AUTUMN 2013 PROFESSIONAL NEWSLETTER

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1 AUTUMN 2013 PROFESSIONAL NEWSLETTER ACT TO GET TAX RELIEF WHILE YOU CAN The recent Government tinkering with the personal tax allowance system means there will be more higher rate (40%) taxpayers in tax year 2013/14. These represent a growing army of people who have total income of more than 41,450 (the higher rate tax threshold). Those, who have taxable income of more than 150,000, will pay income tax at 45% in 2013/14 rather than the previous 50%. Whilst the reduction is good news, 45% is still a high rate of tax to suffer. Such people may be particularly interested in ways to invest tax efficiently. Pensions remain as one of the few investments where contributions are relieved at an individual s highest rate(s) of tax. In this respect, it is undoubtedly advisable to take early action for three reasons: the earlier pension contributions can be made the more that can be accumulated tax effectively the longer the investment is held within a pension plan the greater the scope for the tax-efficient (capital gains tax and income tax free) growth the Government is gradually restricting the amounts that can be invested in pension schemes from 6 April 2014 the annual allowance reduces to 40,000 and the lifetime allowance reduces to 1.25 million. Future reductions cannot be ruled out. The annual allowance sets the limit on the maximum pension savings that can be made by, or in respect of, an individual each tax year. This is currently set at 50,000. Where that limit is exceeded the excess will be subject to an annual allowance tax charge at the individual s highest rate(s) of tax. However, when assessing the overall limit, account can also be taken of any unused annual allowances from any of the three immediately preceding tax years. This means that even if pension contributions of more than the annual allowance have been paid by, or on behalf of, an individual to registered pension schemes in a tax year, the individual will not suffer an annual allowance tax charge provided the aggregate contributions do not exceed the allowance in that tax year plus any carried forward allowances from the three immediately preceding tax years.

2 This means that if Jack, for example, has paid 30,000 to his personal pension plan for the last four tax years, he can (subject to having sufficient income) make a payment of up to 110,000 in 2013/14-50,000 for 2013/14 and 60,000 carried forward from the three immediately preceding tax years. By acting in this way, Jack will avoid an annual allowance tax charge but he will need to have relevant UK earnings (ie very broadly earned income from employment or a trade or profession) of at least 110,000 if he is to obtain tax relief on his total contribution. In practice, if Jack s total relevant UK earnings in 2013/14 are only just over 110,000, he may choose to pay only part of the overall contribution in 2013/14, with the balance in 2014/15 to maximise the available tax relief. This system of carry forward means that not all is lost if a person cannot fully use their annual allowance in a particular tax year. However, there are three good reasons why people should not delay over taking action now to maximise their pension contributions:- by waiting until the next tax year, any unused annual allowance from tax year 2010/11 will drop out of account as explained above, the earlier a contribution is made to a personal pension the greater the scope for enhancing investment returns one can never predict what future changes may be made by the Government to the pension tax reliefs and allowances. In the past any such changes have not been retrospective. It therefore makes sense to pay those contributions while you can. For those who already have a substantial pension pot, one eye needs to be kept on the lifetime allowance the cap on the maximum pension benefits that can be held in a registered pension scheme. This reduces to 1.25 million from 6 April 2014 although there are ways to protect previous entitlements. Finally, for those who are making large contributions to their pension scheme, they may wish to secure greater control over the underlying investments. This control is available by the use of a self-invested pension plan (SIPP) or small self-administered pension scheme (SSAS). Action Call us for more information on the scope for increasing pension contributions for your clients and the SIPP/SSAS options that are available.

3 ISA HAS BECOME NICER Most know about the tax benefits of an ISA, those being: tax freedom on capital gains; and generally tax-free investment income This tax efficiency means that, all other things being equal, there is more scope for investment returns given that investment growth can accrue unreduced by taxation. Indeed, for the higher rate (40%) taxpayer and additional rate (45%) taxpayer, an ISA is almost essential as part of the investor s investment strategy. The price you pay for the tax freedom of an ISA is the restriction on the amount of contributions that can be paid. So, for example, in 2013/14 the maximum total contribution is 11,520 of which up to 5,760 can be paid into a cash ISA with the balance available for a stocks and shares ISA. This ISA allowance cannot be carried forward you either use it or lose it. Whilst a cash ISA is clearly attractive for a saver who needs a level of security, it is not particularly exciting given the current low rates of interest available in the market. For example, the annual tax saving for a higher rate taxpayer on a cash ISA paying 3% on a 5,760 investment is only On the other hand, over the last 12 months most investors in stocks and shares ISAs are likely to have seen spectacular tax-free investment growth. For those more sophisticated investors who want more investment control over their stocks and shares ISA, possibly in collaboration with their stockbroker/investment manager, they could choose an individual share ISA (or own-name ISA). This means the ISA wrapper can apply to a single shareholding or a collection of individual shareholdings. Whilst the income tax and capital gains tax benefits of an ISA are clearly apparent, one tax downside has always been that an ISA holding is potentially subject to inheritance tax on an investor s death. In effect, on a person s death, the tax-free ISA wrapper disappears. This, combined with the fact that an ISA cannot be transferred to another and so cannot be the subject of a lifetime gift has made the ISA difficult to use in planning for an older person who has a potential inheritance tax liability. That has now changed at least to a limited degree. The list of investments that may be held within an ISA was extended from 5 August 2013 to include stocks and shares traded on the Alternative Investment Market (AIM). If such shares are held by an investor for 2 years then they will normally qualify for 100% business property relief which means they are effectively free of inheritance tax. Therefore, on the basis that the investor will be the beneficial owner of such shares, even if held within an ISA, after two years ownership the ISA holding will be free of inheritance tax. And, of course, in the meantime there will have been income tax and CGT freedom. However, it must also not be forgotten that shares on the AIM will be, by their very nature, more risky and over the last 12 months the market has substantially underperformed the FTSE 100 Index. And don t forget that not all companies on the AIM qualify for business property relief treatment. The trick

4 will be to invest in AIM shares that offer good prospects of investment growth but, if possible, restrict the scope for investment loss - and that may not be easy! In the meantime, higher and additional rate taxpayers should, if they have not done so already, act to maximise the use of their ISA allowance in 2013/14. Action If you are interested in these new ISA options for your clients, please call us. MAKE THE MOST OF EPTs - WHILE YOU CAN Domicile is a very important concept for inheritance tax (IHT) purposes and the rules were changed in the Finance Act As well as increasing the spouse exemption to 325,000 when assets pass between a UK domiciled spouse and a non-uk domiciled spouse, there is now scope, in certain circumstances, for a non-domiciled person to elect to be treated as UK domiciled for IHT purposes. In the right circumstances (ie. transfers between spouses), such an election can save a considerable amount of IHT. However, it will not be appropriate for everyone and some will wish to retain their non- UK domiciled status. For those people who are domiciled in the UK then they will potentially be subject to UK IHT on their worldwide assets. For those who are non-uk domiciled, they will only suffer IHT on their UK situs assets. Therefore, for those people who are non-uk domiciled and wish to make an investment that is IHT efficient, the solution is simple invest outside the UK. However, this may not be totally plain sailing. The IHT rules use the concept of deemed domicile. This means that, irrespective of legal domicile, a person will become deemed domiciled for IHT purposes once they have been tax resident in the UK for 17 out of the last 20 tax years. Satisfaction of this test will mean that all of an individual s worldwide assets will suddenly become subject to IHT. And bearing in mind the 2008 changes in the remittance basis for income tax and capital gains tax linked, broadly, to UK residence of 7 out of the last 9 tax years, we may even in the future see a reduction in the number of years of residency that will cause a person to become deemed UK domiciled for IHT purposes. So for the non-uk domiciled person who has been resident in the UK for a number of years and is facing UK deemed domiciled status in the foreseeable future, what action can they take to protect their assets against UK inheritance tax? Well, for such a person, help is at hand in the shape of an excluded property trust (EPT). An EPT is basically a discretionary trust that satisfies two conditions:- (i) (ii) it is established when the settlor is non-uk domiciled for IHT purposes it only invests (and remains invested) in excluded property (see below) The trust must therefore be established before the settlor has UK deemed domicile status for IHT purposes (ie. currently before they have lived here for 17 tax years).

5 By excluded property we mean all overseas property, UK authorised unit trusts and OEICs and certain UK gilts. Many persons with overseas links will prefer the feel of offshore investments and for those people offshore collective investments such as offshore (life assurance) bonds and offshore funds will appeal. Indeed, offshore bonds provide a very tax efficient wrapper for the non-uk domiciled investor in the new rigid remittance basis regime. Another huge benefit of the EPT is the fact that the settlor can be a potential beneficiary under the trust without there being a gift with reservation of benefit. This is because the excluded property rules override the gift with reservation of benefit provisions. HMRC has recently reconfirmed that this is its view of the legislation and this means that an individual can establish an EPT as a means of saving IHT and yet still have access to the trust funds. TRUSTEE DUTIES WHEN INVESTING - A REMINDER The statutory duties imposed by the Trustee Act 2000 (TA) on trustees of all trusts in England and Wales, apply to trustees of all trusts whenever they were created. Although the statutory duty of care can be excluded or replaced by an express provision in any new trust, the statutory duties that apply to trust investments cannot be excluded. In light of this, trustees of all trusts may well need to be reminded of their statutory duties. This particularly applies where private trusts are created with family members appointed as the trustees but also applies where professional advisers are appointed who may not be involved with trusts on a regular basis and so may not always be entirely familiar with the latest legislation. Periodic reminders of trustees statutory duties are especially relevant where trustee investments are concerned as one of the statutory requirements is a duty to periodically review the investments of a trust. In connection with this there is also the trustees duty to obtain and consider proper advice, ie. in practice, advice from an independent financial adviser. Although there is no definition of periodic review, trustees should review the trust investments whenever they receive an annual statement, but in any event at least every three years. When reviewing investments the trustees have to take account of the standard investment criteria, namely the need for diversification and suitability. The principle of diversification is considered to be in conformity with modern portfolio theory which emphasises that investments are best managed by balancing risk and return across the portfolio as a whole rather than by looking at each investment in isolation. So, the requirement is to consider/have regard to the need for diversification there is no actual duty to diversify all trust funds. Where it is appropriate, to diversify the trust fund means that the trustees should use a spread of investments. The duty under the TA (section 4) is to have regard to the need for diversification and suitability of investments to the trust - these are known as the "standard investment criteria". Some trust deeds may include an express provision stating that the trustees are under no obligation to diversify the trust fund. Such a provision may be useful as a guideline for the trustees but should not be equated with an exclusion of any of the trustees statutory duties.

6 Action: Given the requirement for a review of investments as well as the requirement for advice whenever reviewing investments, this is an opportunity not just when a new investment of trust funds is being made but an ongoing one - an opportunity for the IFA to contact his/her trustee clients from time to time with a view to reviewing the trust investments. INSURANCE TO POTECT YOU DURING THE RECOVERY Although the economy is now recovering many people are still feeling the effects of the recession from a couple of years ago. This will inevitably mean that people will need to do even more to protect their finances, as there will be less fat to cover the lean in the bad times. It therefore makes sense for people to consider effecting appropriate insurance now to protect them against future financial risks that arise on ill health and death that can have even more of an impact on their financial wellbeing. For example, how long would a client s money last if they were unable to work because of sickness? The sobering fact is that according to recent research the average family in the UK has enough savings to see them through just 18 days. Household finances are still stretched and many families would struggle if the breadwinner was unable to work and they lost their main income. There are a number of insurance products designed to help in such circumstances. (i) Income protection Income protection aims to provide a tax-free regular income for a person unable to work due to sickness or accident. It is important to protect their income because, without it, their financial situation could deteriorate quite rapidly. Income protection should be at the top of a client s insurance priorities. Despite this, it is estimated that only one in eight of the working population has this cover. Payments continue until the individual can return to work or the policy reaches its expiry date (eg. pension age). The maximum monthly benefit is generally a tax-free payment equal to around 65 per cent of gross income, although some insurers set lower maxima. In some cases, any social security entitlement may be deducted from the amount paid out. Before a policy will pay out, a deferral period following the sickness or accident must elapse. The insured chooses what period they would like at the outset and it can range from one day up to two years. The level of premium will depend on a number of factors, such as age, state of health and occupation. Policyholders can also claim more than once on an income protection policy. For example, they might be off for months with a back complaint and the policy pays out. Provided they continue premiums when they go back to work, they will still be covered and they can claim for the same condition again. Anyone considering an income protection policy needs to ensure they have "own occupation" cover. This ensures that the policy pays out if they are unable to do their own job. Some cheaper policies offer "any occupation" cover which means they will only pay out if the insured is too ill to undertake any type of paid work.

7 It is also important to look at the deferral period. Standard income protection policies will pay out after the policyholder has been off work for three months: this is because most employment contracts will provide sick pay during this period. But if a self-employed person does not have sufficient savings to fall back on, they should take out a policy that has no deferral period. This will, of course, be more expensive than a standard policy. On the flip side, for persons who are lucky enough to have a longer period covered by sick pay - for example, some civil service jobs - they can reduce premiums by going for a policy with an extended deferral period. So what does it cost? As a rough guide a 45-year-old accountant earning 80,000 a year will pay about a month to insure 40 per cent of his earnings. This assumes that payments commence after 13 weeks. Extending the deferral period to 26 weeks brings this premium down to about (ii) Critical illness cover Critical illness cover will pay a lump sum if a person suffers from certain specified serious medical conditions. Frequently the policy will pay out after a fixed period of time (eg. 21 days after diagnosis). All policies cover certain core conditions, such as heart attack, cancer, kidney failure and organ transplant, but it is vital to check the wording of the policy. Some policies will pay out if a person is unable to do their normal day job, while others pay out if they are unable to do any job. The rest pay out if they are unable to carry out certain everyday activities, such as walking or lifting. The number of conditions covered by a critical illness policy can vary from a handful to more than 150. However, income protection, which pays a regular tax-free income until a person is well enough to return to work, has no list of conditions and pays for any medical reason if the insured cannot work. (iii) Term assurance This provides a tax-free lump sum if a person dies within a specified term, subject to certain conditions. If they survive to the end of the term there is no cash value and no benefit will be paid. The main types of term assurance are decreasing term and increasing term. With decreasing term assurance, the benefit amount paid on death reduces by a fixed amount each year, decreasing to nil by the end of the term. This is the cheapest form of term assurance and is usually taken to cover a mortgage as the amount paid decreases in line with the amount owed on the individual s mortgage. With increasing term assurance, the sum assured increases by a fixed amount and aims to increase the level of protection in line with the cost of living or inflation. In many cases it would be appropriate to effect the policy under trust so that the proceeds can be paid speedily and free of inheritance tax. Family income benefit protection is another option, but instead of a lump sum if the life assured dies, the dependants of the life assured will get a regular tax-free income for the remainder of the policy term.

8 Action: Don t forget that when looking to protect the family finances of your clients it is important to weigh up the pros and cons of the various policies available. Income protection won't be ideal for everyone but too many families don't even consider it. Call us for more information. Should you have any questions or require further information please do not hesitate to contact Stephen Watson or Nicholas Wood on or enq@watsonfrench.co.uk Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FCA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at October No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.