In Focus - Winter 2021
Welcome to the latest issue of In Focus, your quarterly financial planning newsletter.
<big>In Focus
<b>Your quarterly financial planning newsletter <br>Winter 2021</b>
<i>In this issue: </i>
• COP26 and your financial plan
• The highest UK taxes in 70 years...
• The new social care cap explained
• How could higher interest rates and inflation affect you?
Welcome
Welcome to the to the Winter 2021 edition of In Focus. Find out what's in this issue:
Welcome
Welcome to the latest issue of In Focus, your quarterly financial planning newsletter.
In this edition of In Focus, we offer four new articles to inform and inspire your thinking.
We hope you find this content helpful and invite any questions you may have on these topics, or regarding your own case.
COP26 and your financial plan
COP26 and your financial plan
The environment has been in the media spotlight again recently when the Conference of the Parties (COP26) met in Glasgow between 31st October to 12th November 2021.
Hosted by the UK and Italy, the event brought together 114 world leaders - including those of the US, India and Russia - to agree on action to tackle rising global temperatures. Queen Elizabeth II urged leaders to act in a video message, joined by others such as David Attenborough.
Some good news seems to have come from COP26, with historic commitments to tackle global deforestation and methane abuse. The Glasgow Breakthrough Agenda was also signed by 35 world leaders - representing 50% of the global economy - to develop new, clean technologies and drive down costs.
However, COP26 has also attracted criticism. China’s President Xi Jinping, for instance, did not attend and also called for a less ambitious target of limiting the global warming increase to 2C (rather than 1.5C, adopted in 2015 under the Paris Agreement). Disappointment has also been expressed over India’s goal to reach “net zero” by 2070; much later than many would like.
All of this attention on climate change has led many people in the UK to ask: “What can I do?” Certainly, there are lifestyle habits that may need examining.
However, how you spend your money and invest can also make a big difference.
Finance and climate change
Litter picking, recycling and regulating fossil fuel-powered travel are all good ideas to reduce your carbon footprint. Yet, as the saying goes, money makes the world go round. Companies (e.g. car manufacturers) are more likely to focus on producing “greener” products if demand pulls profits in that direction. Banks and investment firms, moreover, are more likely to avoid involvement with, say, land abuse if the financial and legal risks become too great.
Here, the COP26 event has made a significant stride forwards, particularly on deforestation. In 2014, most countries pledged to end deforestation by 2030 during the New York Declaration on Forests. Whilst well-meaning, this pledge had no implementation mechanisms and high finance had not been brought aboard to incentivise pursuance. This time, however, the financial sector is highly involved. 30 financial institutions responsible for $8.7tn - including Fidelity, AXA and Legal & General - have committed to move into sustainable farming, rather than “tree slashing” for commodities like palm oil. Much of this behaviour change can be attributed to governments strengthening environmental rules, yet consumer demand is also making a key contribution.
The drive to ESG
For retail investors (e.g. individuals with a pension) it has become increasingly important to check the environmental, social, and governance (ESG) credentials of a fund, or company, prior to investing in it. Younger generations have been especially interested in this style of investing, which has moved from the “fringe” and more into the mainstream over the last 20 years.
Today, about $1 in every $3 under management in the US is classed as “ESG”. This movement is only likely to continue, with the likes of Chancellor Rishi Sunak recently requiring asset managers to set out the environmental impact of every investment product under the new Sustainability Disclosure Requirements (SDR). The public also appears mostly on board, with 70% wanting their money to go towards making a positive difference to people, or the planet.
Many still do not realise that the 2015 Paris Agreement marked a huge shift in Big Money, when it started to move away from the fossil industry. According to Michael Liebriech, founder of Bloomberg New Energy Finance, this was the point where Big Money “Served divorce papers” to coal, oil and gas, and Glasgow will be when the “court order” (“decree nisi”) is served. This, partly, is the reason why oil giants such as Royal Dutch Shell are moving more into natural gas, to try and reach net-zero emissions and put the “customer first”.
It should be noted that ESG investment has received criticism from some quarters. BlackRock’s former sustainable investing CIO, Tariq Fancy, argued that ESG was a ‘dangerous placebo’ and many different alleged ESG strategies have been accused of ‘greenwashing’. We suggest that you discuss these options with a financial adviser.
Strategies for investors
For investors wondering how they can make their portfolio more environmentally friendly, there are a range of options that you could discuss with a financial adviser. The most radical route, of course, is screening to exclude companies, industries and even countries from your portfolio which do not meet your ESG values. This might work for some investors, but is likely to be too restrictive for most. Another option, therefore, is to include positive vetting to identify companies which are setting an example for their peers on ESG matters, and reward them by investing in them. This would allow an investor, for instance, to invest in companies working in areas such as fossil fuels, auto manufacturing and mining provided they are showing evidence of leading the way in their industry towards meeting ESG criteria (and note that even for those without sizable portfolios, it’s worth checking your workplace pension funds to see where the default fund is invested, if this is a concern to you).
Investors do not necessarily need to adopt an ESG strategy for their entire portfolio all at once. Another option would be to pursue integration - gradually including more companies and funds which mitigate ESG risks.
There are, of course, also other ESG options for business owners and major shareholders. If you own your own business, then you can set the ESG agenda to promote environmentally-friendly systems, practices and products. If you’re a major shareholder of another business, you could use your influence within the company to raise matters of ESG importance to the management. This might involve initiating a vote on a change in company behaviour, so that policies and practices help goals such as environmental protection, community engagement or gender equality in the workforce (or board).
If any of the areas covered by this article are of interest to you please get in touch.
The highest UK taxes in 70 years...
The highest UK taxes in 70 years...
The Chancellor, Rishi Sunak, announced his Autumn Budget at the end of October. It confirmed a series of tax rises which are likely to impact household budgets across the UK.
Within 5 years, total Government spending is on course to reach 41.6% of GDP, the highest level since the 1970s. To support this, taxation as a proportion of GDP is expected to rise 36.2% by 2026-27; its highest since the Labour Government under Clement Attlee, between 1945-51.
This appears to have been received well by many Conservative MPs representing the former “Red Wall'' (e.g. in the north of England), but those on the “fiscal right” in the party are unhappy with the tax rises - arguing that they go against the Conservatives’ values of “Small state, free enterprise” and the party’s traditional voting base.
In this article we take a look at which taxes are rising, exactly, and how these might affect your finances and wealth in the months ahead.
Dividend tax rise
One of the key announcements from the Autumn Budget was the planned dividend tax rise, by 1.25%, from 6th April 2022. The cited reason was to help fund UK health and social care. For Basic Rate taxpayers, this means that their dividend tax rate will rise from 7.5% to 8.75% in the 2022-23 tax year. Those on the Higher Rate will see their dividend tax rate rise from 32.5% to 33.75%, whilst for Additional Rate taxpayers it will go up from 38.1% to 39.35%.
Much of the public appears to accept this rise, but it has been described by many brokers as a “kick in the teeth” for investors - particularly after the recent “dividend drought” caused by COVID-19.
To mitigate the impact on your own finances, a range of options can be discussed with your financial adviser.
First of all, remember that UK residents are each entitled to earn up to £2,000 in dividends per financial year, outside of a pension or ISA, without tax. Secondly, you can also put up to £20,000 into an ISA per year and generate dividends within the wrapper, tax-free. So, one option to reduce needless dividend tax is to organise your portfolio to make maximum use of both tax-free options.
Finally, any dividends generated within a pension (e.g. a SIPP) will be free from dividend tax. You can commit up to 100% of your salary into your pension(s) each year, or up to £40,000, whichever is lower (in some individual circumstances this can be reduced - please speak to your adviser). Bear in mind, of course, that these dividends will need to be re-invested until you reach age 55 (rising to 57 in the coming years), at which point you can start to access your pension pots.
National Insurance increase
Another outcome from the Budget was the planned rise in National Insurance for employees, by 1.25% from April 2022. This will appear as a separate item on payslips, as a Health and Social Care Levy, from the following April. The proposal has sparked some anger as it breaks a pledge in the 2019 Conservative election manifesto, although the public appears split on the matter. Self-employed people and employers will also need to pay an extra 1.25%, and pensioners who work will need to pay National Insurance for the first time (in an effort to spread the tax burden across all age groups).
If you want to legitimately reduce your National Insurance liability, then there are a few options that could be explored. One idea is to engage in a “salary sacrifice” scheme with your employer, where you reduce your take-home pay in exchange for higher pension contributions from your employer. This means that both you and your employer should pay lower National Insurance Contributions, and in some cases can even increase take-home pay. However, think carefully before suggesting this to your boss. If your employer offers you life cover, for instance, then this is often worked out as a multiple of your salary. By reducing your salary , you may therefore end up reducing your “death in service” benefits. Your new, lower salary could also affect how much you could borrow when looking for a mortgage, and might affect your eligibility for certain state benefits (e.g. Statutory Maternity Pay).
Future tax cuts?
On Wednesday 27th October, Chancellor Sunak told the 1922 Committee that “Every marginal pound we have should be put into lowering people’s taxes”. Furthermore, he stated his aim to cut taxes over the course of this parliament due to his beliefs as a “fiscal Conservative”. This leads some analysts to believe that, in the short term, taxes will rise but might be cut as the general election approaches in 2024.
However, the big threat hanging over this outcome is a possible rise in interest rates in the coming years. If the base rate eventually rises to, say, 3.5% (i.e. its highest since 2008 and the level likely required to moderate inflation pressures assumed by the OBR), then this would significantly increase the UK’s borrowing costs. For instance, just a 1% rise in the base rate and inflation may lead to a £23bn increase in debt servicing costs. If this rose threefold, then it could cost the UK an extra £72bn per annum and would make it very difficult for the Chancellor to reduce taxes. This scenario is, of course, uncertain. Yet it should caution against optimism that taxes will inevitably reduce, at some stage, under the present Government.
Tax treatment will depend upon individual circumstances and may be subject to change in the future.
The new social care cap explained
The new social care cap explained
Many UK governments have wrestled with what to do about the social care system, shying away from meaningful reform.
This has meant that individuals continue to live with the prospect of costly care fees, one day, eating into their wealth in old age. In worst cases, this can lead to some people needing to sell their home, and can erode an intended inheritance to almost nothing.
Recently, Boris Johnson’s Government has announced a new “social care cap” which, theoretically, will prevent residents in England from ever paying more than £86,000 on social care in their lifetime. Yet the reforms have not arrived without criticism.
Many are asking how the cap will be funded, whether it will work and what the implications are for financial planning.
Funding the new cap
It’s no secret that the Government will be introducing a 1.25% rise in NICs (National Insurance Contributions) for employees, employers and the self-employed from April 2022. From the next tax year, this will no longer be taken from National Insurance. Rather, it will appear as a distinct levy on payslips - called the Health and Social Care Levy. For someone earning £10,400 a year, the additional annual payment is likely to be £130. A £100,000 annual salary, however, is likely to pay an extra £1,250.
How much money the new levy will raise is, of course, uncertain. The Government estimates that it will generate about £12bn extra per year. However, total spending on health and social care in England is approximately £235bn per annum, with much of this funded from sources outside of “ring fenced” taxes. The tax raised from the levy is unlikely to affect how much the government spends on these areas, overall.
Why saving £86,000 may not be enough
Under the current rules, you need to pay for your own social care if you have over £23,250 in savings. If you are under this amount, then the council should help cover your costs - although the exact amount they will pay varies, and they will need to conduct a “needs assessment” to determine which services you need (e.g. equipment such as a zimmer frame).
They will also do a means test (a financial assessment) to decide whether the council pays for all of your care, if you need to contribute or if you need to cover all of your costs. Bear in mind that you are not allowed to deliberately reduce your savings or possessions to fall under the £23,250 threshold, which is regarded as “deprivation of assets” and is likely to lead the council to calculate your fees as if you still owned the assets.
Care costs are not cheap. In England, they can range from £531-955 per week depending on the quality of care, the service you need and where you are in the country. Given that people who enter a residential home do so, on average, for 30 months, it is easy to see how the costs can rack up to £82,000 - or more. This may be part of the reason why the Government has set the new “social care cap” at £86,000, so that most people still end up largely funding their own care and the policy does not place too great a strain on the treasury.
The cap and your financial plan
In light of the above, it starts to become clear why most people will still need to account for the possible future cost of social care in their financial plan - irrespective of the new cap. The good news is, the policy could help preserve some of your estate if you end up in residential care for longer than 30 months. For young people with disabilities facing decades of care, moreover, the policy is also likely to be good news.
However, it is yet to be announced whether the cap covers non-care related costs such as food and accommodation (which could amount to £7,000-£10,000 per year). The policy is also likely to mostly benefit more affluent people in richer areas of England, where the average cost of care is £92,000.
One other question that remains unanswered is how the cap may affect the care home market, and people’s behaviour. After all, if someone is diagnosed with an illness that is likely to result in them needing permanent residential care, would they not simply apply for the best, most costly home available - since the state will ultimately end up footing a lot of the bill? Would behaviour like this lead care homes to put up their prices higher, leading to higher costs for people needing short stays? It is not yet clear how the UK government will regulate this.
This leads us to suggest that each individual strongly considers how to make their own plans to cover possible care costs in old age.
For some people the reality may be that, should they ever need care, it would mean selling the house and forsaking most of the inheritance they hope to leave their loved ones.
However, by planning ahead early, it is possible to build up your wealth so that you can still leave a meaningful inheritance should you need to spend, say, £86,000 or more on your care. A financial adviser can help you examine the options and craft a plan which brings your financial goals together.
How could higher interest rates and inflation affect you?
How could higher interest rates and inflation affect you?
The UK’s largest banks have all recently announced a rise in interest rates, with Barclays and others pulling their cheapest mortgage deals off the market since October 2021. At the same time, headlines have been broadcasting about rising UK inflation in the months following the summer, after COVID-19 lockdown was lifted.
What is the direction of travel for interest rates and inflation in the UK, and how might these affect your savings, investments and overall financial plan?
The state of inflation
In the UK, the Bank of England (BoE) sets the target rate of inflation (the rate by which goods and services, overall, rise in the economy). The BoE aims for 2% per year for inflation, which many economists regard as the “sweet spot” for rising prices. This might sound counterintuitive, but a moderate rate of inflation is often seen as positive since it helps to drive economic growth - e.g. more jobs and a rising overall standard of living.
However, if prices fall sharply (deflation) then people’s spending power also falls, often resulting in lower economic growth. Also, inflation which rises too much - say, by 5% or more - can lead to “hyperinflation”, which can send prices spiralling out of control. This happened in Germany in the 1920s during the Weimar Republic, when the price of a loaf of bread rose from 250 marks to 200,000m in just eleven months.
Fortunately, the UK presently appears nowhere near the extremes of deflation or hyperinflation. However, inflation has been rising in 2021. In August, it rose at the fastest pace since the BoE gained independence (in 1997), to 3.2%. Many factors lie behind this, but a powerful one is likely to be the fact that pent-up demand for goods and services has been released since COVID-19 restrictions were lifted following the UK winter wave. This is reflected in the areas where prices seem to have risen the most such as restaurants, transport and recreation. Currently, the BoE is forecasting that inflation could rise to 4% by the end of 2021, and could even reach 5%.
Why interest rates could rise
One of the BoE’s most powerful tools to help control UK inflation is its base interest rate, which it can alter. Interest rates have been at historic lows since March 2009, when it stood at 0.5%. Since then, rates have fallen further and now, in 2021, stand at 0.10%; the lowest they have ever been. Keeping rates low can, arguably, encourage spending in the economy - especially since savers can no longer access strong interest rates from regular savings accounts at banks (which set their own interest rates based on the BoE base rate). Moreover, low interest rates allow people to borrow money more cheaply. Mortgage deals, for instance, tend to offer lower interest rates when the BoE base rate is lower.
Now that inflation is rising, however, the BoE is facing increasing pressure to raise the base rate to stop the UK economy “overheating”. This could lead banks to raise their own interest rates, which could “cool down” the economy by encouraging more people to save, rather than spend. Rising interest rates would likely also lead to higher monthly mortgage costs for homeowners, leading to less disposable income to buy goods and services.
The key question, however, is whether the current inflation rise is “transitory” or more permanent. Until now, the BoE appears to have been sitting still, not altering the base rate in hopes that inflation will naturally cool down as the UK economy readjusts to “life after lockdown”. However, many analysts believe that the BoE may be forced to raise the base rate to 0.25%, or even 0.75%, by the summer of 2022.
Rising inflation also has a longer-term impact on your financial plan since it erodes the spending power of the income that is derived from your investments, and the growth of your investments in “real terms”.
Financial planning implications
What do these movements in the UK economy mean for your wealth and finances? Of course, rising inflation means rising prices - which could result in higher monthly household bills. There are signs of this already with the cost of food, drink and (more recently) petrol going up since the summer. However, rising inflation also has a longer-term impact on your financial plan since it erodes the spending power of the income that is derived from your investments, and the growth of your investments in “real terms”.
For instance, if UK inflation meets the BoE target of 2% per year and your portfolio rises by 8%, then in “real terms” its value has increased by 6% (excluding fees). However, if inflation goes up to 4% or 5%, then your real returns could fall to 4% or 3%, respectively. For certain investments which offer a lower return (e.g. gilts, or UK government bonds), this could result in a “real terms loss” if the interest rate falls below the rate of inflation. In light of this, many people are putting more money into “higher risk” investments to try and get a higher return (e.g. the stock market), which could beat inflation. This may be fine for some investors, such as those with a longer investment horizon and higher risk tolerance. For many investors, however, this may not be an appropriate strategy, because there is no guarantee that higher risk investments will beat inflation and you could get back less than you invest.
Should the BoE raise interest rates, then this could also have a big impact on your immediate and long-term finances. In the short term, it might lead to a higher monthly mortgage payment if, say, you are on a standard variable rate with your lender. If you hold cash savings, then you might see slightly higher returns from the interest rate on your savings account. Yet perhaps the biggest impact could be on the stock market. After all, if investors feel that they can get a better return on “safer” investments such as gilts, then this could lead to a big sell-off. Depending on your investment goals, risk appetite and horizon, such a scenario could be a bad or good thing. Consider speaking with your financial adviser if you are at all concerned about how interest rates and inflation may affect your portfolio and financial plan in the months ahead.
Note: Investments and the income from them can go down as well as up and is not guaranteed at any time. You may not get back the full amount you invested. Information on past performance is not a reliable indicator for future performance.
