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Insight ~ Page 2 Insight ~ Page 3
Pension transfers under scrutiny
Companies are currently offering high
values to transfer out. This is a function
both of lower government bond yields,
which makes the capital value of the
transfer higher, but also because companies
are trying to get rid of their long-term
liabilities and are therefore offering
higher payouts. As such, some retirees have
been tempted to swap a guaranteed income
for life for a variable income, but with
more flexibility.
This has been a particular issue since the
advent of pension freedoms. Previously,
retirees would have had to buy an annuity
in the longer-term, but now that is no
longer compulsory, many believe they
would rather be in control of their
pension funds. There are also some
inheritance tax advantages to drawdown
schemes over and above annuities.
These are all sound reasons for considering
a change, but the FCA is increasingly
nervous that retirees are giving up
gold-plated schemes without sufficient care and attention.
It has recently drawn up plans for a broad enquiry into the pensions
transfer market to ensure that all advice is suitable and appropriate
for the individual circumstances.
This is likely to include a new requirement that advice on the
conversion, opt-out or transfer of safeguarded pension benefits
should include ‘a personal recommendation’. The regulator says the
merits of transferring or converting safeguarded benefits are
dependent on an individual’s personal circumstances and as such,
an advisor should consider their personal circumstances in depth
and provide a specific recommendation, alongside a consideration
of the value of alternative options.
In most cases, this is already happening.
Certainly, we would not consider
recommending anyone swapped a
valuable income for life for the
uncertainty of a drawdown option unless
we saw compelling reasons to do so.
Nevertheless, there are clients whose
circumstances favour a pensions’ transfer.
The FCA appears to recognise this.
While its stated position is still that
‘keeping safeguarded benefits will be in
the best interests of most consumers’,
it is proposing to remove the existing
guidance that an adviser should start
from the assumption that a transfer will
be unsuitable.
The FCA requires that advisers should
consider a retiree’s income needs and
expectations (and outgoings) and how
these can be achieved, and the role of
safeguarded benefits in providing this
income. It also says that we need to look
at the impact and risk if a transfer
is made. We would do this as a matter of course. Every scheme is
different and needs to be examined on its own merits.
The examination of the pensions transfer market was part of
a wider look at the pensions landscape following the liberalisation
of the market in 2015. Its greatest concerns were around
non-advised pensions and specifically that retirees had been
cashing in their pension pots, but then leaving the money in cash
because they were particularly risk-averse or because they didn’t
know how to invest it. This runs the risk of paying too much tax
and/or missing out on investment growth. There is also a risk that
investments do not keep pace with inflation, leaving retirees on low
incomes later in life.
Passive or ‘tracker’ investments are an alternative to active management.
Rather than an investment manager trying to find those shares that are likely to rise,
a passive investment simply tracks an index, such as the FTSE 100 or S&P 500.
These tend to be a cheap and easy way to get access to the stock market.
But people are generally using pension freedoms sensibly….
The FCA has also recently issued its first report into pension freedoms and the early findings
are that people are generally using the freedoms responsibly.
This counters early fears that retirees would spend their pots on fast cars and exotic holidays.
The report found that ~ after some early pent-up demand ~ most people are using the pension freedoms
to draw money progressively from their pension pots, rather than taking it all at once.
Of the people who took their pension as a lump sum, most (90%+) had alternative sources of income.
Most people are too wise to risk a lifetime’s worth of savings on a few years of fun.
The rise of passive: does it have merits?
In a recent survey of investment trust performance versus ETFs by
Fund Consultants, it found that investment trusts beat ETFs in 18
out of 19 categories. The one exception was ‘US equity large cap
blend’ (i.e. the largest US stocks). This makes sense ~ the US stock
market is the largest in the world, with the most participants,
therefore pricing anomalies are less likely. It is these pricing
anomalies that active managers aim to exploit.
In analysing any data on the performance of active and passive
funds, it is important to recognise that the data will be skewed by
a number of funds that charge fees for active management while
sticking very close to a benchmark.
These so-called ‘closet trackers’ give index-like performance butperform poorly because of the higher fees. This can make theperformance of active funds look worse than it is and flatter therelative performance of passive funds.
We believe there are certain markets, such as Europe or emerging
markets, where active managers can add real value. There are others,
such as the US, where good active managers are more difficult
to find and passive investments may be more appropriate.
We are not dogmatic. That said, where we choose active investment, managers must be genuinely active
and looking for the best ideas.
They are increasingly popular: Net inflows into European passive funds in
2016 were nearly double those into active funds over the same period,
according to data from Morningstar. In the US, passive funds are expected
to have a majority share in the market by 2024.
Passive investment attracts many evangelists, who argue that active
investment managers cannot, in aggregate, beat the index, so investors may
as well go for the low cost option. Passive funds are simple, they suggest,
giving diversified access to stock markets, while investors know exactly
what to expect.
This argument has its merits, but it does not give a complete picture. First,
it is important to note that the recent performance of stock and bond
markets gives a distorted view of the relative strengths of active and passive
funds. When all markets are gaining ground, passive investment will
inevitably look good ~ a rising tide floats all boats.
Defined benefit pension schemes ~ where the income is determined by final salary ~ are increasingly rare.
Finding them unaffordable, companies have generally moved to defined contribution schemes whereemployees pay in over time, and the income is determined by contributions and investment growth.
The index : MSCI Europe ex UK, Net dividends reinvested. Index is using an assumed TER of 0.09%. As at 31 March 2017.
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The index : MSCI Europe ex UK, Net dividends reinvested. Index is using an assumed TER of 0.09%. As at 31 March 2017.
Peer group: Europe ex UK equities (rolling 5yr cumulative performance)
The index : MSCI Europe ex UK, Net dividends reinvested. Index is using an assumed TER of 0.09%. As at 31 March 2017.
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1st Quartile 2nd Quartile 3rd Quartile 4th Quartile Index (TER: 0.09%)
Markets have been rising almost without a break for the last five years.
Active managers tend to come into their own when markets are more
volatile and picking the right stocks and sectors is more important.
Equally, aggregate statistics are not very informative. There are certain
markets, for example, where it is very difficult to beat the index return,
while others have far more opportunities for active managers.
For example, recent comparative data from Schroders on the European
markets shows that passive funds are consistently in the third or fourth
quartile over almost every period.
There are other markets where passive investment makes
more sense. For example, relatively few US active managers
consistently beat the market.
In defence of active management
Source: Schroders/Lipper. The index: MSCI Europe ex UK, Net dividends reinvested. Index is using an assumed TER of 0.09%. As at 31 March 2017.
So why would anyone with agold-plated defined benefitscheme give up the income
it provides?
IMPORTANT NOTICE
The contents of this newsletter are intended to inform, not offer specific advice on your individual circumstances. If you think any of the points we have featured may be to your benefit, pleasecontact us for further advice. We cannot accept responsibility for any financial loss incurred as a result of reading and acting on this newsletter without receiving individual advice and our writtenendorsement. Our comments are based on our understanding of current tax and HMRC legislation which often changes.
Taking your pensions benefits early, including the tax free cash sum, can reduce the pension you will receive in retirement. Taking withdrawals may erode the capital value of the portfolio,especially if investment returns are poor and a high level of income is taken; this could result in a lower income if an annuity is eventually purchased. That high-income withdrawals may also not besustainable. Please note that income drawdown is not suitable for everyone and advice should always be sought before entering into such an arrangement as future pension income is notguaranteed as there is a reliance on investment returns and performance. The value of your investment will rise and fall in value depending on which portfolio you invest in and inflation can reducethe future value of your investment.
Churchill Investments plc is authorised and regulated by The Financial Conduct Authority
Key issues in personal financial planning Summer 2017
Insight
Page 2.... Pension transfersPage 3.... ‘Passive’ investments
Page 4.... Keep it in the family Page 4.... Why cash is not king
In this issue
The UK General Election result was a surprise,
not least for Theresa May, who lost her parliamentary majority.
She managed to form a government by enlisting the support of the Democratic Unionist Party, but
now faces an uphill struggle in trying to navigate Brexit, while keeping the economy on an even keel.
InvestmentsStock markets have absorbed the General Election result withequanimity. In practice, many of the UK’s largest companies drawtheir revenues globally and the recent weakness in sterling is anatural advantage. A weak pound is generally good for thosecompanies that generate profits from overseas because theybenefit from the translation effect. That said, even the moredomestically-focused FTSE 250 recovered its ground in the weeksfollowing the election.
Some sectors saw a hit: in particular, housebuilders and bankssaw falls in the immediate aftermath of the election result. In contrast, some of the power companies benefited, as investorsconcluded that a weakened Conservative party was less likely tointervene in energy markets.
Sterling It has been a sorry time for sterling. It had already been hit by theBrexit vote and the General Election result sent it lower stillagainst the Euro and the US Dollar. That is likely to mean moreexpensive holidays for all except those ‘staycationing’ this year.
With the pound now at €1.12 versus the Euro, travellers aregetting around €200 less for every £1,000 they exchange than theywere prior to the Brexit vote.
Government Bonds Government bonds tend to do better at times of uncertainty. In the period since the General Election, gilt yields have risen(which means prices have fallen). This suggests there is no greatpanic about the UK economy, though this may be more a functionof the global situation and higher interest rate expectations thananything to do with the UK election.
Tax Reliance on the DUP’s support is likely to influence theConservative government’s tax policy. The DUP supports movesto raise the personal allowance to £12,500, but may not supportan increase in the higher rate threshold to £50,000, which was oneof the Conservatives manifesto promises. In practice, tax policymay not change very much as the Government focuses elsewhere.Controversial measures that might struggle to get throughparliament are likely to be given a lower priority. Having saidthat, a drop in the annual allowance for dividends from £5,000 to£2,000 announced in last year’s budget, will go ahead as planned.
PensionsPensions were a key election battle ground, with the Tories sayingthey would abandon the triple lock (a rule that says the statepension will rise each year by the greater of the rate of inflation,the rate of wage growth or by 2.5%). Again, the strictures ofcoalition are likely to play a role. The DUP was in favour ofkeeping the triple lock and the Government is therefore unlikelyto get changes through parliament. The DUP is also in favour ofkeeping the winter fuel allowance for everyone, rather thanmeans testing.
The removal of higher rate tax relief has long been discussed, butit remains in place for the time being. With any significant changeto the tax treatment of pensions unlikely, higher rate relief mayremain in place for the time being.
That said, the government has managed to push through an earlyrise in the state pension age. It will increase to 68 (from 67)between 2037 and 2039, affecting those born between 1970 and1978. Equally, changes to the Money Purchase Annual Allowance(which governs how much people already in drawdown can putback in a pension), originally announced last year, but delayedbecause of the General Election, will go ahead as planned.
Social careSocial care was another divisive issue in the election, with Theresa May’s U-turn on ‘dementia tax’ a key part of her poorperformance on polling day. It will now be difficult for PrimeMinister May to push social care measures through parliament.However, the issue may be too big to ignore and she may need tobuild cross-party consensus. Watch this space...
In general......the election adds to the broader uncertainty
about the UK and its economic fortunes.Investors are learning to live with volatility andit doesn’t look like it will abate any time soon.
What now?
For further informationOur website www.churchillinvestments.co.uk contains our regular newsletter Insightand other publications and articles of interest ~ it also provides access to online valuations.
Contact detailsTo arrange an appointment, or for further advice, please contact us on 01934 844444 or Email: [email protected]
Churchill Investments plc, 9 Woodborough Road, Winscombe, North Somerset BS25 1AB
Tax allowances can’t be transferred between spouses, but it is possible
to transfer assets so that income and gains are distributed more evenly.
This can ensure that savings last longer in retirement and more is passed
onto future generations.
For example, as a family unit, the pension annual allowance doubles
to £80,000. It can be worth topping up a spouse’s pension to gain
maximum tax relief within a family. This can also help deal with
problems such as the tapering of the annual allowance or hitting the
lifetime allowance. Contributions aren’t limited to £3,600 but by the
difference in their partner's current payments and their earnings.
It is also possible for couples to save £40,000 tax free in an ISA.
Making pension contributions also reduces the income used to
determine eligibility for certain allowances and benefits, including the
personal allowance (which reduces when income exceeds £100,000),
or child benefit (which reduces when income exceeds £50,000).
It may also be worth transferring assets between spouses. This means
that both spouses can use their capital gains tax allowance if they sell
the asset at a higher price. If one person pays tax at a lower rate,
that will also reduce the amount of capital gains tax payable. Assets
transferred between spouses do not attract a tax charge. However, this
is not true for transfers to other family members such as children.
This also applies to inheritance tax: A widow(er) can also share any
unused part of a deceased spouse’s IHT nil rate band. If someone dies
and leaves everything to their spouse, for example, the whole of the nil
rate band would still be available.
As long as you trust your spouse, looking at finances as a
family can help minimise a tax liability and ensure that savings
last as long as possible.
The UK system taxes individuals on their own
income and gains, and each person has a set of tax
allowances. For families, where wealth is shared,
equalising income and gains can ensure that
everyone makes the most of their allowances,
and tax bills are kept to a minimum. The days when savers could achieve returns of 5%
or more just from a bank account feel like a long time ago. Today investors are lucky to achieve
any return at all from their cash savings.
Yet many people still keep a lot of their money in cash.
Around 80% of all ISA investment still goes into cash.
This is perhaps understandable. There has been a lot of political
and economic ‘noise’ and this can make people nervous about
stock or bond market investment.
However, cash also comes with a number of risks:
Keep it in the family... and doubleyour allowances
There are also implications for people’s finances. Here are some of the key areas:
Why cash is NOT king
1. Your money won’t grow fast enough to give you the retirement
you want ~ historically, stock market investment has been a
better way to grow capital over the longer-term.
2. You will struggle to generate an income ~ the income available
on cash savings is negligible, while the income available on
stock market dividends or from bonds is higher.
3. Your savings won’t keep pace with inflation ~ inflation is rising
and there is a danger that money held in cash will lose its
purchasing power over time. Calculations from Standard Life
show that a £10,000 investment put in a savings account paying
0.85% will be worth just £9,221 after five years in real terms
(assuming inflation of 2.5%).
4. You won’t make the best use of your tax allowances ~
The personal savings allowance means that you can receive
£1,000 of tax-free cash without paying tax anyway. As such,
there’s no real difference between a cash ISA and an instant
access savings account. Holding cash in an ISA uses up your
annual allowance and limits the amount you can pay into a
stocks & shares ISA.
Insight ~ Page 4