January 2012 Newsletter

In investment terms, 2011 was a challenging year if you were an equity investor. But those of you holding fixed interest investments should be feeling more content.

If anything, last year underlined the importance of having an ‘active’ portfolio and changing your investments to suit economic conditions. But the returns from just one single year should not be over emphasised as medium and long-term returns are the most important thing.

And as one of the articles below shows, if you do not need to take income from your investments the best results could be achieved by reinvesting dividends and interest.

But if you would like to discuss your portfolio and financial plans, or review how they performed over the past year, just let us know.

In this edition:

1. A year for gilt investors
2. The importance of dividends
3. The IMA swaps ABC for ABI
4. Steps taken to encourage people to use their open market option
5. Income tax rates and allowances 2012/13
6. A date for your diary

BUSINESS SECTION :

7. Enterprise zones
8. DWP is consulting on auto-enrolment
9. NEST part seven – payment of contributions

A year for gilt investors

Last year was a trying one for UK equity investors: the FTSE 100 ended 2011 in negative territory after two years of rises.
But it could have been much worse – in early October the Footsie was over 600 points lower than its eventual closing level of 5,572.3.
The Footsie is used a benchmark because it represents 81% of UK market capitalisation (value of shares in issue), but it is only part of the story and how it compared with other indices last year is shown below.

Note: ‘caps’ indicates the size of companies’ capitalisation

Over the year the dividend yield on the FTSE All-Share rose from 2.89% to 3.52%, partly due to the fall in values.

Total dividend income from the UK equity market was up 13% from 2010. This is a reminder that for all the doom and gloom, companies are still generating and paying out large amounts of cash.

And if you add in the dividend income over the year, the total return on the FTSE All-Share, for example, was only about 3% below par.

The negative performance of the UK equity market paralleled results in most other stock markets. The Euro Stoxx 50 Index fell by 17.1% amidst the euro troubles and the Nikkei 225 dropped by 17.3%.

The best performer among major stock markets was the USA, where the S&P 500 moved from 1,257.64 at the start of the year to 1,257.60 at the end, albeit with more than a few exciting swings en route.

The place to be in 2011 was not equities, but government bonds. The FTSE 10-15 year gilt index climbed by 15.1% in 2011 while the FTSE Over 15 years Index-linked index rose by 24.6%.

But mentioned earlier, these are just one year’s performance figures in isolation. You should ensure that you have a spread of investments in a portfolio and if required, it can be actively managed.

The importance of dividends

In a recent article in the Financial Times Money section (David Stevenson: Dangerous Investor), it was stated that “Dividends are generally more reliable than earnings for more equity investors.

By and large, companies that pay a dividend are keen to maintain their payments and, if possible, increase them...

Dividends from FTSE, 100 companies will keep pace with inflation at the very least...”

If you are an equity investor, buying a fund that invests in equity income stock be more rewarding than an equity growth fund – as is indicated by the index returns above for last year.

And if you are a higher rate (40%) or additional rate (50%) taxpayer, you could find that the most rewarding way to invest in an equity income fund is an investment bond.

An onshore investment bond would give you a tax shelter on the dividend income, regardless of your income tax rate, because the dividends are the provider’s tax responsibility, not yours.

Tax freedom on dividends at fund level will also be secured if you invest in an offshore investment bond, at the time they are received.

However, in both cases, depending on your tax position and the overall returns from the investment bond, there may be a tax liability when the bond is cashed in.

If you would like more information on how the bond would be taxed in your particular circumstances, please let us know.

The IMA swaps ABC for ABI

Back in May, the Investment Management Association (IMA) put forward its proposals for revising its managed fund classifications.

These are used to guide investors as to what type of investments are held by a fund – such as UK equity income, Japanese smaller companies and so on. A managed fund indicates that the provider of the fund manages a selection of different types of investments, as he sees appropriate.

The IMA's proposals were for three existing managed sectors to be renamed A, B and C and a new D sector to be added. Bizarrely, the IMA justified its approach by saying that the names were “…deliberately intended to provide no other information about the sector”.

This proposal met with considerable criticism and many people said they should instead use the names already used by the Association of British Insurers (ABI).

The IMA decided to be pragmatic and has now announced that they and the ABI, after discussion, will be harmonising their managed fund sector names from 1 January 2012.

The outcome is shown in the table below:

Steps taken to encourage people to use their open market option

If you are approaching retirement, and are not a member of a final salary pension scheme, you must be despairing at the current low annuity rates.

But it is still surprising how many people are not taking advantage of their open market options, which allow them to buy the best annuity rate available.

Especially when many companies are offering much better rates if you have a medical condition or are a smoker. Approximately half the annuities bought on the open market via independent financial advisers nowadays are of this type, that is ‘non-standard’.

Now the Association of British Insurers (ABI) is to introduce a new compulsory code of conduct for its members in the first quarter of 2012, in order to increase shopping around for the best annuity rate.

This new code of conduct will apply where ABI members are writing to members of money purchase schemes that are approaching their retirement date.

Under the code, customers receive all the information they need to shop around in one easily accessible place.

The ABI has proposed the following: 

• All communications, whether written, on-line or over the telephone, must take consumers through a clear customer journey covering the three key steps of understanding retirement, understanding the different ways of taking retirement income, and understanding how to buy.
• Illustrations provided by the provider which have not been requested by the customer must include a clear statement about the higher income available from non-standard annuities based on lifestyle or medical conditions.
• Providers must take customers through the key questions they should consider in order to buy the appropriate product.

This new initiative is to be welcomed. Buying the best annuity is crucial as the income provided will be payable for the rest of your life – and commonly, that of your partner after you.

Income tax rates and allowances 2012/13

The Autumn Statement issued by the government at end of last year included details of the rates and allowances applying from 6th April.

Bands of taxable income

1 There is a 10 % starting rate for savings income only. The starting rate limit for savings is £2,560 for 2011-12 and will increase to £2,710 for 2012-13. If an individual's taxable non-savings income exceeds the starting rate limit, then the 10 % starting rate for savings will not be available for savings income.

2 The rates available for dividends for the 2011-12 tax year are the 10 % dividend ordinary rate, 32.5 % dividend upper rate and the 42.5 % dividend additional rate. These rates will stay the same for the 2012-13 tax year.

You will see that the higher rate threshold has been reduced again for next year, by an amount equal to the increase in the personal allowance (£630 - see below). But unlike 2011/12, the threshold was not been reduced even further to ensure that the overall tax bill for a higher rate taxpayer is not reduced.

Income tax personal allowance (£ a year)

Everyone benefits from the increase in the personal allowance, with higher rate taxpayers having another £126 to spend; although this may be more than offset by changes in the tax credits system!

The aim of the government was to ensure that higher rate tax threshold kicked in at £42,475 from 6th April, for everyone under age 65, the same as the current fiscal year.

The allowance traps

As you can see above, in two instances there is a loss of personal allowance if income exceeds certain limits.

This can be crucial for the elderly in 2012/13 as they could lose allowances of £2,395 (age 65-74) or £2,555 (age 75 plus) if they have sufficient income. This is additional tax of £479 and £511 per year respectively.

This is effectively a tax rate of 30% within the ‘age allowance trap’ band.

To avoid this, there is a well accepted tax planning strategy in reducing conventional taxable income by replacing income-producing investments with non-taxable income.

The same situation occurs for people with taxable income in excess of £100,000 – at any age – when they lose their standard personal allowance.

In 2012/13 they could lose their whole allowance of £8,105 if they have income of more than £116,210. This is additional tax of £1,621 and represents an effectively tax rate of 60%!

If either of these situations could affect you, please let us know and we can provide you with suggestions for how you can reduce your immediate tax liability.

A date for your diary

During a meeting of the Treasury Select Committee, George Osborne announced that this years Budget will be on Wednesday 21st March.

Three month’s notice is now given of major changes to legislation, which means that his speech may contain surprises for the next tax year (2013/14) rather than the forthcoming year (2012/13).

BUSINESS SECTION

Enterprise zones

Legislation is being introduced to provide 100% first-year allowances (FYAs) for companies investing in plant or machinery for use primarily in designated assisted areas within enterprise zones.

To qualify for this new relief, the expenditure must be incurred in the period from when an area is treated as being a designated assisted area and 31 March 2017.

'A company' means that unincorporated businesses and partnerships of companies, even if the partnership may be a body corporate, are not eligible for these new FYAs

There are four further conditions to be met:

1. The new relief is restricted to UK resident companies, which are liable to corporation tax, and that carry on a trade or a mining, transport or similar undertaking;
2. The EU's General Block Exemption Regulation (GBER) requirement for the expenditure to comprise investment aid, rather than operating aid, must be met. This effectively means that the expenditure must be incurred on setting up a new business, expanding an existing business or on a fundamental change to a product or production process of, or service provided by, a business carried on by a company;
3. The relief is for new and unused plant and machinery; and

DWP is consulting on auto-enrolment

With auto-enrolment in pension schemes due to start in less than ten months' time, you might have thought that by now all the earnings thresholds for contributions would be in place. Alas for payroll system programmers everywhere, that is not the case.

The maximum gross contribution that can be paid by, or in respect of, an individual to the new National Employment Savings Trust (NEST) in 2012/13 will be £4,400.

A review of auto-enrolment commissioned by the incoming coalition government and published in October 2010 recommended that auto-enrolment should not occur until an employee’s earnings matched the standard income tax personal allowance.

The DWP has now published a consultation paper on the earnings thresholds in which it has considered using PAYE thresholds instead.

In its paper the DWP examines three policy principles:

1. Will the right people be brought in to pension saving?
2. What is the appropriate minimum level of saving for people who are automatically enrolled?
3. Are the costs and benefits to individuals and employers appropriately balanced?

The DWP then decided to ask for views on introducing the following limits:

• £8,105 for the automatic enrolment earnings trigger (aligning it with the PAYE personal allowance threshold);
• £5,564 for the lower limit of the qualifying earnings band, aligning it with the NICs Lower Earnings Limit; and 
• £39,853 for the upper limit of the qualifying earnings band, which is the Pensions Act 2008 figure of £33,540 revalued in line with earnings.

These numbers have been a long time coming. Hopefully, now they are here they will meet with little opposition.

NEST part seven – payment of contributions

Contributions paid by the employer or deducted by the employer from a member’s pay should normally be paid over by the employer to the scheme provider by the 19th of the month following their due date (or date of deduction from member’s pay).

The regulations provide for an alternative definition of due date for contributions to an occupational defined contribution or workplace personal pension scheme.

This is the 19th day of the month following the month in which contributions were due under a payment schedule or direct payment arrangements.

Where, for whatever reason, no contributions have been deducted from the worker, the due date would be the 19th of the month following the month that any contributions became due according to the payment schedule.

Exceptions will apply for occupational defined benefit (final salary) schemes and hybrid schemes from the above rules.

An amendment to the due date will be made in relation to contributions deducted between the automatic enrolment date, the automatic re-enrolment date or the enrolment date and the end of the opt-out period.

For these, the due date will be the last day of the second month following the month in which automatic enrolment occurs.

Failure to pay over the contributions by the above date will result in the Pensions Regulator issuing an unpaid contributions notice.

Where such contributions remain outstanding for three months or more the Pensions Regulator can order that the employer pays the missing member contributions as well as those due from the employer.

Where contributions are not paid over by the due date the Regulator will have discretion to charge interest on the outstanding amounts due from the employer.

This will be calculated as 4.2% (an estimate of long-term equity return) on top of the increase in the Retail Price Index (RPI), with no floor to the RPI.

Any such interest paid by the employer will be added to the members’ benefits to help compensate for the loss of investment growth resulting from the late payment of the contributions.

Where an employer is not prepared to co-operate with the regulator in determining the outstanding contributions the Regulator will use the following formula to estimate the missing contributions:

Unpaid contributions owed = maximum monthly qualifying earnings x 8 per cent x number of jobholders affected (or PAYE scheme size where the number of jobholders affected is unavailable) x number of months late.

The information regarding taxation is based on our understanding of current legislation, which may be altered and depends on the individual financial circumstances of the investor.

© 2012 Highwood Financial Services , Victoria House, 45 - 47 Vicarage Road, Watford WD18 0DE
t: 01923 479 850 e: enquiries@highwood.co.uk

Authorised and Regulated by the Financial Services Authority. Registration Number 135717