Archive: May 2017

  1. Gift Aid Payments and the Abolition of Dividend Tax

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    The abolition of tax credits on dividends from 6 April 2016 has had some potentially serious consequences for donors whose income is largely made up of dividends as well as for charities receiving gift aid.

    This has been referred to as the “gift aid tax trap” and it affects, from 6 April 2016, individuals who make gift aid donations and whose income predominantly comprises of dividend income. Whilst on the one hand this could be interpreted as unintentionally penalising the donors, on the other hand the change appears to be a logical consequence of what, in fact, has been a fiction of the tax credit since the abolition of the advance corporation tax.

    The problem has arisen because of the way that relief on gift aid payments is given.  Basic rate relief on such payments is given at source while the relief at the higher rate or additional rate is based on the grossed up amount of the gifts (grossed up at 20%).  Higher rate and additional rate relief is then given by increasing the basic rate band and the higher rate band of the donor by the grossed up amount of the gift.  The relief is not given against any particular type of income although, obviously, if the result is that the individual is no longer a higher rate taxpayer (by virtue of their basic rate band having been increased by their gift aid donation), then effectively they will pay tax at the basic rate.  Where their income originates predominantly from dividends, the basic dividend rate is only 7.5%.  This assumes the dividend income exceeds the £5,000 annual dividend allowance where it is received tax free.  It should be noted that the dividend allowance is due to reduce to £2,000 from 6 April 2018. 

    It can be seen from the above that there is a mismatch between the tax relief on gift aid being given at 20%  and potentially no tax or tax at only 7.5%  having been paid by the individual donor on their dividend income.  Clearly there will be a problem if most of the individual’s income originates from dividends so that the individual in question has not actually paid enough income tax to cover the 20% tax credit.

    Until 5 April 2016 the tax credits that were attached to dividends could be used to discharge an individual donor’s requirement to account for basic rate tax deducted from gift aid payments, even though the dividend tax credit was only 10%.  Since from 6 April 2016 dividends no longer carry a tax credit, the donors must have paid enough tax to cover the 20% credit that a charity claims under the gift aid.  If the donor has not paid enough tax but signs the gift aid declaration and does not withdraw it, HMRC will ask them to pay the additional tax.

    So, for example, if a taxpayer receives £500,000 in dividends and makes gift aid donations of £320,000 net (grossed up donation of £400,000), the actual tax withheld on the gift aid donation would be £80,000 (ie. 20% of £400,000).

    This means that for 2016/17 the taxpayer must have paid at least £80,000 in tax which clearly would be substantially more than their actual tax liability on their total income of £100,000 (as reduced by the gift aid donation).  

    It would have been possible to carry back any gift aid payments to the previous tax year as long as it was done by 31st January 2017.  If the individual doesn’t want to pay the extra tax, they would need to withdraw any gift aid declaration, which of course would mean that the charity receives so much less. 

    The gift aid declaration forms published in October 2015 by HMRC include a very clear statement and an explanation confirming that the donor needs to pay the same amount or more of tax (UK income tax and/or capital gains tax) as charities will claim on the donor’s gifts in any specific tax year.  It also explains that the donor is responsible for any difference.  Clearly while gift aid is an excellent way of reducing a taxpayer’s tax liability and possibly the tax rate on their other income, this potential “trap” needs to be borne in mind.

     

  2. Pensions: Forget the 4 percent rule on drawdown

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    When it comes to drawing down from your pension, how much is enough?

    It used to be the “4 percent rule”.   An annual drawdown of 4 percent of your pension would see you through 30 years of retirement without you running out of money.

    But the popular rule has been brought into question in recent years by several studies. No longer can you withdraw 4 percent of your pension, index this by inflation and be assured your capital will not be exhausted if you accept a 60/40 equity/fixed interest mix. In fact, closer to 3 percent now looks to be the right ballpark.

    With the state pushing back retirement ages, and our lifestyles leading more of us to live longer, it’s harder to know where the balance lies between enjoying retirement to its fullest and facing the terrible prospect of funds running out. Working out a safe drawdown is no longer simple.

    The solution? Planning. It pays to look at your retirement like a long-term business plan.

    Produce a comprehensive financial plan, outlining your inflows of capital and earnings. Detail as best you can your expenditure, and project this forward with assumed rates of return on capital assets (such as your pension). It’s worth doing this to 100 years old.

    How income drawdown works: 

    • You can choose to take up to 25% (a quarter) of your pension pot as a tax-free lump sum.
    • You then move the rest into one or more funds that allow you to take an income at times to suit you. – Most people use it to take a regular income.
    • The income you receive might be adjusted periodically depending on the performance of your investments.
    • There are two main types of income drawdown product: 

    Flexi-access drawdown – introduced from April 2015, where there is no limit on how much income you can choose to take from your drawdown funds.

    Capped drawdown – only available before 6 April 2015 and has limits on the income you can take out; if you’re already in capped drawdown there are new rules about tax relief on future pension savings if you exceed your income cap.

    Source: Money Advice Service

    The key is to conduct regular reviews before and after retirement.

    In the first 10 years, it’s likely you will want to travel more often and further afield; therefore, your expenditure for travel and leisure is likely to be higher.

    The second chapter begins around 75 and involves less travel. When we approach the third chapter, from 85 onwards, we often consider expenditure such as motoring or taxis and medical expenses.

    Pensions remain the most tax-efficient means when planning for retirement. Just make sure you have accrued enough to enjoy the time off.

    For more information on Drawdown or any other Financial Planning matter please call 01793 771093

  3. Investors shouldn’t worry – the FTSE will continue to rise whoever is in Government

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    Theresa May shocked many pundits when she announced a snap election, giving the public 50 days to decide who should lead the UK through the Brexit negotiations and onwards for the next five years.

    It’s easy to assume that the policies of the winning party will, to follow the well-worn phrase, ‘impact the market’ in different ways depending on who triumphs in June; thereby influencing the performance of our pensions, ISAs and other investments.

    So how should investors react? Specifically, what influence does the resident of Number 10 have on how we should invest? Does the election mean a rethink of retirement planning and investment strategy?

    Surely, the policies of a Conservative government affect the economy and the returns we achieve on our investment portfolio differently than if the Labour or Lib Dem party were in power?

    The data says otherwise.

    The chart below shows the total return of the FTSE All-Share index from 1955 to the present day, and the relative government in office during that time.

    It’s no surprise that the overall trend is upwards, whatever the political climate. Through Conservative, Labour and Coalition periods in office, the FTSE All-Share has shown sustained growth.

    Looking in more detail, the index approximately doubled during Labour’s 13-year government, which of course included a huge financial crash; and the market is on course to roughly double again in the following eight or so years of Conservative-led governments. No clear trends to follow so far.

    What if we look at the average FTSE All-Share monthly returns for each of the parties?

    Can we draw any conclusions from this? None that I would rely on for my investment strategy.   While the Conservatives have a history of higher monthly returns, their sample size is much larger, which must be taken into consideration.

    When Warren Buffet was asked his favourite holding period for shares, the legendary investor replied: “Forever.” If someone of his stature isn’t bothered about who’s in the White House, perhaps we shouldn’t worry about the occupant of Number 10 either from a financial planning perspective.

    Timing is Everything

    While elections themselves and the relative hue of the governments that followed have had little distinguishable impact on stock market performance, an interesting piece of research by Fidelity indicates something much more pertinent to focus on.

    The study focused on the impact of market timing on returns over a 15-year time frame. It highlighted the effect of an investor missing the best 10, 20, 30 or 40 days in the market and compared this with annualised returns if they had been fully invested all along.

    The message is clear: if you try and ‘time the market’ (consistently switch the shares in which you’re invested in anticipation of rising prices) and get it wrong by just 10 days, you could be looking at a reduction in your returns of over 60 per cent.

    Miss the best 20 days and you’ve gone from making money to losing money.

    It’s also important to remember that timing the market increases the costs and taxes associated with your portfolio, and subsequently has a drag effect on your returns. Looking at both sets of data, it appears that who’s in your financial planner’s chair will affect your investment outcomes rather than who’s in Number 10… something that’s worth remembering over the coming weeks of headlines and opinions.

    If you have any questions regarding the above or any other Financial matters please call us on -01793 771093

    Click here to read more of Warren’s Articles from the Independent 

  4. Personal Allowance – Do I lose it if I earn over £100k?

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    The Personal Allowance is the amount of income an individual can earn before they start to pay Income Tax but it will be reduced and potentially lost altogether for those whose total income exceeds £100,000. The Personal Allowance (under age 65) is currently £11,000 but you will lose £1 of Personal Allowance for every £2 of Income over £100,000. Anyone with income over the £122,000 (£11,000 x 2) will lose their entire allowance.

    As a consequence the Marginal Rate of Tax for someone with income between £100,000 and £122,000 will be 60% (Tax at 40% on income over £100,000 up to £122,000 PLUS Tax at 40% on the loss of Personal Allowance up to £11,000). You can recover the Personal Allowance by reducing your income below the £100,000 limit. Apart from asking your employer to pay you less (not a sensible or popular decision, it may save Tax at 60% but you still lose out on the remaining 40%) the only viable option to consider is a Pension Contribution. Your Total Income is expected to be £112,000 i.e. you have £12,000 of income over the £100,000 and in effect you are losing £6,000 of your Personal Allowance.

    If however you invested a gross amount of £12,000 into a pension it would reduce your income to £100,000, thus restoring your Personal Allowance. The pension investment will qualify for Basic Rate Relief at source and so to invest a gross amount of £12,000 a pension would only cost you £9,600. You would then be eligible for a further 20% Tax Relief (representing the Higher Rate Tax Relief). This is claimed via your Self-Assessment Tax Return and you would end up with a Tax Rebate of £2,400. Overall it has cost you £7,200 to invest £12,000 into the pension. But in addition you will regain the lost £6,000 of Personal Allowance which gives you a further Tax Saving of £2,400 (£6,000 x 40%). It could therefore be argued that the cost of the £12,000 gross pension contribution is £4,800 (£7,200 – £2,400). 

    Please contact us if you would like further information regarding the above.