When life gives you lemons, make lemonade, so the saying goes. This blend of optimism and pragmatism has been vital during 2016. And those qualities continue to serve the financial services industry well, given the rule changes that are keeping product providers, financial advisers – and investors – on their toes.
Take the recent adjustments that affect pensions and retirement planning. Pensions are still one of the most tax-efficient investments out there. But they’re no longer as efficient as they used to be. Since 2015, a tapered annual contribution limit has been introduced, ranging from £40,000 (the upper limit) to as little as £10,000 for those who earn £210,000 or more. And back in April this year, the Lifetime Allowance (LTA) was reduced from £1.25m to £1m.
Should your pension exceed the LTA, not only will valuable pension tax relief be lost but there will also be a hefty charge of up to 55 per cent on the excess withdrawn. For anyone who started their pension early, and has been paying in diligently over the years, there’s a very good chance they could end up over the LTA before hitting retirement age. In fact, the lower LTA is expected to affect up to 55,000 individuals in 2017. They might be entitled to feel a little bitter.
Keep calm and back UK smaller companies
The response to the rule changes has been positive, and has led to an upsurge in demand for venture capital trusts (VCTs). According to the Association of Investment Companies, VCTs raised £458m for the 2015-16 tax year, making it the biggest fundraising year in over a decade. VCT investors can claim 30 per cent income tax relief on investments of up to £200,000 in any tax year, as long as the VCT shares are held for a minimum of five years and the VCT is invested in qualifying companies. Additionally, any dividends earned are tax-free, and there’s no capital gains tax to pay when the time comes to sell the shares.
But it’s not just the tax benefits that are attractive. For many VCT investors, there’s the feel-good factor of sharing in the growth potential of fast-growing, British companies. It’s worth noting that the majority of the high-growth small businesses in a VCT portfolio will be less exposed to global market risk than their larger, listed cousins. However, given their small cap status, VCTs are higher risk investments and the value of VCT shares could fall or rise in value more than shares listed on the main market of the London Stock Exchange. This means a VCT shouldn’t be considered a like-for-like replacement for pension investments. They can, however, be considered as a tax-efficient way to complement and diversify an existing retirement plan, particularly for investors worried about breaching those pension limits.
Changes to buy-to-let rules
Of course, a pension isn’t the only popular retirement planning strategy. Buy-to-let has also been highly tax-efficient, with landlords able to offset their mortgage interest costs against rent received before they declare their income.
But from April 2017, new rules will limit mortgage interest relief so that by 2021 just 20 per cent of rental interest will be subject to tax relief. Some buy-to-let landlords are likely to be pushed into a higher tax bracket, without them earning a penny extra of rental income. Limiting the ability for landlords to deduct the cost of mortgage interest from their rental income, coupled with the higher rate of stamp duty for buy-to-let properties, is making more individuals think about the higher tax implications that now come with using property as a pension proxy.
P2P lending on the up
According to HMRC, 12.7m adults subscribed to an individual savings account (Isa) in 2015-16, and four out of every five opted for the cash Isa version over stocks and shares. But with average interest rates on cash Isas falling below 1 per cent for the first time in November, and inflation at a two-year high of 1.2 per cent, anyone with cash savings is travelling backwards in real terms.
As a consequence, peer-to-peer (P2P) lending has also been gaining mainstream recognition, and the government is starting to accommodate it. The introduction of the Innovative Finance Isa back in April, bringing P2P within the Isa family (and giving it an unsurprising popularity boost as a result), is another step in the right direction. In 2015, some £2.7bn was invested into the regulated P2P industry and crowdfunding platforms, according to the Financial Conduct Authority.
This year, as P2P gains more mainstream acceptance, the investment inflows are likely to be considerably higher. Although P2P is very much still a new asset class for financial advisers to get to grips with, the fact that some well-known entrants are gaining a foothold in the P2P market is helping many to overcome their concerns.
Rule changes are commonplace within the financial services world, and one of the more positive aspects of the UK financial services industry is its ability to adapt. But amid suggestions that the next two decades could see significantly lower returns from traditional investments, it’s really encouraging to see consumers adapting their investment behaviour in search of more positive outcomes too.