Marginal Gain – July 2019
With a summer of sports progressing, it is appropriate to refresh our reasoning behind Marginal Gain! To recap, elite sports men and women use the ideal of a marginal gain to make small tweaks to their performance. In isolation, each part is incremental and so in terms of financial planning our delivery to clients of a higher level of knowledge, a reminder of the benefits of investing appropriately and an openness to new opportunities should enhance your experience of working with a chartered financial planning firm. So welcome to our July edition…
An unintended consequence of the Lifetime Allowance
Pension scheme members with group life cover may face unexpected tax charges as many employers do not consider the effect the product has on pension tax, according to Aon.
Research from the retirement consultancy, published last month, showed that out of the 1,150 employers surveyed, 67 per cent had not considered the tax implications of lump sum death-in-service benefits on the lifetime allowance.
The lifetime allowance, introduced in 2006, limits the total amount individuals can build up in pension benefits over their lifetime while still enjoying the full tax benefits.
If an individual exceeds the lifetime allowance, which is currently £1.05m, they may face a tax charge on the excess.
The research also showed that only a third of employers have acted to address this issue by using excepted death-in-service cover.
Excepted group life insurance provides tax-free benefits and is sometimes used for high earners. It allows for lump sum benefits to be paid outside of the lifetime allowance, meaning that pension scheme members can avoid a 55 per cent tax charge above the allowance.
This compares to registered group life insurance which provides a tax-free lump sum up to the lifetime allowance.
This is because excepted group life policy is subject to life insurance legislation not pensions legislation and so these life insurance benefits are not tested against the lifetime allowance.
Many people believe that the lifetime allowance only affects high earners, but this is no longer true as growing defined contribution pension values, higher levels of lump sum life cover and the current level of the lifetime allowance mean that mid-earners are also being hit by lifetime allowance tax issues, according to Aon.
Aon stated: “With the generally unknown or at least underestimated impact that lump sum death in service benefits have on an individual’s available lifetime allowance on death, this should be a key topic on the agenda for all employers.”
Aon’s research considered whether all lump sum death benefits could be covered by excepted insurance, which would mean that all life assurance cover would be “taken out of the lifetime allowance equation altogether”.
The research found that the ‘100 per cent excepted’ eligibility approach increased in popularity among smaller companies.
Aon stated this could be because the approach was “easy to communicate and manage in a smaller organisation, resulting in a greater appetite”.
The lower percentage of large employers adopting this approach indicates a continued caution, Aon stated. So, for senior executives, the amount of life insurance paid out, is tested against the lifetime allowance along with their other pension benefits, and any excess is taxed up to 55 per cent. This could leave dependants with less money than initially planned, and the effects are more prominent on young families with children.
Purchasing Commercial Property
Every company director will at some point consider buying premises from which to operate. This might be a large manufacturing company considering whether the time has come to buy their factory or on a smaller scale someone considering whether they should move out of their home office. Cashflow, surveys, legal fees, location will all be key considerations but perhaps the most fundamental issue will be what type of ownership is best for your unique situation.
There are three basic options for company directors; direct purchase by the company, direct purchase by the directors/shareholders, purchase by a self-invested personal pension (SIPP). Most advisers will have discussed these options with clients many times over the years and the answer is never simple. Not only is each individual company unique but the rules have changed extensively over time. This is a large topic so initially we will cover direct purchase by the company and go through the other options in later articles.
The purchase of the property by the company is probably the default option for most businesses and feels like the path of least resistance. The obvious first benefit is the company no longer having to pay any rent. This may mean replacing rent with interest, but both are tax-relievable and, with interest rates currently very low, the rent saved is likely to exceed the interest due.
Holding the property in the company also means that collateral is available for any future loans depending on whether the purchase was funded by cash or borrowing. The company might also be able to access greater borrowing than a pension scheme as there are strict limits on borrowing relative to pension assets.
It is also important to consider what would happen in the event of the death of a director. If the property is owned by the company, then surviving directors have the certainty that they won’t have to worry about the beneficiary of a pension scheme wanting to sell the property to generate liquidity.
One of the key attractions of holding assets in a pension scheme is the protection it offers for inheritance tax however in this case there is no benefit to transferring it to the pension. The value of the property will be reflected in the value of the shares and as long as it is used for the conduct of the business will benefit from 100% business property relief.
In terms of capital gains, corporation tax (19% at present but falling to 17% in 2020) will be due on disposal of the asset however the tax could probably be deferred through rollover relief if used to purchase a replacement property.
Although the benefits listed above are attractive there are some key drawbacks. The expense of buying a property can be a big drain on liquidity and companies will often need to borrow. The terms that lenders impose on a company may be kind or severe depending on their view of cashflow and the overall health of the business. They may for example expect capital and interest to be repaid which could blow your calculations of rent saved against interest due out of the water. In addition, creditors will be able to go after the property in the event of default or the company becoming insolvent.
One of the key tax drawbacks is that there are potentially two layers of taxation on capital gains for property held within the company, once for the company and then again when the profit from the disposal is taken by the shareholders.
As with any other borrowing by the company there may be additional costs associated with life insurance for any director that dies unexpectedly. This ensures that it remains affordable for the surviving directors/employees. One interesting new development in protection for directors and employees is the ability to add on a kind of critical illness cover to the traditional relevant life policies. Previously these did not benefit from corporation tax relief and had to be paid from net income rather than gross.
Hopefully this provides an overview of the costs and benefits associated with buying business premises through a company. Next month’s article will cover purchase by directors/shareholders.
Discretionary Fund Management
The Financial Conduct Authority has identified a range of areas of potential harm wealth managers can cause their clients. In a ‘Dear CEO’ letter sent to wealth managers and stockbrokers the watchdog told firms they should assess whether their business poses a risk and consider strategies to mitigate them. The FCA believes firms can harm clients in the following four ways:
• Reduced levels of savings and investments due to fraud, investment scams and inadequate client money, or assets controls
• A loss of confidence in the industry’s ability to deliver their financial objectives due to mismanagement of conflicts of interest and market abuse
• Reduced levels of savings and investments due to order handling procedures and execution processes that do not deliver best outcomes
• Inability to understand the costs of services provided by firms, due to insufficient or inaccurate disclosure of costs and charges
The FCA described this as a ‘priority’ area and said it would use a range of data to identify the ‘small’ number of firms which are cause for concern.
‘Customers place a great deal of trust in their wealth managers and stockbrokers,’ the watchdog said.
‘In recent years, we have identified, and taken action against, a number of firms which have abused that trust. Many of them have used their clients’ portfolios in investment scams or other highly unsuitable investments or to conduct market abuses.’
The FCA also wants to see evidence that firms are endeavouring to obtain the best possible result for their clients when executing client orders or passing them to other firms for execution.
It noted that its Investment Platforms Market Study, published in March 2019, ‘highlighted specific issues and weaknesses in platform service provider firms’ order handling procedures and best execution evaluations’.
The FCA expects firms to have effective day-to-day executions processes, contingent arrangements for periods of market distress and clear, comprehensive and effective oversight and monitoring arrangements.
Costs and charges disclosure
As we have mentioned before, the European directive (MiFiD II) introduced new and revised requirements for disclosing costs.
As part of its supervision work, the FCA said it had looked at ex-ante costs and charges disclosures of a sample of 50 firms in the retail investments sector.
The regulator said it has found flaws in the system, with firms interpreting the rules in a wide variety of ways. It noted that while firms were generally better at disclosing the costs of their own services, they were not so great at disclosing relevant third-party costs and charges.
‘We found evidence that firms were not sharing their costs and charges with each other to meet their obligations to provide aggregated figures to clients.’
The FCA said it may conduct further work to assess how firms are implementing ex-post costs and charges disclosure.
The rise of contested Wills
In recent years it has been widely reported that the amount of Wills being contested through the courts has increased drastically. However, the cases which get to court and get media attention are only a tip of the iceberg.
These few cases do not account for the hundreds and potentially thousands of inheritance claims which are brought every year. This is a topic which has the ability to divide public opinion on whether an individual should be allowed to challenge someone’s final wishes.
The reasons for the increase in disputes about inheritance can be as a result of a variety of different factors including;
• Increase in dementia rates – as our ageing population is living longer some are also living with illnesses which can impact their cognitive ability and mental capacity. This could mean that some people might be making Wills when they are not in the best of health and as such the Will is likely to be susceptible to challenge.
• Modern families – with the rise of divorce and remarriage, families living further apart and overall more complex family arrangement there is a wider scope for disputes.
• Increase in property values – this makes the prize of a successful claim increasingly valuable and worth fighting over.
There are two ways in which a Will can be challenged, an individual can challenge the validity of it or bring a claim that it does not make ‘reasonable financial provision’. This month’s article will cover challenges of the validity of a Will and we will follow this up in the August Issue with an article focusing on the latter.
The most common ground for challenging the validity of the Will is lack of testamentary capacity, meaning that the testator (individual making the Will) must have had the requisite mental capacity at the time of making their Will. As mentioned above, our population is living longer with illness’ like Dementia and Alzheimer’s, which can severely impact our mental capacity.
Banks v Goodfellow (1870) sets out the common law test for testamentary capacity. The testator must:
• Understand the nature of the act and its effects;
• Understand the nature and extent of the property which they are disposing;
• Able to appreciate the claim to which they ought to give effect; and
• Be of sound mind and have no insane delusion influencing the disposal of their property in the Will.
If it is believed that the testator did not have the necessary capacity when the Will was made, then it may be deemed to be invalid if the challenge is successful. However, it must be considered that if the challenge is to be successful, and there was an earlier Will then the deceased’s estate would be distributed in accordance with the earlier Will. If there was no earlier Will, then the estate would be distributed in accordance with the rules of intestacy. It could therefore be that the claimant would receive no greater share of the estate even if they were successful in challenging the validity of the Will.
Another common ground for challenging the validity of a Will is undue influence. If a testator is coerced into making a Will which they do not want to make, then it could be deemed invalid if the challenge is successful. Coercion is assessed on a case by case basis and can vary depending on the vulnerability of the testator and the strength of the Will in question. Undue influence may be suspected if someone has changed their Will unexpectedly, if a person benefitting from the new Will was not included in any previous Wills or the deceased was dependant on the individual when the changes were made. If they were dependant this can make them more susceptible to forceful coercion. As mentioned above elderly individuals with Alzheimer’s are vulnerable to being coerced or influenced by a particular individual to change their Will to benefit them.
Undue influence can be difficult to prove and the burden of proof is on the individual making the allegation to show that there is no reasonable explanation for the Will being changed and including the provisions it has. Unfortunately, these instances usually occur behind closed doors by people who are in a position of trust such as a child, partner or carer and as such create difficulties if challenged.