Death & Taxes - Money For Nothing
In this new regular column for Master Investor, Alan Steel of Alan Steel Asset Management will be holding out a helping hand to readers trying to navigate the minefield of financial planning. This often misunderstood or overlooked area can have a big impact on your wealth, regardless of your investment performance.
If you read the Sunday Times Money section you will be well aware of their "Fame and Fortune" feature. Every week a "celebrity" is grilled about their financial beliefs and habits. Whilst entertaining, it does lead you to wonder how they built a "fortune" in the first place.
Though the names change every week, the questions and answers remain the same. Do they invest in stocks and shares? Nope – they're far too complicated and dangerous. They just don't understand them, apparently. So what do they do? Deposits and National Savings appeal to them, and judging by recent reports from the sports community, so did exciting tax breaks like Film Partnerships, which have unfortunately helped to bankrupt more than a few of them. Ouch.
Next up it's the financial journalist's favourite tie breaker. Do they prefer pensions or property as an investment? Guess the answer? Yes, a cool 95% of the geniuses who don't understand stock markets, because they're too 'dangerous' and 'complicated', plump for property.
Do they take advice from experts? Nope. They don't see the point. Hmm… I suppose if they ever need surgery they'll have a go at it themselves then. A minority who admit to seeking advice say they have an accountant for that sort of thing or they read money sections. Well, that's just perfect. I haven't noticed many millionaire accountants or journalists about lately, but that's another story…
Over the years since I became an IFA, in January 1973, it's always astonished me how many (otherwise intelligent) investors or business folk I've met who are baffled by, or allergic to, pensions. Take accountants. They're trained to wallow in small print. Yet I've not met one over all these years who really understood pensions. And as the years go by it's going to get so much worse.
Go check how many changes that UK governments have chucked at pensions small print over the last twenty-five years. Fifty between 1992 and 1999. And over 300, would you believe, over the following six years. Then in April 2006 Chancellor Gordon Brown, the man convinced he could end Boom and Bust cycles and the architect behind the attack on Final Salary Pension Scheme effectiveness, brought in "Pensions Simplification". Since then, no fewer than 200 more changes have been thrust upon us (his warped sense of humour I suppose). We now have no fewer than eight "Lifetime Allowance" tax/pension regimes. HMRC's mantra appears to be "the more complicated we make it, the more tax we'll collect".
If all that wasn't confusing enough to digest, George Osborne introduced Pensions Freedom two years ago. Supposedly created to give us greater control over our own money, it seems it has ended up giving the taxman greater access to it as well. Anybody notice that HMRC recently announced that more tax has been collected from pension withdrawals than they'd expected?
True to form, this vast increase in confusing small print coupled with sudden freedoms (an odd combination if you think about it) has created a taxation and security nightmare for the unwary. No wonder our "celebrities" stick to deposits and property!
But is there another way to look at pensions? How about "Money for Nothing – Cheques for Free" (assuming you remember Dire Straits – and cheques for that matter!)?
That's the way to do it It's true the original intention (allegedly) in April 2006 was to introduce a cap on how much of a pension fund you could build up that qualified for the special low tax treatments available to pension pots (25% tax free cash, freedom from Capital Gains Tax and Inheritance Tax etc.). This cap was retrospectively placed at £1.5 million and would increase over the following five years to £1.8 million. Gordon Brown then promised the cap would increase by inflation. To secure the deal you had to apply for a Lifetime Allowance Certificate. Far too many folks without knowledgeable advisers didn't bother.
Since then more promises have been broken. The inflation increases didn't happen. The cap itself has been reduced rather than increased, first down to £1.5 million, then £1.25 million, and soon £1 million. Those well advised serious savers with a cap secured at £1.8 million can still encash £450,000 tax free through the 25% tax free lump sum withdrawal. Those who could have applied, but didn't because they didn't take advice, will be lumbered with a lower Lifetime Allowance of £1 million unless they pull their finger out. A quarter of that is £250,000. Those readers any good at arithmetic will spot the difference of a cool £200,000 of "money for nothing".
All is not lost however. If you haven't secured your Fixed Protection of £1.25 million to guarantee yourself an extra £62,500 tax free, it's not too late. Now that that's cleared up, to underline how complicated it can be to pocket extra money for nothing, it's possible you could qualify for "Individual Protection 2014" of £1.5 million cap. But this option will disappear on 5th April. It's certainly worth looking into – extra "money for nothing" of £125,000 is nothing to be sniffed at.
All the best things in life are free
If you're still with me – and believe me, it's well worth it – try looking at "pensions" from a different perspective. For starters, why ignore something which, when you put money into it, gets topped up to the tune of almost 82% in year one if you pay tax at 45%? If you're a 40% taxpayer, why ignore
the chance of getting a free 67% added in year one?
Then the whole shebang is invested in your own plan where you can invest in your favourite shares or funds, all rolling up free of Capital Gains Tax. It's free of Inheritance Tax at 40%, too. And should you pop your clogs before age 75 (yes, this column is called Death & Taxes), not only is it free of IHT and CGT, but with an up-to-date simple nomination form added your family can enjoy unlimited tax free income. If you're fortunate enough to survive beyond 75, you'll still avoid CGT and IHT. A pension fund is far more tax effective than property and much easier to offload.
The price to pay
If you have already secured some Lifetime Allowance do be aware that if you make any pension contribution at all there's a stiff price to pay. Think of it like Snakes and Ladders (oldies like me will remember the board game). You throw a dice and move up ladders heading for the top. One wrong move and down you go. All that progress gone in an instant. Lifetime allowance secured at £1.8 million? Make one stakeholder payment or join auto enrolment, for example, and you pay the price. Instead of £450,000 tax free cash, it's £250,000. Instead of £1.8 million free of IHT, it's £1 million. And so on.
And for those higher rate taxpayers who don't like the sound of missing out on tax breaks, and who are way short of £1 million pension kitties, if you don't act soon another opportunity will have passed you by. Right now you can take advantage of tax relief on the higher contributions allowed in the 2013/14 tax year. That chance disappears on the 5th of April. Don't be an April fool.
If like Dobie Gray "day after day you're more confused", don't dismiss pensions as over complex and too expensive. With the right advice neither assumption is true. A pension pot is just a first class "money for nothing" investment with funny rules. Time is of the essence. Go talk to somebody who really does know how to avoid the snakes.
You can find this article in February's Master Investor Magazine.