substantial life expectancy and a much larger discount would therefore be appropriate.

 It has now been reported that HMRC is still not content to accept the Special Commissioner’s compromise discount value and plans to appeal.  This is disappointing but not necessarily a surprise.  Mr Nowlan actually came up with a somewhat ‘Heath Robinson’ approach to valuing the discount which involved taking two thirds of the calculated actuarial discount and then deducting likely expenses of £1,000!  I think all of us would have preferred a straightforward acceptance of the practical and traditional approach used for those under the age of 90 and which was generally accepted until a few years ago.  Anything else amounts to ageism in its meanest form.  The graph shows a typical level of discount applicable at different ages and indicates that whilst discounts will gradually reduce with age there is no justification whatsoever for them to ‘fall off a cliff’ to nil at age 90 just because HMRC wish to arbitrarily hit those least able to defend themselves.  How can income or withdrawal rights be very valuable one week before attaining the age of 90 and have no value one week later!

 We await the appeal process with interest and hope that reason will prevail.

 In the meantime it was usefully stated in the judgement from Mr Nowlan that “it was accepted by HMRC that the 5% annual withdrawals under the policy, these being the sole entitlement of Mrs. Bower under the Trust, would be tax free and would occasion no liability for higher rate tax as “chargeable events” under the Income Tax provisions relating to insurance policies. It was also accepted that as Mrs. Bower’s rights were clearly defined, there would be no question of her being treated as having made a gift with reservation of benefit for Inheritance Tax purposes such that the whole gift would be disregarded. It was also accepted that she was not to be treated as having a life interest in the whole of the settlement and treated as owning all the settled property for Inheritance Tax purposes”.  Pre-owned asset tax would therefore also not apply. 

 In essence we have been delivered a watertight judgement about the general efficacy of Discounted Gift Schemes even if we temporarily remain in disputed territory for older clients entering such schemes.

Mark Benson,
Technical Manager, WAY Group.

Posted on 20th April, 2008 |
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Multi-Manager a.k.a. Unitised Portfolio Funds

The concept of collective investment has been around for almost a century.  Unit trust companies like M&G and Save & Prosper were pooling investor funds and investing with the benefits of economies of scale from the 1930s onwards.  The principle of collecting together investors’ moneys and then appointing a specialist stockpicker to run a large and effective fund of invested shares became very popular with the more sophisticated investing public.  Instead of having an individual portfolio which needed regular attention, large amounts of administration, including the completion of annual tax returns, and the potential for regular tax liabilities every time profits were taken, investors could suddenly buy and enjoy owning a collective fund.  The benefits were not limited simply to convenience or to putting off any tax liabilities.  The primary benefits were the ability to achieve much greater diversification than would be possible with one’s own limited portfolio and the opportunity to share in the rewards of employing a top class manager and his or her 24/7 team rather than simply your tired local stockbroker.

 In those early days investment tended to be limited to the UK market where many international companies were, in any case, listed.  As exchange controls disappeared (as late as 1979 in the UK when Margaret Thatcher opened up the markets) it then became more conventional to have some exposure to overseas companies within your mainly-UK portfolio.  It was in the ensuing decade, the 1980s, when overseas unit trusts really took off.  Specialist funds based on various markets around the world, both large and small, managed by specialist managers who were often based in those geographical areas, flourished during this time.  I recall funds investing specifically in Hong Kong, or Singapore and Malaysia becoming very popular.  During this phase your local friendly stockbroker would have progressed to setting up client portfolios, mainly comprising a range of UK blue chip shares, supplemented by two or three holdings in specialist overseas unit trusts.

 In my own case as a Licensed Dealer in Securities, back in the dim and distant early eighties, I became manager of a range of third party insurance funds.  In my view funds like these were in the vanguard of the Multi-Manager movement.  Regulation then was not even a twinkle in the Government’s eye and yet most of us were highly professional both in our motives for establishing such funds and in the way they were managed.  It was an opportunity to set up a pooled fund of investors’ money and then to invest and manage it across the world, utilising the combined skills of all the top specialist managers and funds available.  Many of those early funds (subsequently dubbed ‘broker bond funds’) were pretty effective for their unitholders.  In those early days the life companies tended to be scrupulous in their vetting of the competencies of anyone wishing to set themselves up as managers of such funds. Generally anyone appointed was extremely talented and professional.

 Unfortunately the success of such funds was their undoing.  They had generally turned in competitive performances during those early years and were attracting increasing amounts of money.  Not only that they gave advisers the opportunity to collect their clients’ assets into a more easily managed format – one which offered not only a greater sense of corporate ownership but a regular management income deducted at source and paid over by the life company.  Soon a number of commercially successful advisers, but with far less adequate skills and experience, were set up with these broker bond funds.  To compensate for their lack of skill certain insurance companies invented ways for such managers to ‘milk’ the system by indulging in historically priced switching – betting on certainties.  Of course any such benefits were always at the expense of the other unitholders in those underlying funds who suffered the cost of such historic dealing.  By this time the new Financial Services Act was in force and it was not long before broker bond funds were under the microscope.

 As one door closes another one generally opens.  Whilst the broker bond saga was brewing the more purist investment industry, comprising the unit trust companies, was developing funds which were not invested in shares but instead across a range of other specialist unit trusts – the fund of funds unit trust was born.  Initially such funds were only permitted to buy underlying funds on a charge-free basis in an attempt to avoid double-charging.  Fortunately it was not long before rule changes were introduced into the administration of such trusts whereby fund of funds unit trusts were permitted to buy underlying funds at ‘best’ rather than at cost.  This was October 1991.  Being the unit trust industry this development was seen as offering a more comprehensive means of accessing specialised markets rather than as a potential panacea for portfolio investors.

 For us portfolio-style managers, however, it offered an even more effective means of delivering collective portfolio management than was available from the old broker bond funds.  The costs were lower and the potential tax savings were even greater.  Firms like Old Mutual and what subsequently became Capita, started offering their unit trust administration structures to third parties who wished to manage their various clients portfolios on a more efficient, contemporary and effective basis.  Firms like WAY have come in later offering even more specialised services whereby third party managers can access sophisticated financial planning structures underpinned with their own funds and/or fund management.

 Recent bear markets and the associated volatility within funds and markets have continued to highlight the benefits of Multi-Manager style investment in the hands of competent and independent managers.  More recent changes in fund rules permitting greater mixing of asset classes has improved the scene even more, allowing the professional Multi-Manager to utilise all the important funds, managers, assets, asset classes and financial instruments to generate competitive returns with low volatility.  We must not allow this success to be the undoing of the new breed of third party MultiManagers just as we did with broker bond funds.

 In reality TCF dictates that we all manage our clients’ assets in the most effective and fair manner possible.  So long as MultiManager funds are established with very clear investment mandates and are managed appropriately by fully-qualified and top-class managers they will go from strength to strength.  Long live the MultiManager Fund!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Note: WAY Fund Managers has recently launched a new Multi-Manager fund, the WAY MA Growth Portfolio, managed by T. Bailey Asset Management.  WAY Fund Managers also acts as host ACD to several third party unit trusts under the Elite banner.

Posted on 1st April, 2008 |
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Pernicious tax hits surplus Pension Funds

For many years there was a persistent clamour from the financial community and from aging pensioners for the Government to change the rule that made the purchase of an annuity compulsory for 75 year olds with non-vested pension funds.  This was because pensioners wished to keep their funds intact for their beneficiaries to inherit when they finally departed this mortal coil rather than pay out the accumulated fund in exchange for what was often a surplus and highly-taxed income.  Similar funds for those departing before age 75 had been available for payment to beneficiaries free of Inheritance Tax (IHT) and with increasing life expectancies it was becoming obvious that compulsory annuities at this increasingly young age were a problem.

 Gordon Brown came up with a great solution – the Alternatively Secured Pension or ASP.  This was launched in April 2006 having been mooted as long ago as 2003.  It allegedly came about as a result of the Plymouth Brethren objecting to being forced into ‘gambling’ on life expectation – which is how they view annuities.  Gordon Brown took due notice of their concerns and introduced ASPs aimed at those with principled religious objections to annuities. 

 As he has subsequently pointed out many times, they were never intended as a means for wealthy people to pass on tax-advantaged savings to dependents.  In other words, although residual pension funds left by pensioners dying before age 75 can be passed to beneficiaries, he is determined that those living beyond that arbitrary age should be committed to either taking an annuity or losing their funds to the tax man!  This is why he launched the concept in April 2006 and effectively knocked it on the head again in December 2006 by imposing a tax and penalty charge of up to 82% on residual funds!

 So in effect we are back to taking our pensions by some means or another before age 75 and finding an alternative route to diverting them to our families in the most tax-effective manner possible.  This is particularly the case for all those post-war baby boomers who have acquired non-pension assets well in excess of their likely lifetime needs in addition to healthy and ’surplus’ pension funds.

Is there an alternative means of dealing with a surplus pension fund of £1 million which can both:
           a)      Allow beneficiaries to receive more than the derisory 18% on offer if it goes into ASP?
           b)      Avoid the compulsory income accumulating in the individual’s estate and thus inflating their IHT liabilities?

 The simple answer is yes, and how some!  Although the saver does not need the money the sensible approach is to take the maximum tax free lump sum (of 25%) early on in the process.  On £1 million this will equate to £250,000 which can conveniently be gifted into a flexible IHT mitigation trust to remove it from the tax man’s reach whilst retaining flexible planned access.  So long as the saver/settlor survives seven years this will become IHT free ready to be passed to beneficiaries whenever it appears appropriate (this option is available under a flexible trust during the life of the settlor). 

 Maximum pension/drawdown should then be taken.  This may suffer 40% Income Tax but since (a) it derives from savings which probably enjoyed this level of relief when contributions were made and (b) it has grown in a tax-free environment within the exempt fund, such a tax can be considered neutral.  The ‘pensioner’ will then be in possession of regular slugs of net income.  Of course this is taxed income which is surplus to living requirements and is regular.  Hey presto an obvious candidate for ‘normal expenditure’ gifting.

 Now I am not going to suggest that the recipient gifts this money to his or her beneficiaries completely and immediately free of IHT from that point until death – although I could.  It would seem quite tax efficient.  No I am going to suggest that he or she gifts it, on an immediately exempt basis, into another flexible IHT mitigation trust so  that it too can be available to the pensioner should it ever be necessary.  However, just as with the lump sum arrangement the trustees can also make monies available to beneficiaries during the settlor’s lifetime should this be necessary.

 To put this effect into context consider the retiree who has an untouched pension fund of £1 million and dies one month before his 75th birthday.  His beneficiaries can inherit the whole fund entirely free of IHT.  Contrast this with the same person who lives the extra month and is all set to take his pension under the ASP rules.  He dies within the first month and because he has already gone into ASP his beneficiaries suffer the full 82% tax and penalties and receive only £180,000 (rather than the £1 million they previously would have received).  Can this be right?  The arbitrary nature of the 75 year old deadline is crass to say the least.  This immediately begs the question as to whether the retiree should have taken the tax free lump sum and entered drawdown just before his birthday.  This is a great idea except that a male aged 75 has a life expectation of something like 9 years which is perilously close to the 7 years needed to move the tax free cash outside his estate and escape IHT.  It will also leave 75% of his fund at the mercy of the 82% tax.  Were he to do this and then die his estate would potentially suffer 40% on the tax free cash (40% of say £250,000 leaving £150,000) and 82% on the residual £750,000 fund (leaving 18% of £750,000 which is £135,000).  This would still be worthwhile compared with not taking the tax free cash (beneficiaries would potentially receive £285,000 rather than £180,000) but we can do even better.

 The trick is to take the tax free cash and enter drawdown early enough to reduce the residual fund.  Every monthly pension payment which is taken and transferred into a ‘normal expenditure’ scheme will help address the balance between exempt monies withdrawn and residual fund left behind.  The drawback of this is that the impact of any early IHT charge on the tax free cash and the Income Tax payable on drawings will improve matters greatly for anyone living beyond 75 but will inevitably dilute the returns to beneficiaries if the retiree dies before 75 when the fund would have otherwise been payable free of IHT.

 The following graph shows the impact of taking action early for a retiree aged 66.  The blue line represents the net proceeds available to beneficiaries if the fund is kept until age 75 then goes into drawdown after taking tax free cash.  The red line shows net proceeds if early action is taken.  There is little doubt that the single IHT gift plus normal expenditure route is highly effective beyond 75, especially if the arrangement is started early.  The only difficulty arises if the retiree dies before attaining 75.  This can be simply addressed by the purchase of term assurance in trust to cover the shortfall.  Rates for cover for a 66 year old male per £100,000 of cover are approximately £80 per month for 7 year term (to cover the inter vivos period) and approximately £100 per month for cover to age 75.  This is effective financial planning at its best and makes a good fist of overcoming the pernicious taxes and penalties imposed by Gordon Brown on ASPs in the last Budget. 

 

Assumptions:  Income Tax Rate 40%; Net annual growth rate 6%; 15yr Index Gilt Yield 4.81%;
Drawdown basis 7.5%; Table annuity rate age 75 10.2%; IHT NRB used elsewhere.

 

 

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 6th November, 2007 |
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The NURS effect on Multi-Manager Funds

In October 1991 they changed the rules on fund of fund unit trusts so that one could buy underlying funds at ‘best’ rather than at creation.  This was a massive change which let the multi-manager genie out of the bottle and, as they say, the rest is history. 

 I was fortunate in being a private client fund manager at the time and had already rearranged most clients’ portfolios into one or more ‘models’ which, in those steam-driven days, we controlled by spreadsheet.  The new rules meant that we could establish a number of new fund of funds unit trusts to replicate our models and conveniently share-exchange most of our clients into them.  This made a huge difference both in our ability to manage actively and to put aside any previous worries about creating CGT liabilities for clients as a result of our active management.

 There was a major drawback, however, as far as I was concerned.  Many of our models (remember this was 1991) had previously included direct Gilt holdings which we bought for individual clients within their portfolios.  This was because it was easier to control individual Gift holdings and their yields than if one bought into what were, in any case, rather expensive Gilt unit trusts.  We had no choice once we had moved to fund of funds because each unit trust was either designated as a securities fund – which could buy individual equities and Gilts – or a fund of funds – which could only buy other funds (including Gilt trusts but not Gilts directly).

 A couple of years ago there was a long overdue and massive change to the regulation of collective funds within the UK with the introduction of UCITS 3 and, in the context of asset allocation, the introduction of NURS (non-UCITS retail schemes).  Many funds launched in the last couple of years have been launched as NURS schemes and several other pre-existing funds have been converted into NURS.  The benefits of NURS within multi-management are absolutely legion, especially as fund management becomes more sophisticated and new and slightly esoteric investment opportunities unfold.

 It is now possible to mix all sorts of asset classes and types within the same fund so that both risk and reward can be enhanced by blending the most contemporary of investment vehicles.  A NURS fund can invest up to 20% in a mix of unapproved securities and unregulated collective investment schemes (including hedge funds).  It can have permanent borrowings of up to 10% permitting a minor level of gearing.  It can comprise larger holdings both of individual securities and of collectives.  Importantly it can invest in property and gold.

 These possibilities open all sorts of doors for the professional manager and as a result many fund of fund managers are choosing to switch their multi-manager portfolios to NURS rules.  This allows them so much more freedom to mix and match investment types and include absolute return funds, structured products, bricks and mortar, funds from strange or specialist jurisdictions as well as commodities. 

 NURS rules permit managers to select funds which are managed very precisely by objective or within very esoteric areas, such as oil exploration or particular commodities.  Funds such as these are frequently closed-ended funds (often investment trusts) which allow their own managers to drive longer term strategies without having to worry about their capital base shrinking or expanding through outflows or inflows of shareholder money.

 A major attraction of closed ended funds is their tendency to fluctuate between discounts and premiums (being under or over valued) depending on market movements.  Often a manager of a multi-manager fund can pick up shares in an investment trust very cheaply where both the sector and thereby the trust are under-valued.  When there is a recovery there is likely to be a double rise enjoyed as both the sector and the fund move northwards.

 Because of the flexibility within NURS and the increased choice and complexity of options available to managers and, particularly, to multi-managers, there is a far greater degree of skill and experience which must be brought to bear.  This is why returns from well run multi-manager portfolios, which have always tended to be superior to single manager funds within each relevant sector, are becoming ever more competitive.

 There has always been a strong case for multi-management in achieving economies of scale, tax-efficiency, wider diversification, lower risk and higher returns, compared with running individual portfolios of shares or collectives.  But the recent emergence of highly sophisticated asset blending with judicious use of derivatives and other contemporary vehicles, following the introduction of NURS rules, means that the performance gap between old style collectives and new style funds is likely to increase even further as time goes by.

 This differentiation has brought multi-manager investing to new levels of sophistication.  Nowhere is this more obvious than within the Cautious Sector where managers can now incorporate absolute return funds, guaranteed funds and property funds into the mix to reduce both volatility and the degree of correlation between cautious funds and the equity markets.  It is time for investors to re-evaluate the quality of NURS funds operating within the Cautious Sector.

 One of the great difficulties is the preoccupation within the market place for looking at performance tables.  Many truly cautious funds, such as WAY’s own, have a benchmark equity weighting of some 30% against an IMA benchmark for the cautious managed sector of “up to 60%”.  This means that these more cautious funds will always under-perform the sector during bull market conditions because they have far less of an allocation to the single asset class which is going like an express train. 

 One has to ask whether a portfolio which contains 60% equities can reasonably be described as cautious.  To my mind we are still operating in sectors based on investment considerations from the last century.  In today’s markets there is much greater sophistication.  When one currently talks of caution we are not talking about focusing on high income equities or simply reducing the equity allocation by a few per cent, we are talking about a well-diversified portfolio containing a range of asset classes including property, absolute and guaranteed funds.  These will deliver lower volatility and robust cautious performance but they will not deliver 60% of equity performance!  Whilst the IMA Cautious Sector is full of equity income funds earning star ratings, the genuinely cautious funds will get little credit for the wonderful job many of them do for their cautious unitholders.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 15th October, 2007 |
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