A NEW TAX YEAR FULL OF CHANGES

The Tax Year 2010/2011 is bringing many more changes to our finances than is immediately obvious. The changes, and promised changes, leave one feeling like the Matrix has shifted or that one has walked through Alice’s Looking Glass (depending on your preference of books and films). There are substantial changes in pension legislation yet again and talk of major changes to the State Pension. There are some boosts in personal tax allowances, but higher VAT and rising costs of petrol and basics leave many living a bit on the knife edge and dreading the moment when the Bank of England finally increases the Bank Base Rate.

So what has changed and how do we need to respond? Pensions deserve the closest look because they are likely to impinge on our lives most in the long term. In the previous decades those working many years for major companies could rely on a worthwhile pension when they reached State Retirement Age - which for many, many years had been age 65 for men and age 60 for women. The quality pension schemes have been subjected to harsher and harsher regulations over recent years, and the great majority of companies can no longer afford to keep them going. Even the Blue Ribbon public service schemes, such as the Civil Servant Pension Scheme, can no longer be afforded by the Government and will have to change. The Government’s talk of a higher State Pension to help handle this problem is so far in the future that it really is little more than an effort to raise hopes and avoid a backlash from the other changes. The Government cannot even afford the current level of State Pension, which is why they are having to extend the State Retirement Age.

Junior ISAs - New kid on the block

The Coalition Government has now confirmed details of the long awaited savings plan analysts had been expecting since the withdrawal of Child Trust Funds (CTF) last year. The Junior ISA will be launched in November and will extend to under 18s the same tax benefits which parents (and all adults) already enjoy. Their exact structure is subject to final legislation which may change, but this is the plan so far. The Junior ISA will allow parents to open up a specific account in their child’s name, into which they, their family and friends can contribute a total of up to £3,000 a year. These contributions will then be invested in a chosen mixture of cash and/or stocks and shares and the benefits locked up until that child reaches 18. Anyone under 18 born before September 02 or after January 11 (i.e.: those who do not have a CTF) will be eligible for a Junior ISA (and for those with CTFs, the annual limits are expected to be brought in line). The Junior ISA could provide a significant step up for children whose family and friends get together for their benefit. Final values are subject to growth rates but just to give you an idea, assuming an average of 5% pa (net of charges), that £3,000 pa could leave the lucky beneficiaries with a contribution of over £80,000 towards their world trip, first house or those hotly debated university tuition fees.

Budget 2011 - Tax

Chancellor George Osborne had already decided to raise the personal allowance to £7,475 from 6 April this year. He used this latest Budget to extend that allowance by another £630 to £8,105 from April 2012. He has also brought down the rate at which people start to pay higher rate tax from £43,875 to £42,475. As a legacy from the last Labour budget, the personal allowance will still be withdrawn completely at an income of £115,000. The Chancellor has also announced that, in future, tax allowances will be increased in line with the Consumer Prices Index rather than the Retail Price Index. Historically, the Retail Price Index has been higher, so this could have a long-term impact on the value of such increases for all taxpayers. The rules on inheritance tax and capital gains tax (CGT) remained largely unchanged. However, anyone leaving more than 10% of their estate to charity will see their inheritance tax bill fall by 10% while the amount qualifying for Entrepreneur’s Relief on CGT - where tax is charged at 10% rather than 18% or 28% - has doubled from £5m to £10m. There were some changes at the top end of the investment scale. Upfront tax relief on Enterprise Investment Schemes will rise from 20% to 30% while the amount that can be invested annually will rise from £500,000 to £1m. The Chancellor is also relaxing some of the rules around eligible companies for these and venture capital trusts to expand the potential for attracting this type of investment.

Tax year start - Get in early

You only receive one ISA allowance every tax year. Since you cannot carry your allowance over to next year, if you do not use it, come the end of the tax year, you will lose it. The annual allowance has been raised for everyone this tax year, to £10,680 (2011/12), up to £5,340 can be placed in cash - and this is available to be used any time up until 5 April 2012. However, you don't have to wait. You can invest any time from now and, particularly with cash ISAs, you might benefit more from doing so. The earlier you get your money into a deposit account, the more interest you will earn. For stocks and shares ISAs, there are those who try to 'time' their investment - that is, buy when prices appear cheaper (and thereby benefit more as they recover). However, even experts seldom manage to time the market on a consistent basis, and individuals can find it even more difficult. If you are concerned about market volatility, a better idea than 'timing' might be to drip feed your money in on perhaps a monthly basis - in other words, invest smaller regular amounts - to smooth out the risk of a price fall by buying your investment at a range of different price levels. This system is called 'pound cost averaging' and can offer long-term benefits, particularly for nervous, first-time investors. Regardless of how you invest your money, however, remember you only receive one allowance a year. It is therefore best to start your research early and speak to your adviser about all the options. This will help ensure you make the right decision.

Interest rate update

Uncertainty appears to be the watchword among policymakers at the Bank of England (BoE). Recent events have provided few hints on the possible direction of interest rates and the timing of any potential movements, and the Monetary Policy Committee (MPC) remains divided on future strategy.

Rates were kept on hold for the 24th month in a row in March. However, minutes of both the February and March meetings show a split has begun in the Committee. Three members have twice voted for an increase of at least 0.25 percentage points, while another continues to vote for an expansion to the currently dormant quantitative easing programme.

Despite that, external speculation about further quantitative easing measures appears to have abated, at least for the time being. Current inflationary pressures reduce the scope for injecting more money into the economy, as this would likely fuel prices. The Consumer Price Index remains stubbornly high, well above the BoE’s target of 2%, and registered a further rise during February, to over double that target, ie: 4.4%.

Nevertheless, the MPC is limited in how much it cool inflation by raising interest rates; although they remain at their lowest level since records began more than 300 years ago, it is difficult to increase them without impacting the UK’s fragile economic position. The economy shrank by 0.6% in the final quarter of 2010 and government spending cuts, coupled with the increase in VAT from January, are likely to further impact any prospects for economic expansion, particularly in the construction sector, and the full effects of these are yet to be seen.

Although inflation remains significantly above target, the MPC’s expectations for inflation in the medium term remain "anchored". It is not until 2013 that they expect it to fall back below 2%. With the lack of any other clear signal, the path of interest rates is therefore likely to be influenced by other events in the world economy albeit with one eye on what happens once the government spending cuts properly take hold.

For the moment then, low interest rates continue. Such a strategy will continue to be welcomed by borrowers; however, it will prolong the headache for savers, particularly those who are looking for a low-risk home for their money. Whilst the rest benefit from lower repayments on borrowing, those who focus on deposit accounts are getting little return on their money and inflation continues to eat away at its real value.

Start saving: Time to take action

Total UK personal debt had reached £1,452bn by January 2011, according to figures from Credit Action – more money than the whole country produces in a year and a sum that equates to nearly £8,500 per household (excluding mortgages).

Contrast that with the nation’s current savings levels, which have seen the average household save just £996 over the last 12 months – or £2.73 a day. However, in an environment where it has become the norm – and, until recently, all too easy – for individuals to make purchases with debt, changing this ‘enjoy now, pay later’ mentality is going to be difficult.

You may be sure, however, that the coalition government is keen to encourage such a change. Work & Pensions Secretary Iain Duncan Smith has been quoted as saying: “We do not save enough in this country…it is appalling, and changing the culture is critical.” Right now, the main incentives to encourage such saving involve limiting the amount of tax you pay on certain savings products. Certainly, the Government needs to do more if they are going to generate the kind of interest that will push more people to act.

Yet, if there was ever a good reason to start changing our behaviour, it is surely the fact it costs the average household £2,500 a year in net income just to meet its interest payments. That is approximately 15% of the average net wage going to lenders that could otherwise be heading into our pockets. That fact really should be an incentive to start saving.

Preparing for 2012 - Corporate Pensions

In the UK, we are now living longer and having fewer children. As a result, workplace pension schemes have come under increasing pressure as they have to cover the income of retirees for longer with less investment. At the same time, people are not saving enough for their retirement off their own back. The government is therefore becoming concerned about its ability to cope with the future demands for state payouts. Consequently, the Government has decided it is time to try and persuade more individuals to start saving towards a private pension. Their latest measure is the National Employment Savings Trust (NEST) and is set for implementation from 2012.
NEST is designed to encourage both a greater level of saving for old age and open up access to saving for individuals who do not currently have a decent workplace pension scheme. Therefore, from 2012, all eligible employees will start to be automatically enrolled into NEST unless a suitable workplace scheme exists to take its place.

For employers, this creates a lot of issues. First, and perhaps most importantly, NEST or its workplace alternative MUST be part funded by the employer – with a contribution of 3% of eligible earnings. This will be added to a 4% contribution from the employee and another 1% from the Government (via tax relief), making a total of 8%*. The aim, primarily, is to promote a savings culture, particularly amongst low-to-moderate income earners, and will affect those from age from just 22 right up to state-pensionable age. These are earners who in the past have either not had easy access to independent savings or have simply opted not to take part. Consequently, the cost of having to fund such workers is likely to increase costs for virtually all businesses. There is also the question of whether to continue with – or set up – a workplace pension scheme instead. For employers whose workforce is made up of the higher paid, or who consider the incentive of an in-house arrangement key to their benefits package, the rigidity of NEST may not provide the flexibility they are looking for. Some may therefore consider that either opening, extending or simply increasing the funding for an existing workplace scheme is something they should sort out in advance. There may even be contractual issues to sort out with existing staff. Whatever your current situation, it is a good idea to start considering how you can meet the needs of your own workforce. Whether you employ 2, 200 or even 2,000 employees, the earlier you beginning to consider your options, the better prepared for the changes your business will be.
* Eligible earnings are those between £5,035 and £33,540, indexed with average earnings from 2007