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Foreword No one likes paying tax! We are pleased to publish this financial handbook in order to help you make sense of how the United Kingdom (UK) tax system works and to show you a few ways of mitigating some of the tax that you may have to pay. This is bolstered by information on the myriad of financial products available in the UK today. We hope you will find this handbook to be a valuable reference work. If you have any ideas on how to improve it, we will be delighted to hear them.
1
Contents The Financial Handbook Your essential guide to making the most of your finances while in the UK. Introduction Chapter 1
So What Tax Do We Pay?
Chapter 2
Overview of Tax Changes
Chapter 3
Tax Efficient Investments
Chapter 4
Tax Returns & Payments
Chapter 5
Sole Traders & Small Businesses
Chapter 6
Limited Companies
Chapter 7
Capital Allowances
Chapter 8
Obtaining Tax Relief at More Than 40%
Chapter 9
Capital Gains Tax
Chapter 10
Inheritance Tax
Chapter 11
Residence & Domicile
Chapter 12
National Insurance
Chapter 13
Buying a Property
Chapter 14
Savings & Investments
Chapter 15
Borrowing Money & Insurance
Appendix
2
UK Tax Rates & Allowances 2006/7 to 2009/10
organising
your finances
Sable specialises in Financial Advice for expats and contractors, covering Investments, Pensions, Tax, Insurance and Mortgages.
38178
For further information, call us on 0808 141 1608 or visit our website at www.1stcontact.com/sablewealth Authorised & regulated by the Financial Services Authority (FSA). The Financial Services Authority does not regulate all the services provided by Sable Private Wealth Management.
Introduction
By way of an introduction, we have extracted some of the key points that you should be aware of and could use as an ‘efficiency checklist’ in both a personal capacity, and also for those individuals who are operating a Limited Company.
Personal Planning Checklist > ISAs: Use your annual ISA allowance. Any growth on or income from an investment within an ISA is tax free. > Pensions: Contributing to a pension is one of the most tax-efficient ways to build long-term wealth in the UK. The contributions you make receive full tax relief. If you are planning on leaving the UK at a later stage, you can move the pension investments with you, too. > NI Rebates: You are allowed a rebate on a portion of your National Insurance (NI). This would normally sit as part of your State Pension and, in many cases, you are better off managing this yourself. > Partner Tax Differentials: If you have a partner, there are advantages to holding assets in the name of the
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partner with the lowest marginal rate of tax. > Tax Refunds: If you are working a part year, make sure that you investigate whether you are owed a tax refund or not. > Use your Unique Tax Status: If you are an expat or are planning on leaving the UK in the near future, make sure that you understand fully the advantages and opportunities that you may possibly have. There are very useful tax-planning opportunities around the tax statuses of being non-ordinarily resident, non domiciled and future non resident. > Money Transfers: If you are sending money overseas, seriously consider using a money-transfer specialist. The banks generally take a healthy margin on transfers; a specialist service will normally save you a fair bit. > Mortgages: If you are buying a property or remortgaging, make sure that you use an independent mortgage specialist. They will normally have access to a far wider range of products, than if you just use your local bank.
> Financial Planning: Set clear goals for your finances that cover your short, medium and long-term requirements. Use the services of an adviser to help you through your planning and decision-making process. > Alternative Investments: If you have the appetite for more risk and have a good understanding of investments, consider the tax advantages provided by VCT and EIS investment.
Limited Company Owners > Register for flat rate VAT: HM Revenue & Customs (HMRC) allows smaller companies to pay a different level of VAT on its outputs than it does on its inputs. > Write expenses off through the company: As your company is actually a business, you can offset profits with any expenses you incur while working. > Set your salary at an optimal level: Although the first £6,454 of your salaried income is tax free, you are required to pay PAYE tax and National Insurance, together
Introduction
> Offshore Bank Accounts: If you are an expat, make sure that you understand the tax advantages that could arise out of using offshore bank accounts and investments.
43.8% (20% + 11% + 12.8%) on the rest. We suggest setting your salary at a threshold of £12,000, which is the minimum wage level. > Contribute a portion of your income to an Executive Pension: Any contribution to a director’s pension will entitle you to a rebate of the 43.8% (if completed as a salary sacrifice). This effectively means that you are getting £2 for every £1 you contribute to your own pension. > Maximise your dividend payments up to the higher-rate tax threshold and leave the rest of the profits as retained earnings in the company: You can take out approximately £3,300 per month in net salary and dividends, before you start paying higher-rate dividend tax. > Keep the retained earnings in the company as long as possible: Retaining funds in the company gives you more flexibility and choice at a later date to get profits out more tax effectively. > Diarise key submission dates: There are quite a number of filing dates that you should aim to be aware of if you are the director of a Limited Company. These are of importance to both Companies House and HMRC. •
Disclaimer Please note that this financial handbook is intended as general guidance only for individual readers and does not constitute accountancy, tax, investment or other professional advice. Accordingly, 1st Contact Limited and Sable Private Wealth Management Limited accept no responsibility or liability for loss which may arise from reliance on information contained in this handbook. Please also note that tax legislation, the law and practices by government and regulatory authorities (e.g. HM Revenue & Customs) are constantly changing. We therefore recommend that for accountancy, tax, investment or other professional advice, you consult a suitably qualified accountant, tax specialist, independent financial adviser or other professional adviser; they will be able to give specific advice based on your personal circumstances. 1st Contact Limited and Sable Private Wealth Management Limited will not be held liable for information that may be outdated after the publishing date of this book, where any relevant updates can be viewed in the e-book version, which can be viewed on www.1stcontact.com.
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Chapter 1 So What Tax Do We Pay?
The exact amount of tax that each individual will pay for a tax year depends not only on the level of your income, but also on the type of income that you receive. Each of us will have a slightly different mix of income types, giving us each a completely unique tax profile.
Employment Income Employment income is currently subject to Income Tax at rates of 20% and 40%. The employee also suffers Class 1 National Insurance at a rate of 11% on earnings between £5,715 and £43,875, and at a rate of 1% on any further earnings that fall above the £43,875 mark. The combination of Income Tax and National Insurance produces effective total combined tax rates on employment income, as is shown below in the table that follows: First £5,715:
Nil
£5,715 to £6,475:
11%
£6,475 to £43,115:
31%
£43,115 to £43,875:
21%
Over £43,875:
41%
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In addition to the sums shown above, the employer must also pay secondary National Insurance Contributions at a rate of 12.8% on all payments to employees in excess of £5,715 per annum. While this further charge is paid by the employer, it naturally adds to the cost of employing that employee. This in turn limits the level of salary which the employer is able or willing to pay.
Self-Employment The self-employed pay Income Tax at exactly the same rates as employees. Their National Insurance situation is, however, completely different. Instead of Class 1 National Insurance at 11%, the self-employed pay Class 4 National Insurance at the lower rate of 8%. There is no employer’s secondary National Insurance but, for all self-employed taxpayers with annual earnings over the ‘small earnings exception’ limit of £5,075, there is also Class 2 National Insurance of £2.40 per week to pay.
First £5,075:
Nil
£5,075 to £5,715:
£124.80 (fixed cost)
£5,715 to £6,475:
8%
£6,475 to £43,115:
28%
£43,115 to £43,875:
21%
Over £43,875:
41%
Partnership trading income is also subject to exactly the same tax regime.
Property Income The one great virtue that can be attributed to property income is that it is generally exempt from all classes of National Insurance. Property investors (landlords) receiving rental income only will pay Income Tax at the same rates as those detailed above for employment or selfemployment income; however, these individuals have no NI liabilities.
Interest and Other Savings Income The 10% starting rate of Income Tax was abolished for all other types of income from 06 April 2008, but continues to apply to interest and other savings income not classed as dividends. This income is therefore still subject to Income Tax at three rates: 10%, 20% and 40%. It is important to note that the 10% starting rate can now only apply where the taxpayer’s other income (excluding dividends) is low enough to enable their interest and other savings income to fall into the starting rate band. Subject to this point, the 2009/10 tax rates on interest and other savings income are as follows: First £6,475:
Nil
£6,475 to £8,915:
10%
£8,915 to £43,875:
20%
Over £43,875:
40%
Investment Income
Dividend Income
Investment income is also exempt from all classes of National Insurance, but is subject to a slightly different Income Tax regime from earned or property income.
The tax treatment of dividend income is rather more complex than the above. For all dividend income – whether UK or foreign – the actual Income Tax rates that apply are as follows:
For tax purposes, we must divide investment income into two categories:
First £6,475:
Nil
£6,475 to £43,875:
10%
Over £43,875:
32.5%
> Interest and other savings income not classed as dividends; and > Dividends.
However, in practice, the position is considerably more complicated.
7
So What Tax Do We Pay?
This time, the combination of Income Tax and National Insurance produces effective total combined tax rates on self-employment income, as follows:
For each 90 pence of dividend actually paid by a company, a tax credit of one ninth, or 10 pence, is added. This produces a ‘gross’ dividend of £1. The recipient is then treated as having received a dividend of £1. When calculating their tax liability, however, the taxpayer may then deduct the 10 pence credit.
rental income. The position for older taxpayers is, however, somewhat more complex, as we shall now examine.
The practical upshot of all this is that when one looks at the tax payable on the actual amount of dividends received, the effective Income Tax rates on most dividends are actually 0% and 25%.
Younger and older taxpayers are exempt from National Insurance.
However, the ‘grossing up’ under the tax credit system has another effect – it reduces the size of the tax bands by one tenth. This produces the following effective tax rates for taxpayers receiving dividend income in 2009/10: First £39,487.50:
Nil
Over £39,487.50:
25%
Foreign Dividends from Large Shareholdings Prior to 06 April 2008, the one ninth tax credit described above did not apply to dividends received by UK taxpayers from foreign companies (i.e. companies not resident in the UK). From 06 April 2008 onwards, however, the tax credit does apply to most foreign dividends, except where the recipient taxpayer owns 10% or more of the share capital in the paying company.
Pensions Pensions received by taxpayers aged under 65 are taxed at the same rates as
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Older Taxpayers All of the above rates and tables apply to male taxpayers aged 16 to 64, and female taxpayers aged 16 to 59.
For those reaching State retirement age (currently 65 for men and 60 for women), the exact date on which National Insurance ceases to apply depends on the type of income: > For employees, the exemption applies to any payments made after State retirement age is reached. > For self-employed taxpayers, the exemption is not applied until the tax year after the one in which they reach retirement age. (Except for taxpayers born on 06 April, who are exempt from National Insurance for the tax year beginning on the day they reach retirement age.) Employers must continue to pay secondary National Insurance on payments to employees over State retirement age. Individuals aged 65 or over by the end of the tax year are also entitled to a higher personal allowance. The personal allowance is increased again at the age of 75. (These age limits are not dependent on the taxpayer’s gender.) •
Chapter 2
A number of future tax amendments – proposed to apply from the 06 April 2009 tax year or later – have already been announced.
> Basic personal allowances will be reduced by £1 for every £2, where an individual’s ‘adjusted net income’ exceeds £100,000.
However, given the current government’s financial difficulties, it is highly probable that the measures which have been announced will be subject to some significant changes.
Adjusted net income is total income less specified deductions – such as trading losses, payments made to pension schemes (grossed up if necessary) and grossed up gift aid contributions. For that band of income, tax will be over 60%!
Nevertheless, it is still worth considering the newly proposed changes with the knowledge that further amendments are highly likely. These further changes will most likely relate to Income Tax. The future changes from April 2010, which are currently proposed, are as follows: > The personal allowance for taxpayers aged 75 or older is guaranteed to be at least £10,000 for 2011/12. > The Corporation Tax rate for small companies will remain at 21%. > The Inheritance Tax nil rate band will increase again to £350,000. > Taxable income exceeding £150,000 will be taxed at a higher rate of 50%.
Overview of Tax Changes
Overview of Tax Changes
> There will be three rates of tax on dividends: 10% for basic rate taxpayers, 32.5% for 40% taxpayers and a new rate of 42.5% for 50% taxpayers. > Trusts will pay tax on their dividend income at 42.5%, and the trust rate will be increased from 40% to 50%.
Planning for Tax Changes Proposed changes to the tax regime may sometimes result in an anticipated change in the tax rate, applying to a person’s income or capital gains. Where the rate applying is set to decrease, this only adds more weight to the general philosophy that taxable
9
income and gains should be deferred whenever legitimately possible. Where, however, the rate applying is set to increase, there may be instances where it is actually beneficial to accelerate taxable income or capital gains in order to benefit from the lower rate currently applying. This is only worthwhile, however, where the current tax rate applying is lower than the future rate to such an extent that this will adequately compensate for the effective interest cost arising by accelerating the tax liability. Furthermore, even in a situation which meets this criterion, it will only ever be worth accelerating the taxable income or capital gains if it is certain that the income or gains are going to be taxable in the foreseeable future.
10
Most of the cases where opportunities exist to legitimately accelerate or defer taxable income arise in the context of taxpayers in business, and we will return to this subject in more detail later. Capital gains are covered elsewhere. It nevertheless remains worthwhile for all taxpayers to bear in mind the principles set out above, namely: It is generally beneficial to defer taxable income or capital gains whenever legitimately possible but, in some instances, it may be better to accelerate these where a future increase in the applicable taxation rate is anticipated. This is the main reason that operating through a personal service company is so beneficial, as it not only allows one to save tax, but also to defer tax. •
Chapter 3 Tax Efficient Investments
In this chapter, we will consider the various forms of tax-advantaged investments currently available to help you reduce your current or future tax liabilities.
This limit will be raised to £10,200 (£5,100 of which can be invested in cash) for those aged 50 and over from 06 October 2009, and for all ISA investors from 06 April 2010.
The role of this handbook is to make you aware of the types of investments available and the tax implications of investing in them. All forms of investment carry an inherent degree of risk. We strongly recommend that you always consult a financial adviser before making any of the types of investment described here.
Each person’s annual ISA investment may be made through investments of up to £3,600 in ‘Cash ISAs’, together with other investments in quoted shares and securities within ISAs, up to an overall total of £7,200 for all ISA investments for the year.
The simplest piece of basic tax planning is to make full use of your annual ISA allowance. Investments in ISAs are completely tax free during your lifetime – that means that all interest, dividends and capital gains within the ISA are totally exempt from tax. While these exemptions are a valuable tax-saving tool, investors should be aware of one thing: ISAs are only exempt from tax during your lifetime. ISAs are NOT exempt from Inheritance Tax! The current annual investment limits are £3,600 for cash and £7,200 overall, including quoted shares and securities.
Tax Efficient Investments
Individual Savings Accounts (ISAs)
For e.g. an individual could invest £3,600 in a Cash ISA, plus a further £3,600 in quoted shares and securities in another ISA. Alternatively, they could invest just £1,000 in a Cash ISA and a further £6,200 in quoted shares and securities in another ISA, or even just invest the whole £7,200 in quoted shares and securities within the same ISA. The two investment limits may be spread across as many ISAs as the investor wishes. For e.g. a person could invest £2,000 in a Cash ISA, a further £4,000 in quoted shares and securities through another ISA, and another £1,200 in either cash or shares through a third ISA.
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Any combination is permitted, provided that no more than £3,600 in total is invested in Cash ISAs, and no more than £7,200 in total in all ISAs. These investments are available to all UK resident individuals aged 18 or over. Cash ISAs are also available to 16 and 17-year-old UK resident individuals, with the usual £3,600 annual investment limit. Interest, dividends and capital gains received within the ISA may be re-invested, and this does not count towards the annual investment limits. Funds may also be transferred from existing Cash ISAs into shares and securities still held within the ISA regime. While there is no ‘exit charge’ on withdrawal of funds from your ISA, it is important to remember that funds withdrawn may not be reinvested once the annual investment limit has been reached.
Pension Schemes Personal pension contributions attract tax relief at the investor’s highest marginal rate of Income Tax, often 40% or, as we shall see later, even more. Unfortunately this has been tweaked despite ‘A-Day’, which arose on 06 April 2006 – the day on which the entire UK pensions regime underwent a radical transformation. On A-Day, a complex system of seven different pension regimes were brought together under one single set of rules. The situation is now complex and we would recommend that anyone seeking to undertake pension planning, or tax planning involving pensions, should take independent professional advice. 12
Sable specialise in this area, so please do get in touch if you have any questions. The two main tenets of the new pension taxation system – which came into force in 2006 – are the annual allowance and the lifetime allowance. The annual allowance represents the maximum amount that may be added to an individual’s total pension funds during the tax year ended on 05 April. For 2009/10, the annual allowance has been set at £245,000 (increasing to £255,000 by 2010/11). The lifetime allowance represents the maximum permitted value for all of an individual’s qualifying pension savings. This allowance is set at £1,750,000 for 2009/10 and will rise over the next year as follows: 2010/11: £1,800,000 A 25% tax charge will be levied on any funds in excess of the lifetime allowance. Such excess funds may alternatively be withdrawn as a lump sum, but the charge on such withdrawals increases to 55%. Anyone whose pension fund or funds are likely to have a total value in excess of the lifetime allowance, should take specialist professional advice promptly. It is important to remember that both the annual allowance and the lifetime allowance must be applied to each individual’s total qualifying pension funds. This will include any element of foreign pension funds derived from contributions for which UK tax relief has been obtained. An individual’s total qualifying pension funds will also include any defined benefit
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or ‘final salary’ schemes. For defined benefit schemes, a valuation factor of 10:1 is used to measure the increase in the value of the scheme for the purposes of applying the annual allowance.
Since basic-rate tax relief at 20% is given at source on the contributions; the maximum net contribution qualifying for relief in 2009/10 is therefore the greater of: a) £2,880; or
If contributions, or deemed contributions in the case of a defined benefit scheme, in excess of the annual allowance are made, a 40% tax charge will apply to the excess.
Tax Relief for Pension Contributions It is important to understand, that under the new regime after ‘A-Day’ there is no longer a direct link between the maximum amount of contributions that may actually be made, and the maximum that will attract tax relief. Taxpayers may, in fact, make unlimited contributions if they so desire but, as is explained above, they will incur penalty charges if they breach either the lifetime allowance or the annual allowance. These charges effectively ensure that such excessive contributions are not attractive from an investment perspective. Furthermore, while the annual allowance and the lifetime allowance govern the maximum contributions which may be made to qualifying pension schemes during the year (without incurring a tax charge), the amount of gross contributions qualifying for tax relief is also limited to the greater of:
b) 80% of the taxpayer’s total ‘earnings’ for the tax year. In 2009/10, a taxpayer with ‘earnings’ of £245,000 or more, and existing pension funds not exceeding £1,505,000 in value, can obtain tax relief of up to £98,000 by making the maximum qualifying net pension contribution of £196,000 (i.e. 80% of £245,000). Unfortunately, ‘earnings’ for this purpose include only employment income and self-employed or partnership trading income. Many sources of income – including most rental income and any interest or dividend income – are not classed as earnings for pension purposes. Furthermore, unlike the previous system, the new regime does not allow taxpayers to base the calculation of their maximum personal pension contributions on their earnings in the previous five tax years. The new ‘simplified’ system is based on current year earnings only.
a) £3,600; or
It is important, therefore, to consider maximising pension contributions in the current tax year whenever a fall in ‘earnings’, as defined above, is anticipated. This might include those who:
b) The taxpayer’s total ‘earnings’ for the tax year.
> Form a Limited Company to take over a business or partnership.
(Naturally, there is also a third limiting factor: the amount of contributions actually made!)
> Give up employment to pursue another form of income, which may not qualify as ‘earnings’ – e.g. rental income.
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It is also worth bearing in mind the fact that the reduction in the basic rate of Income Tax means that net pension contributions now represent 80% of the gross contribution, rather than the former 78% for contributions made before 06 April 2008. For e.g. a net contribution of £7,800 made before 06 April 2008 would have equated to a gross contribution of £10,000. The same net contribution made this year will result in a gross contribution to the taxpayer’s pension scheme of just £9,750. In other words, pension contributions made last year represented better value for money than contributions made this year. (About 2.6% better value, in fact.) On the other hand, however, while the tax relief given at source on pension contributions has fallen, the further relief which higher-rate taxpayers receive through their self-assessment Income Tax calculations has increased. A net contribution of £7,800 made during 2007/8 would have provided a total tax relief of £4,000, of which £2,200 was given at source, leaving £1,800 to be claimed via the selfassessment system. The same contribution made in 2009/10 will provide total tax relief of just £3,900 (£9,750 at 40%). However, only £1,950 of relief will have been given at source, and the amount claimed via the selfassessment system will therefore increase to £1,950.
Whether this is good news or bad news overall depends on whether you’re more interested in accumulating a pension fund for the future, or in making immediate tax savings. If it’s the value of your fund which is more important to you, then you will simply need to increase the amount of your net contributions from 2009/10 onwards. For those whose main objective is to reduce their tax liabilities, however, this change means that pension contributions have become better value for higher-rate taxpayers since 06 April 2008. There is however a nasty sting for individuals earning more than £150,000 per annum. With effect from April 2011, these individuals will have their income tax relief on pension contributions restricted to the basic rate. Notwithstanding, there are ‘forestalling’ provisions that have been put in place to prevent access to relief being accelerated prior to the new provisions taking effect. These apply to contributions made on or after 22 April 2009.
Venture Capital Trusts (VCTs) Venture Capital Trusts are a specialised type of tax-advantaged investment vehicle, allowing a broad range of investors to pool their resources and invest in new or developing business ventures. For the tax year 2009/10, up to £200,000 may be invested in Venture Capital Trusts, generally providing Income Tax relief at a rate of 30% of the amount invested. To be precise, the relief given is equal to the lower of: 15
Tax Efficient Investments
> Expect to benefit from significant tax reliefs the following/next year (e.g. capital allowances).
> 30% of the amount invested (up to a maximum investment of £200,000); and > The amount which reduces the individual’s total Income Tax liability to nil. Example During the year ended 05 April 2010, Mike will receive a salary of £120,000. This will give him a total Income Tax liability for 2009/10 of £37,930. Mike wishes to invest £200,000 in a Venture Capital Trust. The maximum relief available for such an investment, at 30%, would be £60,000. However, this exceeds Mike’s 2009/10 Income Tax liability and if he was to make the whole of this investment before 06 April 2010, he would be wasting over £20,000 of potential relief. What Mike should do, therefore, is to invest no more than £126,433 in the Venture Capital Trust before the end of the 2009/10 tax year on 05 April 2010 and, if he so wishes, invest the balance after that date so that it falls into 2010/11. This way, Mike will be able to get the full £60,000 worth of relief on his investment. Note that the relief for Venture Capital Trust investments is given only against Income Tax. No relief is available against Capital Gains Tax, or against National Insurance of any class. Had Mike been a self-employed taxpayer on the same level of income, his maximum Venture Capital Trust relief for 2009/10 would have remained unaltered, even though he would have been paying £3,814 in Class 4 National Insurance.
16
Venture Capital Trusts may only invest in qualifying trading companies with gross assets not exceeding £7,000,000 prior to the investment being made (and not exceeding £8,000,000 immediately after that investment). Venture Capital Trust shares issued after 05 April 2006 must be held for at least five years, or the initial tax relief will be withdrawn. (A minimum holding period of three years applies to Venture Capital Trust shares issued between 06 April 2000 and 05 April 2006.) Dividends on qualifying ordinary shares in a Venture Capital Trust are tax free. Capital gains arising on the sale of such shares after the expiry of the minimum holding period, referred to above, are also tax free. ‘Qualifying’ in this context means that the original investment qualified for Income Tax relief, as explained above. (Had Mike invested the whole £200,000 in 2009/10, all of his shares would have qualified for relief, notwithstanding the fact that the amount of relief given would have been restricted.)
Enterprise Investment Scheme (EIS) Shares Investments in Enterprise Investment Scheme shares up to a specified annual limit each tax year are eligible for Income tax relief at the lower of 20%, or at the individual’s own total Income Tax liability. The annual investment limit is £500,000, giving a maximum tax reduction in any one year of £100,000. Up to half of any Enterprise Investment Scheme investments made between
There is a minimum investment limit of £500 per tax year and this applies to each Enterprise Investment Scheme company in which a taxpayer invests. However, where the taxpayer invests through an approved investment fund, this minimum investment limit does not apply. Enterprise Investment Scheme shares are issued by a single, qualifying, unquoted trading company. As with Venture Capital Trust investments, the company issuing the Enterprise Investment Scheme shares must have gross assets not exceeding £7,000,000 prior to the share issue (and not exceeding £8,000,000 immediately after the issue). To obtain Income Tax relief, the investor must not be connected with the company issuing the shares. An investor is generally deemed to be connected with the company for this purpose, when they own 30% or more of the share capital in the company after the Enterprise Investment Scheme shares are issued. Capital Gains Tax reinvestment relief may still be obtained where appropriate, however, even when the taxpayer is connected with the company. Where the investor is not connected with the company issuing the Enterprise Investment Scheme shares, the total combined Income Tax and Capital Gains Tax savings could total up to 38% of the amount invested (or even 60% where the gain to be deferred arose before 06 April 2008).
You must bear in mind, however, that investment in an unconnected Enterprise Investment Scheme company is inherently risky, and professional advice from a financial adviser is essential when choosing such investments. Products are available that reduce the overall level of risk by pooling several investors’ funds and investing them in a portfolio of Enterprise Investment Scheme shares issued by a range of different companies. Enterprise Investment Scheme shares must be issued wholly for cash, and must be held for at least three years (and sometimes longer). The issuing company must also continue to carry on a ‘qualifying trade’ (broadly, one which is not property-based) throughout this period. The Income Tax relief on the initial investment will be withdrawn if any of these conditions are breached. Any capital gain arising on the sale of Enterprise Investment Scheme shares that initially qualified for Income Tax relief, as described above, is exempt from Capital Gains Tax. This exemption is also lost if the Income Tax relief is withdrawn.
Tax Efficient Investments
06 April and 05 October in any year may be carried back for Income Tax relief in the previous tax year, subject to an overall maximum carry back of £50,000.
Conversely, a capital loss on sale of Enterprise Investment Scheme shares remains allowable, although it must be reduced by the amount of Income Tax relief given on the initial investment. Note that it is only the capital gain on the Enterprise Investment Scheme shares themselves that may be exempt. Gains held over on reinvestment into Enterprise Investment Scheme shares will 17
become chargeable to Capital Gains Tax on a sale of those shares, at any time.
‘cashed in’ free from Income Tax or Capital Gains Tax.
Further Investment Limits
Receiving Interest Gross
Under a similar scheme to the Enterprise Investment Scheme, companies may make tax-advantaged investments in other qualifying trading companies. This other scheme is known as the Corporate Venturing Scheme.
A number of accounts are now available which will pay interest gross without the deduction of basic rate Income Tax. Typically, these accounts are accessed through an intermediary, such as a stockbroker.
Companies issuing shares under the Enterprise Investment Scheme or the Corporate Venturing Scheme, or in which investments are made by a Venture Capital Trust, may not raise total new capital of more than £2,000,000 in any 12-month period under the three schemes taken together.
It is important to remember that the interest received on such accounts remains taxable. The full amount of tax due on the interest must ultimately be paid through the self-assessment system.
For all three schemes, the recipient company must also have fewer than 50 full-time (or equivalent) employees.
Friendly Societies Due to a little known quirk in the tax system, taxpayers aged between 16 and 74 years may invest up to £25 per month in tax-exempt savings policies issued by friendly societies. Not only do these policies provide life cover, but they also provide an additional opportunity to make investments within a tax-free environment. Typically, the funds are invested in quoted shares and securities. Investments in friendly societies do not need to be taken into account when considering whether the taxpayer has utilised their annual ISA investment limits. The tax exempt savings policies run for a period of ten years, and may then be 18
The receipt of gross interest does, however, represent a considerable cashflow advantage. Instead of suffering basic rate Income Tax at source, the taxpayer will retain the full amount of interest received and should not have to pay the tax arising on this income for at least another ten months, and possibly up to 22 months.
Offshore Bonds & Platforms Certain life-assurance policies and offshore bonds provide the opportunity to accumulate income in a form that is treated as capital growth, and not taxed until the funds are realised. Furthermore, for suitably qualifying investments, up to five per cent of the initial capital invested may be withdrawn each year free from tax. This enables the investor to receive what is, in effect, a tax-free income stream, while at the same time the balance of their investment fund continues to appreciate in value within a tax-free environment.
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There are opportunities to utilise offshore investment platforms to manage portfolios (or even actively trade) so that gains or income are strictly kept offshore. This is of particular importance to nondomiciled or non-resident individuals (discussed elsewhere in more detail). Some of these offshore platforms are extremely cost efficient, flexible and allow for the trading of direct equities and even currencies.
what curtailed the tax benefits of these investments.
The Offshore bond wrapper can be very effectively combined with an offshore platform, thereby creating a tax-efficient tool for the more active investor.
Firstly, the total cumulative amount of loss which a non-active partner may claim is restricted to the amount of capital which they have invested in the partnership.
Partnership and other Trading Losses A number of structures have been developed over the last few years to give investors ‘sideways loss relief’ for investments in partnerships and other trading entities. The most successful of these schemes have undoubtedly been film partnership investments, and we will return to these shortly. In principle, these schemes work by enabling the investor to claim partnership or other trading losses and to set these off against their other income in the same tax year. This provides effective tax relief at the investor’s highest marginal rate of tax. The beauty of these schemes lies in the fact that the loss claimed is usually only (or mostly) a technical loss for tax purposes, generally due to the availability of special allowances in the underlying trade, and is therefore not a true economic loss. Hence the investor will generally get their money back in the end! Unfortunately, recent anti-avoidance legislation has some20
The first attack came with legislation specifically targeted at ‘non-active’ partners, i.e. investors who are not actively involved in the partnership trade. For this purpose, a partner is generally classed as ‘non-active’ if they spend an average of less than ten hours per week engaged in the partnership’s trading activities.
Secondly, an annual limit of £25,000 has been placed on claims for partnership loss relief by non-active partners. This limit applies to the total claims made by a taxpayer in any tax year, in respect of all partnerships in which they are a non-active partner. Furthermore, for most investments made by non-active partners after 01 March 2007, a further rule excludes any capital contributed to the partnership where the main purpose, or one of the main purposes, behind the contribution is to enable the partner to claim sideways loss relief. Where this rule applies to capital invested after 01 March 2007, the investment cannot be counted towards the amount of capital invested by the non-active partner for the purposes of calculating their maximum cumulative claim for partnership loss relief under the first rule above. From 12 March 2008, any trading losses made by a ‘non-active sole
Similarly, relief is barred altogether for trading losses made by a ‘non-active sole trader’ as a result of arrangements made on or after 12 March 2008 for tax-avoidance purposes.
Film Relief Film partnerships and other investments qualifying for film relief continue to enjoy significant tax advantages, as none of the restrictions on ‘sideways loss relief’ apply where a partnership or other trading loss is derived from ‘film-related expenditure’.
Child Trust Funds Every child born in the UK on or after 01 September 2002 is entitled to a Child Trust Fund. Parents of new-born children will receive a £250 voucher to use to open up a Child Trust Fund account on their child’s behalf, at major banks and building societies. If the child’s parents fail to use the voucher within a specified period, the Government will open a Child Trust Fund to the same value on the child’s behalf. A second payment of £250 will be made on the child’s seventh birthday. For families on lower incomes, both of these payments are increased to £500. Parents, family and friends of eligible children may also put up to an additional £1,200 in total per tax year into each child’s Child Trust Fund.
Monies within the Fund will be invested in a long-term account to grow free from Income Tax or Capital Gains Tax, rather like an ISA. On maturity, the funds within the Child Trust Fund may be transferred to an ISA in the child’s name. However, the first of such funds will not mature for more than a decade!
Lloyds Underwriters Lloyds underwriters are also exempt from the restrictions on ‘sideways loss relief’, as referred to above.
Business Premises Renovation Allowances Some readers may recall the Enterprise Zone Property Trusts which were very popular a few years ago. Sadly, the last Enterprise Zone’s tax-favoured status expired in October 2006. On 11 April 2007, however, a new relief came into being for expenditure on the renovation or conversion of vacant commercial property in designated disadvantaged areas, which is then brought back into business use. The property must have been vacant for at least a year and certain types of business use are excluded from the relief. The new business use does not need to be the same as the property’s previous use, however, and could include offices or shops. This new relief, known as the Business Premises Renovation Allowance, provides immediate 100% relief for qualifying expenditure at the investor’s highest marginal rate of tax. • 21
Tax Efficient Investments
trader’ must also be included within the amounts covered by the £25,000 limit.
Chapter 4 Tax Returns & Payments
Tax Returns Most higher-rate taxpayers, directors and people in receipt of any gross, untaxed income will fall into the selfassessment system. Under the self-assessment system, the taxpayer must complete and submit a tax return each year by: > 31 October following the tax year for paper returns; or > 31 January following the tax year for electronic returns. If your return reaches HM Revenue & Customs by the above deadlines, they will calculate the amount of tax you are due to pay. However if your returns are submitted late, from April 2010 the following penalties will apply: > £100 penalty immediately after the due date for filing (whether or not the tax has been paid); > Daily penalties (£10 per day; annual obligations only) for returns more than three months late, up to 90 days; 22
> Penalties of five per cent of tax due for the return period for prolonged failures (over six months and again at 12 months); and > Higher penalties of 70% of the tax due where a person fails to submit a return for over 12 months, and has deliberately withheld information necessary for HMRC to assess the tax due (100% penalty if deliberate, with concealment).
Tax Payments The Income Tax due under the self-assessment system is basically the taxpayer’s total tax liability for the year, less any amounts already deducted at source or under PAYE and less any applicable tax credits. All Income Tax due under the self-assessment system, regardless of the source of the income or rate of tax applying, is payable as follows: > A first instalment or ‘payment on account’ is due on 31 January during the tax year; > A second payment on account is due on 31 July, following the tax year; and > A balancing payment or, in some cases, a repayment, is due on
Each payment on account is usually equal to half of the previous tax year’s self-assessment tax liability. However, payments on account need not be made when the previous year’s self-assessment liability was either: a) No more than £500; or b) Less than 20% of the taxpayer’s total tax liability for the year. The £500 threshold referred to above will be increased to £1,000 in respect of payments on account due on or after 31 January 2010. Hence, where a taxpayer’s self-assessment liability for 2008/9 is no more than £1,000, no payments on account will be due on 31 January or 31 July 2010. From April 2010, the following penalties for late payment will arise: > penalties of five per cent of the amount of tax unpaid, generally one month after the payment due date; > further penalties of five per cent of any amounts of tax still unpaid at six and 12 months; and > suspension of late payment penalties where the taxpayer agrees a time to pay arrangement (where a tax debt is paid over time) with HMRC.
The Self-Assessment ‘Double Whammy’ The system of payments on account under self-assessment, as described above,
causes major cashflow problems whenever a taxpayer first receives a new source of income, or experiences a significant increase in any existing source of income, outside the PAYE system. Effectively, one and a half years’ worth of tax on the new source, or the increase, falls due on 31 January following the tax year. Six months later, another half-year’s worth of tax becomes payable, meaning that two years’ worth of tax must be paid within a six-month period. This is often the cause of major cashflow problems and it is imperative that anyone receiving a new source of income for the first time, or experiencing a significant increase in any income which is not within the PAYE system, makes appropriate provision for the tax arising. Example In April 2008, Reg buys an apartment block in a popular seaside resort. During 2008/9, this property yields rental profits of £20,000. Reg is a higher-rate taxpayer and, prior to 2008/9, all of his income was received under the PAYE system. Hence, on 31 January 2010, Reg has to pay additional Income Tax under the self-assessment system for the first time. On that date he will have to pay a total of £12,000, made up of £8,000 tax due for 2008/9 (£20,000 x 40%) and his first payment on account for 2009/10 of £4,000 (half of £8,000). Furthermore, Reg will also have to make a second payment on 31 July 2010, on account of £4,000 in respect of 2009/10. By this point, Reg has had to pay Income Tax equivalent to 80% of his first year’s profits!
23
Tax Returns & Payments
31 January following the tax year of submission.
What If Income Reduces? Applications to reduce payments on account may be made when there are reasonable grounds to believe that the following year’s self-assessment tax liability will be at a lower level. Reduced payments on account may then be made based on the estimated selfassessment tax liability for the following year. If, however, it later transpires that the actual liability for the following year is greater than the reduced payments on account made by the taxpayer, interest will be charged on the difference. Nevertheless, in certain circumstances, this does provide scope to avoid the adverse cashflow impact of the ‘payments on account’ system. Example Scott has a salary of £50,000 and also owns a small trading company. In 2008/9, Scott takes a dividend of £20,000 out of his company. This gives rise to a selfassessment tax liability of £5,000 due on 31 January 2010. Normally, Scott would also have to make payments on account of £2,500 on 31 January and 31 July 2010. However, he decides to refrain from taking any dividends out of his company during 2009/10, and is therefore able to reduce his payments on account to nil. As Scott does not take any dividends out of his company during 2009/10, he has no selfassessment tax liability to pay on 31 January 2011 and does not need to make any payments on account on 31 January or 31 July 2011. In 2010/11, therefore, he will be able to take out dividends once more without having had to make any payments on account in respect of this income.
24
In other words, where a taxpayer can arrange to receive their income bi-annually, they are able to avoid making any payments on account.
Self-Assessment and PAYE Taxpayers with self-assessment tax liabilities not exceeding £2,000 who are also in employment or in receipt of a private pension may apply to have the tax collected through their PAYE codes for the following tax year. This produces a considerable cashflow advantage, where relevant. HM Revenue & Customs will only guarantee this treatment when you submit your tax return by 30 September following the tax year. (E.g. Submit your tax return for the year ending 05 April 2009 by 30 September 2009 to claim to have up to £2,000 collected through your PAYE coding for 2010/11.)
Investment Income and PAYE HM Revenue & Customs are now attempting to collect Income Tax on up to £10,000 of estimated annual investment income, including rental income, interest and dividends, through the PAYE system whenever possible (i.e. where the taxpayer also has employment income or private pensions). This results in the tax on this income being paid on a ‘current year’ basis as it arises, just like the tax on wages and salaries. Even when HM Revenue & Customs get their estimates right, this accelerates the payment of tax on this income by an average of more than six months. For a higher-rate taxpayer, the resultant interest cost is effectively equivalent to around an extra 1% to
1.5% tax charge! Furthermore, where HM Revenue & Customs overestimate the investment income, the excess tax paid will need to be reclaimed through the selfassessment system and interest will only run on the repayment from 31 January, almost nine months after the end of the tax year, or an average of almost 16 months after payment of the excess tax.
> Partnership trading income;
Worse still, where the taxpayer might otherwise have been able to apply to have up to £2,000 of tax collected through a later year’s PAYE coding, as explained above, this new approach by HM Revenue & Customs would result in tax payments being accelerated by two years!
> ‘Large’ foreign dividends.
Nevertheless, the PAYE system is most certainly not the way to save up for your tax liabilities! Instead, we would generally recommend an ISA, a high-interest bearing deposit account or an offset mortgage.
New Sources of Untaxed Income Strictly speaking, whenever a taxpayer begins to receive untaxed income from a new source, they should advise HM Revenue & Customs of this new source by 05 October following the tax year in which it first arises. New sources of income for this purpose include: > Self-employment trading income;
> Interest received gross; > Foreign rental income; > Foreign interest; and
In practice, however, as long as the taxpayer completes and submits a tax return by the usual deadline, includes the new source of income and pays the full amount of tax due on time, there are generally no penalties for failure to report most new sources of income by the 05 October deadline. A taxpayer who commences trading as a sole trader or as a partner in a trading partnership must, however, register with HM Revenue & Customs for Class 2 National Insurance within three months of the end of the calendar month in which trading commences. Failure to register these activities on time carries a penalty of £100.
Personal Pension Payments Made Directly by Employers From 06 April 2006, employers making personal pension payments directly on behalf of their employees may choose to operate the ‘net pay arrangements’ or to operate basic rate tax relief at source. It is important to understand which method is being operated. Under the net pay arrangements, full tax relief is already given via the PAYE system, and the employee need 25
Tax Returns & Payments
Naturally, once investment income has been removed from your PAYE coding, you will need to ensure that you are able to pay the tax arising when it falls due under the self-assessment system. As explained above, this can be especially painful when the ‘double-whammy’ effect comes into play.
> UK rental income;
not make any further claim in their tax return. Where only basic rate tax relief is given at source, however, the employee needs to ensure that they claim any higherrate tax relief due via their tax return. PAYE forms If you’re an employee, your employer must give you certain documents – forms P45 and P60 – about the tax you pay on your wages. If you receive benefits or expenses, your employer sends a P11D to HM Revenue & Customs (HMRC). You receive a copy of that information. P45 You get a P45 from your employer when you stop working for them. It’s a record of your pay and the tax that’s been deducted from it so far in the tax year. A P45 shows: > Your tax code and PAYE (Pay As You Earn) reference number; > Your National Insurance number; > Your leaving date; > Your earnings in the tax year; and
during the tax year. Your employer should give you a P60 to keep as a record at the end of every tax year (which runs from 06 April to 05 April of the next year). If your employer doesn’t give you a P60 at the end of the tax year, ask for it – you’re entitled to it by law if you are still working for the employer on 05 April. You might need it: > To complete a Self-Assessment tax return, if this applies to you; > To claim back any tax you’ve overpaid; and > To apply for Tax Credits. You may also need it as proof of your income if you apply for a loan or a mortgage – so it’s important to keep all your P60s safe. P11D Your employer uses a P11D to tell HMRC about the value of any benefits in kind they’ve given you during the tax year. This means benefits or expenses that effectively increase your income, such as:
> The tax deducted from your earnings. > A company car; A P45 has four parts – Part 1, Part 1A, Part 2 and Part 3. Your employer sends Part 1 to HMRC and gives you the other three. When you start a new job, or claim a Jobseeker’s Allowance, you give Part 2 and Part 3 to your new employer or to the Jobcentre. You keep the remaining one – Part 1A for your own records. You are legally entitled to a P45 from an employer when you stop working for them. P60 Your P60 is the summary of your pay and the tax that’s been deducted from it 26
> Private medical insurance; or > Interest-free loans Your employer will only declare them if you’ve earned at least £8,500 in the year, including the value of the benefits. They will work out how much each benefit is worth, record it on the form and send it to HMRC. You’ll also get a copy, which you’ll need for your records or if you complete a tax return. A P11D is proof of extra income if you apply for a loan. •
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Chapter 5 Sole Traders & Small Businesses
In this chapter we will explore some of the tax-planning issues common to both unincorporated businesses (sole traders and partnerships) and incorporated businesses (companies). Issues specific to people with their own companies will be covered in the next chapter. Please note that all businesses set up as either partnerships or companies may potentially be affected by the proposed ‘income-shifting’ legislation, which at the moment has been put on ‘the back burner’.
personal allowances (generally £6,475 for 2009/10, but see Appendix A for further details). Note, however, that payments to employees below State retirement age in excess of the National Insurance earnings threshold (£5,715 for 2009/10) will be subject to both employer’s and employee’s National Insurance, giving rise to a total tax cost of 23.8%.
Capital allowances will also be an important factor for many businesses.
In many cases, it will therefore make sense to limit any salary payments to family members for 2009/10 to a maximum of £5,715, rather than the full amount of the personal allowance.
Generally, for most tax reliefs applying to businesses, it is the business’s own accounting period and year-end date which is the critical deadline. There are, however, a few matters where the end of the tax year provides the critical deadline date.
However, where the employer is a higher-rate taxpayer sole trader, or a partnership comprised predominantly of higher-rate taxpayer individuals, a salary equal to the full personal allowance will often remain beneficial overall for tax purposes.
‘Family Allowances’
The total National Insurance cost of the additional £760 salary over the earnings threshold will be £180.88 (£760 x 23.8%), including employer’s National Insurance of £83.60.
Those with a spouse, partner or other family member, working in their business may wish to maximise the use of personal allowances by ensuring that these employees receive sufficient salary or wages each tax year to utilise their 28
However, the total tax relief received by the higher-rate taxpayer employer on the
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extra £760 salary will be £345.88 (£760 + £83.60 = £843.60 x 41%), thus producing an overall net saving of £165 (£345.88 - £180.88). Any salary payments should, of course: > Only be considered when justified by the amount of effort put into the business by the intended recipient; > Actually be paid to the employee; and > Be reported to HM Revenue & Customs as required under the PAYE system (even if no Income Tax or National Insurance is actually due). Where justified, salary payments to family members should attract tax relief in the employer’s business. A further benefit of these payments is the fact that, provided payments exceed the level of £95 per week, the recipient will be entitled to State benefits, including a State Pension on reaching the Statespecified retirement age.
PAYE and National Insurance When making small salary payments, it is important to be aware of the weekly or monthly payment thresholds which apply for PAYE and National Insurance purposes. Each employer has to operate PAYE by reference to ‘pay periods’. A ‘pay period’ may be either a week or a month, depending on how the employer operates their payroll. For Income Tax purposes, the personal allowance and basic rate tax band are divided over all of the pay periods in the tax year. When a payment is made 30
to an employee, only the cumulative proportion for the tax year to date can be taken into account. Still, when it comes to Income Tax, it does all ‘come out in the wash’ and if the pay period system results in an overpayment, the excess can always be reclaimed subsequently: when another salary payment is made, through the self-assessment system or by way of a repayment claim. Sadly, National Insurance does not operate in the same way. Unlike Income Tax, there is no scope for reclaiming any excess National Insurance payments when the final total pay for the tax year is known. For most employees, any payment in excess of the ‘primary threshold’ for the pay period will attract both employee’s primary National Insurance at 11% and employer’s secondary National Insurance at 12.8%. That’s a total cost of 23.8% which cannot be recovered! For 2009/10, the primary threshold is £110 for weekly pay periods or £475 for monthly pay periods. Hence, when paying a small salary to a family member, it is important to pay them on a regular basis over the course of the tax year and not in irregular lump sums.
Higher Salaries for Family Members When employing your spouse, partner or other family members in a business, it may be worth considering whether to pay them sufficient salary to utilise their basic rate tax band.
The total National Insurance cost on most salary payments in excess of the primary threshold will be 23.8%. Small overall tax savings can sometimes still be achieved, however, where the employer is a higher-rate taxpayer.
Year-End Planning As explained above, the critical deadline for most year-end planning is the business’s own accounting date. Most businesses are free to choose their own accounting date, except unincorporated property rental businesses for which an accounting date of 05 April is compulsory. As the business’s accounting year end approaches, some steps may be taken to reduce the amount of taxable profit for the year, including the following: > Purchasing assets eligible for capital allowances;
In March 2009 they have some repairs done to their barn roof. They do not receive an invoice for the work until May 2009, and do not pay it until July 2009. Despite not having to pay for this cost until July 2009, Andy and Lisa are entitled to claim it in their accounts for the year ended 31 March 2009.
Value Added Tax (VAT) VAT is a tax that you pay when you buy goods and services in the European Union (EU), including the United Kingdom. Where VAT is payable, it’s normally included in the price of the goods or services that you buy. Some goods don’t attract VAT. Each EU country has its own rate of VAT. In the UK, there are three rates: Standard rate You pay VAT on most goods and services in the UK at the standard rate, currently 17.5%. The standard rate of VAT was temporarily reduced to 15% from 01 December 2008. The rate will stay at 15% until 01 January 2010, when it will return to 17.5%.
> Payment of bonuses to employees; and > Undertaking necessary repairs and maintenance work. It is always worth bearing in mind that business expenditure is allowable when incurred, not when it is paid for.
Reduced rate In some cases, for e.g. children’s car seats and domestic fuel or power, you pay a reduced rate of five per cent. Zero rate There are some goods on which you don’t pay any VAT, like:
Example Andy and Lisa run a small market gardening business. They have a 31 March accounting date for tax purposes.
> Food; > Books, newspapers and magazines; 31
Sole Traders & Small Businesses
However, it must be borne in mind that payments in excess of the primary threshold will generally be subject to both employee’s and employer’s National Insurance Contributions.
> Children’s clothes; and > Special exempt items – for e.g. equipment for disabled people. When someone charges you VAT, they multiply the original (‘net’) price of the item or service by the VAT rate to calculate the amount of VAT to charge. They then add the VAT amount to the net price to give the ‘gross’ price – this is the price you pay. Most retail prices on bills and receipts include VAT – it is not shown separately. However, some may have a line under which they show the VAT element. This does not mean you’re being charged extra
32
– it just shows how much of the price is made up of tax. Non-retail invoices from VAT-registered suppliers (for e.g. from builders, or painters and decorators who are VAT registered) must show a separate amount for VAT. They must also show the ninedigit registration number of the business. Businesses with annual sales below £68,000 (2009/10) don’t have to register for (and therefore charge) VAT, but they may choose to do so voluntarily. If they don’t, the price you pay for their goods or services may be cheaper than if you bought the same goods or services from a VAT-registered supplier. •
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Chapter 6 Limited Companies
A Limited Company is a business that has been incorporated at Companies House. Shares in the company are allocated to individuals or companies who collectively own the Limited Company, and the shareholders’ liability is limited by law to the initial value of the shares.
Providers came into effect in July 2007. This was implemented to prevent payroll businesses from structuring solutions to mitigate taxes. It now puts the onus on the individual to know how and what they were doing with regards to their affairs and taxes.
For most businesses, the limited liability aspect is the most significant reason for being incorporated. This is true for contractors, but equally significant is the fact that the Limited Company is considered a legal entity (think of it as another person) that is allowed different tax treatment and a vehicle for working through an agency other than as a PAYE employee.
HMRC guidance notes state that a firm of accountants carrying on business as accountants are not caught by the legislation, as they fall outside the definition of an MSC Provider. MSC legislation addresses a number of areas. Principally, a company can be caught by the legislation if:
In particular, retained earnings/ distributable profits can be paid as dividends that are not taxed under PAYE and NI in the way that salaries are taxed. The reason for this different treatment for a Limited Company is because the dividends have already been taxed under the corporation tax regime, which is at a much lower tax rate of 21%.
> The provider is not a firm of accountants carrying on a business of being accountants; > The provider does not offer professional advice as chartered accountants and is regulated by the Institute of Chartered Accountants in England & Wales;
Managed Service Company Legislation (MSC)
> The provider does not offer tailored advice or services to clients, but charges a percentage rate per invoice; and
The legislation surrounding the Managed Service Companies/Managed Service
> The provider is involved with the running of their client’s companies.
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If a company is caught by the legislation, then all its earnings are deemed to be chargeable to PAYE and NI.
> The contract is signed by the director or authorised representative of the company;
The UK government has introduced more drastic legislation to counter what they see as widespread tax avoidance by contractors, who they believe are using companies to ‘disguise employment’ and pay business levels of tax when they should be taxed as employees. It is therefore vital for you to seek advice from reputable and regulated accountants to ensure that you stay within the rules and do not become overwhelmed with potentially costly compliance burdens.
> There is an end date and/or information explaining the termination clauses;
IR35
> There are clauses relating to liability and the responsibility for the company to provide the necessary insurances; and
Whether you’re new to contracting or you’ve been doing so for some time, you may have heard about IR35. IR35 was announced in the March 1999 Budget and came into effect from 06 April 2000. IR35 is a fundamental issue which you will need to consider at the very start of your contracting career and every time you accept a contract. The IR35 rules seek to determine the circumstances under which a contractor should be treated as ‘self employed’ or ‘employed’ for tax purposes. If deemed ‘outside’ of IR35, a contractor is viewed as self employed and can be subject to business levels of tax. If ‘inside’ IR35, they should pay employee levels of tax which can be considerably higher. Below are some recommended guidelines* for what you should include in your contract: > The contract is to be made out to the Limited Company, not to an individual;
36
> The contract has a substitution clause. This allows the company to send any approved consultant representing it to do the work – it does not have to be the director/person who signs the contract; > The Limited Company is solely responsible for paying all of the correct taxes;
> There are clauses relating to the possibility of the company having to provide its own equipment. * Please note that the points made here are guidelines only.
The Basic Forms of Tax > VAT. If your company is VAT registered, then this tax needs to be charged to your client by your company for services rendered. The current rate is 15% (changing to 17.5% on 01 January 2010). > Corporation Tax. All profits made in your company after expenses and salaries have been deducted will be taxed at 21%. Taxes on Salaries > Income Tax (PAYE). When the company pays your salary, it will be taxed at your personal tax rate.
> National Insurance. In addition to PAYE you have to pay Employees’ National Insurance at 11%; and > Employers’ National Insurance at 12.8%. This is on all amounts above £5,720. > Higher-Rate Dividend Tax. Dividends are distributions of company profits paid to the shareholder. A basic rate taxpayer pays 0% tax on these dividends, but a higher-rate taxpayer has to pay 25% tax on these dividends. (NB, this is over and above the 21% corporation tax that has already been paid at company level.) The higher-rate tax threshold currently sits at £43,875.
Corporation Tax Rates
paid by the vast majority of companies in the UK, over a three-year period. So, while the Chancellor’s friends in big business can celebrate their tax cut, the vast majority of hard-working small company owners in the UK have been asked to pay for it with a 16% tax increase! For companies with annual profits of between £300,000 and £1.5M, there is an effective marginal rate band, which is currently 29.75%. The following paragraph sets out the effective Corporation Tax rates for the period from 01 April 2006 to 31 March 2010.
Company Profit Band
2006/7
2007/8
2008/9
2009/10
The main rate of Corporation Tax for large companies, with annual profits in excess of £1.5M, reduced from 30% to 28% with effect from 01 April 2008.
Up to £300,000
19.00%
20.00%
21.00%
21.00 %
£300,000 to £1.5M
32.75%
32.50%
29.75%
29.75%
However, while large companies are now paying less Corporation Tax, small companies with annual profits of £300,000 or less have faced steady tax increases.
Over £1.5M
30.00%
30.00%
28.00%
28.00%
The rate of Corporation Tax applying to companies with annual profits of no more than £300,000 has increased as follows: Prior to 01 April 2007
19%
From 01 April 2007
20%
From 01 April 2008
21%
In all, these increases produced a 16% increase in the total Corporation Tax bill
As we can see in the table above, smaller companies with profits not exceeding £300,000 suffer a steady tax increase, whereas medium-sized companies with profits of £500,000 fluctuate at around the existing level of Corporation Tax, with little overall change. Larger companies, however, with profits of £1M-plus, actually gain from the proposed changes. All of the figures are based on a single company, with no associated entities.
37
Limited Companies
The first £6,475 is tax free (of a personal allowance) and the next £37,400 is taxed at 20%.
Summary Table Tax scheme
Period covered
Name of return
Return due date
PAYE & National Insurance
06 April to 05 April
P35 & P14
19 May each year
Payment due date Quarterly scheme:
19 July 19 October 19 January 19 April
Annual scheme:
19 April
Why?
Example
Legislative requirement of the Companies Act 2006
PAYE & NI payments are due on: 19 Jul 08 19 Oct 08 19 Jan 09 19 Apr 09 P35 & P14 are due on: 19 May 09 PAYE & NI payments due on: 19 April 09 P35 & P14 due on: 19 May 09
Expenses & Benefits
06 April to 05 April
P11d & P11d(b)
06 July
06 July
Due 06 July 2009 for all UK companies
Corporation Tax
12 months to Accounting Date
CT600
12 months after Accounting Date
9 months after Accounting Date
ABC Limited has an Accounting Date of 31 March 2008; it’s CT600 is due by 31 March 2009.
Annual Financial Statements (Accounts)
12 months to Accounting Date
Income Statement & Balance Sheet
HMRC: 12 months CH: 9 months
n/a
ABC Limited has an Accounting Date of 31 March 2008; it’s accounts are due: HMRC: 31 Mar 09 CH: 31 Jan 09
Companies House Return
12 months to Accounting Date
Annual Shuttle Return (ASR)
1 month after Accounting Date
n/a
ABC Limited has an Accounting Date of 31 March 2008; it’s ASR is due 30 April 08
Value Added Tax
Quarterly (company specific)
Vat Return
1 month after quarter end
1 month after quarter end
Personal Tax Return
06 April to 05 April
SA100
Paper 31 October
31 January
Online 31 January
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Or, to put it another way, should they refrain from the usual tax-planning measures designed to defer their taxable income? For companies with taxable profits of around the £300,000 threshold, it remains worth bringing forward their taxable profits whenever legitimately possible when the current year’s profits lie below £300,000 and next year’s profits are expected to exceed that level. This can save Corporation Tax at between 8.75% and 12.5% for accounting periods ending during 2009/10, reducing the tax bill on the accelerated income by between 29% and 38%, which more than compensates for accelerating the tax liability by a year. The amount saved by following this strategy may be reducing over the next few years, but it still remains a highly valid tax-planning point. The new question facing us since 01 April 2007 is whether it is worth accelerating profits within the £300,000 profit band in view of the increasing Corporation Tax rate that will apply over the next few years. Generally, we would say no, as a reduction of around 5% in the Corporation Tax payable on the accelerated income is probably not enough to compensate for accelerating the tax liability by a year.
Filing Requirements As a director of a Limited Company in the UK, the following requirements are to be met:
HM Revenue & Customs > Submission of Employers Annual Return (Forms P35 & P14); > Annual submission of Expenses & Benefits Return (Forms P11 & P11D); and
Limited Companies
Should Small Companies Accelerate Taxable Income?
> Annual or Quarterly PAYE & National Insurance payments, depending on which scheme you take up: Quarterly PAYE and NI Payments Quarter 1 – Payment Deadline 19 July
For the period 06 April – 05 July
Quarter 2 – Payment Deadline 19 October
For the period 06 July – 05 October
Quarter 3 – Payment Deadline 19 January
For the period 06 October – 05 January
Quarter 4 – Payment Deadline 19 January
For the period 06 January – 05 April
Annual PAYE and NI Payment Payment Deadline 19 April For period 06 April – 05 April
VAT – Value Added Tax payment > Submission of quarterly returns; and > Quarterly payments of any scheduled VAT or Flat Rate VAT. Company Annual Accounts (Financial Accounts) > A set of company Annual Accounts must be submitted to the Companies House and HMRC, 12 months from your company year end; and 39
> Submission of your Company Tax Return (CT600) takes place nine months from your company year end. Corporation Tax > An annual corporation tax payment is due nine months after your company year end. Personal Tax (SA100)
you incur while working. These are typically travel, telephone, stationery, etc. Any expense you set off will save you 21% corporation tax, and potentially 25% dividend tax. You can maximise these but ensure that you can justify and prove these expenses to HMRC if required. Set your salary at an optimal level
> Form 363 is required to be submitted annually to the Companies House giving details of your company’s directors and secretary, registered office address, shareholders and share capital.
Although the first £5,720 of your salaried income is tax free, you are required to pay PAYE tax and National Insurance, together 43.8% (20% + 11% + 12.8%, see above) on the rest. Although there is no legal requirement for your annual salary level, we recommend that you don’t set this too low. It may trigger an investigation by HMRC. On the other hand, it doesn’t make sense to set it too high due to the tax rate of 43.8%. Alternatively, you can set your salary at a threshold of £12,000 which is the minimum wage level.
Setting Up Your Company To Optimise Your Tax Position
Contribute a portion of your income to an Executive Pension
There are various high-level strategies that play off at the different tax levels. Some of the easier strategies are:
Any contribution to a director’s pension will entitle you to a rebate of the 43.8% (if completed as a salary sacrifice). This effectively means you are getting £2 for every £1 you contribute to your own pension. You can contribute up to 100% of your earnings, however we recommend a level between 10-15% of your gross income (invoiced amount).
> A personal tax return is to be submitted by 31 January of each year. Annual Shuttle Return (ASR)
Register for flat rate VAT For smaller companies, HMRC allows you to pay a different VAT level on outputs than inputs. Effectively, this means you receive 15% on your invoices from your client but only have to pay 12% (typically) on your income. You make a few extra per cent on your income, free. Write off expenses through the company As your company is actually a business, you can offset profits with any expenses 40
Maximise your dividend payments up to the higher-rate tax threshold (£43,875), and leave the remaining profits as retained earnings in the company You can take out approximately £3,338 per month in net salary and dividends, before you start paying higher-rate dividend tax. If you need more income
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to cover living expenses, then you will attract extra tax at 25%. Release earnings in times of unemployment/holiday If you take an extended holiday or are not going to be working in the future, you can continue to pay out dividends tax free during that time. Keep the retained earnings in the company as long as possible Retaining funds in the company gives you more flexibility and choice at a later date to get profits out more tax effectively (see ‘Strategies for minimising tax on exit’, below). You can invest the retained earnings in the company’s name, in a portfolio of unit trusts, if you feel the bank’s interest rate is too low. Capital Gains allowance Take out £10,100 tax free as a capital gain. You can close the company at the end of your work/contract and use your capital gains allowance to release the funds. The first £10,100 is tax free and the rest will be taxed at 18%. Be aware, though, that you can only do this once and it is not possible to repeatedly open and close companies. The information below can also be integrated with that above, as part of the strategy to optimise your company’s tax position.
Using Your Own Personal Allowance Those with incorporated businesses run via a company should consider whether they are taking sufficient salary or wages out of the company to fully utilise their National Insurance earnings threshold (£5,715 for 2009/10). 42
Whether it is worth increasing your own salary by a further £760 to fully utilise your personal allowance depends on a number of factors, including whether you have any other taxable income during the year. However, for company owners with no other taxable income during 2009/10, it will generally be worth increasing your own salary up to the £6,475 personal allowance if your company has annual profits in excess of £306,475, or if the company accounting period in which the salary will be charged ends on or after 31 May 2009. For directors, National Insurance is calculated on a cumulative basis. This means that the ‘primary threshold’ is applied on an annual basis and not by reference to pay periods. A director may therefore be safely paid their salary in a lump sum, without creating excess National Insurance liabilities.
Using the Basic Rate Tax Band Dividends Those with incorporated businesses should consider whether to take sufficient dividends out of their company during the tax year to ensure that they fully utilise their basic rate tax band (£37,400 for 2009/10). The 10% tax credit attaching to all dividends paid by a UK company is deemed to settle any Income Tax liability on the part of the recipient individual, provided that they are not a higher-rate taxpayer. Hence, in the absence of any other income, an individual could receive dividends of £39,488* during 2009/10
However, dividends do not attract Corporation Tax relief and nor do they rank as relevant earnings for pension contribution purposes. As a consequence of these factors, it is sometimes worth considering whether to pay yourself a higher salary or a bonus instead. Where the company has insufficient funds to pay the necessary dividend, it can be declared but left unpaid and owing to the intended recipient until such time as the funds may sensibly be withdrawn from the company. Dividends may not, however, be declared where the company has insufficient distributable profits to cover them.
Dividends Paid to Spouses, Partners and Other Family Members Tax savings may also be generated by paying dividends to a spouse, partner or other family member up to the amount of their basic rate tax band. This well-establish tax-planning strategy, also known as income-shifting is,
however, currently under attack but HMRC have indicated that legislation will be deferred on this until 2010. So, for the time being, married couples and civil partnerships might wish to ensure that they make the most of the current position this year.
Planning for the New Legislation
Limited Companies
and have no further Income Tax liability (*£39,488 plus the attached tax credit of one ninth equals £43,875, which is the total of the personal allowance and the basic rate tax band for 2009/10.)
In the longer-term, all business owners will need to take precautions to avoid problems under whatever ‘income shifting’ rules we end up with after April 2010. The position is likely to depend on how much each partner or shareholder is involved in the business. Couples and families are likely to be exposed to the greatest risks. Looking forward, therefore, the main tax-planning point for everyone with their own business, is to make sure that each partner or shareholder is actively involved in the business. To be as safe as possible from attack, therefore, each partner or shareholder really needs to be working ‘at the coal face’ in the actual operation of the business. Further, each partner or shareholder should aim to be working an average of at least ten hours per week in the business. •
43
Chapter 7 Capital Allowances
Capital Allowances For taxpayers in business, whether as a sole trader, partner or through their own company, considerable tax savings can be generated via capital allowances on eligible expenditure.
allowance: the most notable exclusion being cars. For accounting periods commencing before 01 April 2008 (for companies) or 06 April 2008 (for unincorporated businesses), only part of the annual investment allowance is available.
An individual who is eligible for any form of capital allowance should therefore give careful consideration to the timing of the qualifying capital expenditure.
For e.g. a company with a 12-month accounting period ending 31 December 2008 will be entitled to an annual investment allowance of:
Annual Investment Allowance
275/366 x £50,000 = £37,568
From April 2008, every qualifying business entity is entitled to an annual investment allowance of £50,000.
(There are 275 days in the period from 01 April to 31 December.) Similar restrictions apply where there is an accounting period of less than 12 months in duration.
The annual investment allowance provides 100% tax relief for the first £50,000 of qualifying expenditure on plant and machinery in each accounting year. Most expenditure on plant and machinery for use in any trading business will qualify for the allowance. Qualifying furnished holiday-letting businesses, commercial property landlords and businesses leasing plant and machinery to other qualifying businesses will also be eligible. Certain expenditure is, however, ineligible for the annual investment 44
Temporary First-Year Allowances From 01 April 2009, businesses investing in general plant and machinery will be entitled to claim a 40% ‘first year’ allowance in respect of all expenditure incurred in excess of the Annual Investment Allowance of £50,000.
Writing Down Allowances Expenditure on qualifying plant and machinery in excess of the annual
The rate of writing down allowances on most plant and machinery is now just 20%. Transitional rules apply to accounting periods commencing before April 2008, with the result being that such periods will benefit from a slightly higher writing down allowance – somewhere between 20% and 25%. (E.g. the writing down allowance for a company with a 12-month accounting period ending 31 December 2008 will be 21.24%) Qualifying expenditure in excess of the annual investment allowance is pooled together with the unrelieved balance of qualifying expenditure brought forward from the previous accounting period. This pool of expenditure is known as the ‘general pool’. The writing down allowance of 20% (or more if the transitional rules apply) is calculated on the total balance in the general pool. Certain expenditure must, however, be allocated to a ‘special rate pool’, which is eligible for a writing down allowance of just 10%. This includes: > Expenditure of £100,000 or more on plant and machinery with an anticipated working life of 25 years or more; and > Expenditure on thermal insulation of an existing building used in a qualifying trade. It is worth noting, however, that the annual investment allowance may be allocated to any such expenditure
in preference to expenditure qualifying for the normal rate of the writing down allowance. All writing down allowances are reduced appropriately where the business has an accounting period of less than 12 months.
Small Pools Where the balance on either the general pool or the special rate pool is £1,000 or less, the full balance may be claimed, i.e. written off, for tax purposes.
Timing of Expenditure All plant and machinery allowances are given in full for the year in which qualifying expenditure occurs, even if on the final day! In most cases, therefore, businesses will benefit by accelerating the qualifying capital expenditure so that it falls into an earlier accounting period. Naturally, this is only worthwhile if the expenditure was going to be made fairly soon anyway. It would not be worth making speculative purchases of plant and machinery which may not be needed for some time to come. In some cases, however, a business may benefit by delaying the qualifying capital expenditure. Where a business has already incurred sufficient qualifying expenditure to fully utilise the annual investment allowance, but may not do so in the next accounting period, it could be worth deferring any further qualifying expenditure to the next accounting period. By ensuring that no additional expenditure is added to the pool, 45
Capital Allowances
investment allowance is eligible for writing down allowances.
it will be possible to write off that pool balance. As in the case of accelerated expenditure, the commercial implications of any delay in qualifying capital expenditure will need to be weighed up against the potential tax savings arising.
i) Low CO2-emission cars (generally no greater than 110g/km);
More Points on Timing
iii) Designated energy-saving technologies and products; or
Assets bought on hire purchase must actually be brought into use in the business by the accounting date. Merely purchasing them by that date is not sufficient. Assets bought on credit terms where payment is due four months or more after the purchase may not produce an immediate right to capital allowances.
Asset Disposals Where any item of qualifying expenditure is subsequently disposed of, a deduction is made from the pool equal to the lower of: the sale proceeds or the item’s original cost. If this results in a negative pool balance, a balancing charge arises. In many cases, the asset being disposed of will be replaced and that replacement will fall within the annual investment allowance, so that there will still be an overall beneficial effect. Nevertheless, it may often be worth delaying the disposal of an old asset until after the end of the business’s accounting period, especially when that asset is not immediately being replaced.
Enhanced Capital Allowances First Year Allowances of 100% are available to any businesses that purchase the following items for business use: 46
ii) Equipment for refuelling vehicles with natural gas, biogas or hydrogen fuel;
iv) Environmentally beneficial plant and machinery. Expenditure on items qualifying for these enhanced capital allowances is not counted for the purposes of the annual investment allowance. Companies which do not have sufficient taxable profit to fully utilise enhanced capital allowances are able to surrender allowances on expenditure under (iii) and (iv) above, in return for payment of a 19% tax credit.
Other Assets with Private Use The capital allowances regimes for cars are echoed to some extent in the case of other assets with any element of private use. Where the asset is owned by a company or provided to an employee, full capital allowances remain available under the general principles above – but a ‘benefit in kind’ charge arises in respect of the private use. Where the asset is purchased and used by a sole trader or business partner, capital allowances remain available, but as with cars, a suitable deduction must be made in respect of the private use of the asset. All such assets must also each be placed in their own capital allowances pools.
The writing down allowances on these pools will be either 10% or 20%, as appropriate, less the deduction for private use.
allowances will fall into the general pool or special rate pool, as appropriate, and will attract writing down allowances in future periods.
As with cars, the unrelieved balance on the pool carried forward to the next period is calculated before the deduction for private use.
Disclaimers of capital allowances are useful in a number of situations where the allowance might otherwise go to waste, such as in the case of a small business whose owner has insufficient income to use their personal allowance or National Insurance earnings threshold.
Balances of £1,000 or less in pools cannot be written off like similar small balances in the general or special rate pools. At present, it appears that the annual investment allowance will be available on assets (other than cars) with an element of private use. The allowance will, however, be restricted to reflect the private use, so the annual investment allowance should be allocated to other expenditure first, whenever possible.
Rather than claim an allowance which will effectively be wasted, a disclaimer means that greater allowances will be available in future periods. The usefulness of capital allowance disclaimers is, however, fairly limited as the future allowances gained are generally less than the allowances disclaimed.
Property Businesses Most property businesses are generally not eligible for many capital allowances. In particular, capital allowances are not generally available for furniture, fixtures or fittings in residential property.
Assets purchased for any business proprietor’s own use can only attract allowances if they are genuinely used in the business.
However, capital allowances may be available on the following:
Capital Allowance Disclaimers
> Landlord’s expenditure on fixtures and fittings in rented commercial property, such as shops, offices, etc;
All capital allowances on plant and machinery or cars may be ‘disclaimed’. In fact, any proportion of the available allowance from zero to 100% may be claimed in each accounting period.
> Expenditure on furniture, fixtures and fittings provided within qualifying furnished holiday lettings; and
Any ‘disclaimed’ element of the annual investment allowance or enhanced capital
> Expenditure on office and other equipment used by the landlord in running the property business. 47
Capital Allowances
The great advantage (or occasional disadvantage) is that a balancing allowance (or charge) will arise when each asset is disposed of. These balancing allowances, or charges, are calculated in exactly the same way as for a car with private use, as explained above.
The annual investment allowance is available on qualifying expenditure in each of the above cases (excluding cars, as usual). As explained above, however, expenditure in excess of the annual investment allowance on certain designated integral features in commercial property is subject to a writing down allowance of just 10% in the special rate pool. Most other qualifying expenditure in excess of the annual investment allowance will fall into the general pool. Enhanced capital allowances, as described above, are also available on qualifying expenditure on assets for use in a property business, including qualifying expenditure on residential rental properties. While not strictly classed as a capital allowance, an Income Tax deduction is available for expenditure of up to
48
£1,500 per property on certain designated categories of insulation in rented residential property.
Furnished Lettings: Renewals and Replacements As explained above, capital allowances are not available on furniture, fixtures or fittings in most residential property. The landlord may, however, claim either the 10% ‘wear and tear’ allowance, or may claim under a ‘Renewals and Replacements’ expenditure. Although many landlords prefer to claim the ‘wear and tear’ allowance, anyone who is on a ‘Renewals and Replacements’ basis should consider whether they need to make any replacement expenditure in the near future. If so, it may be worth accelerating such expenditure to before 05 April 2010 in order to obtain a deduction in the 2009/10 tax year. •
Chapter 8 Obtaining Tax Relief at More Than 40%
Example In the tax year 2009/10, Hayley receives an annual salary of £43,875 plus dividends of £1,000. Her Income Tax liability for the year is thus as follows: Salary:
£43,875
Less – Personal Allowance:
£6,475
Total ‘Other’ Taxable Income:
£37,400
Income Tax thereon @ 20%:
£7,480.00
Dividends Received:
£1,000.00 Plus Tax Credit (1/9th) £111.11
Total:
£1,111.11
Income Tax @ 32.5% less tax credit:
£361.11 - £111.11 £250.00
Total Tax Due for 2009/10:
£7,730.00
However, on 13 April 2009 Hayley makes a pension contribution of £800 (net). This is equivalent to a gross contribution of £1,000, and the effect of this is to ‘extend’ her basic rate tax band by £1,000.
This ‘extension’ operates in addition to the tax relief of £200 already given at source and, as we will see, results in further tax savings. Let’s take a look at how this affects her Income Tax liability for the year: Salary:
£43,875
Income Tax thereon (as before):
£7,480.00
Dividends received:
£1,000.00
Plus Tax Credit (1/9th):
£111.11
Total:
£1,111.11
Income Tax thereon – £1,000 @ 10%:
£100.00 + [£111.11 @ 32.5% (the ‘dividend rate’)] £36.11 = £136.11
Less – Tax Credit:
(£111.11) = £25.00
Total Tax Due for 2009/10:
£7,505.00
As we can see, in addition to the £200 of tax relief given at source on her pension contribution, Hayley has also saved a further £225, making a total saving of £425, or 42.5% of her gross pension contribution (equivalent to over 53% of her net cash contribution of £800!).
From this example, we can now see that 40% is not necessarily the limit to the rate of tax relief available under the right circumstances! 49
Obtaining Tax Relief at More Than 40%
It is worth noting that, under certain circumstances, a taxpayer’s marginal Income Tax rate may actually be more than 40%, thus providing the opportunity to make even greater tax savings through the use of some of the measures outlined in the previous chapters.
Reducing Payments on Account It is also worth bearing in mind that any reduction in this year’s Income Tax liability will also reduce the payments on account due under the self-assessment system. As the first payment on account in respect of
50
next year’s tax is due at the same time as the balancing payment in respect of this year’s tax, every £1 of tax saved actually produces a cashflow saving of £1,50. In cashflow terms, a 40% saving actually becomes 60%! •
Chapter 9 Capital Gains Tax
Taper relief and indexation relief were abolished with effect from 06 April 2008 (except that companies are still entitled to indexation relief on their capital gains). Entrepreneur’s relief applies in certain limited circumstances: generally on the sale of a trading business or sales of shares in qualifying companies. Where available, the relief reduces capital gains of up to £1-million, by a factor of four ninths, to provide an effective Capital Gains Tax rate of 10%.
Utilising the Annual Capital Gains Tax Exemption The annual exemption stands at £10,100 for 2009/10. Capital gains of up to the amount of the annual exemption may be realised tax-free each tax year. Where possible, taxpayers should consider making use of the annual exemption before the end of any tax year. Once this date passes, the exemption is lost completely. It’s ‘use it or lose it’.
Both members of a married couple or civil partnership have their own annual exemption, as do minor children. The estate of a deceased person has its own annual exemption in the tax year of the death, and the following two tax years. Trusts also have their own annual exemption, equal to half of the annual exemption available to individuals. However, this amount must be subdivided among all of the trusts set up by the same settlor (but with a minimum annual exemption level of £480). For 2008/09 and later years, you don’t get the Annual Exempt Amount if you are not domiciled in the UK and claim the special ‘remittance’ basis of tax – which means you only pay Capital Gains Tax on gains you bring into the UK and gains on assets located in the UK.
Bed and Breakfasting The old practice that is referred to as ‘Bed and Breakfasting’ is no longer possible in its simplest form (that is, selling assets, usually quoted shares, and buying them back the next day in order to utilise the annual exemption). 51
Capital Gains Tax
From 06 April 2008, Capital Gains Tax is payable at a single flat rate of 18% on the vast majority of all capital gains made by individuals.
There are, however, still a number of ways in which a similar approach can be used in order to utilise the annual exemption: i) Wait 31 days before buying the shares back. (This is fine for Capital Gains Tax planning purposes, but does not always appeal to those who wish to stay in the market.) ii) ‘Bed and Spousing’ – for a couple (married or not), there is a very simple mechanism available. One partner sells the shares and the other one makes an equivalent purchase. (For married couples and civil partners the repurchase must be made on the open market – a direct sale from one spouse or partner to the other will not have the desired effect.)
> If the losses of the period reduce the net capital gains of the period below the level of the annual exemption, some of this exemption is in effect lost. Hence, the timing of the disposal of any assets standing at a loss should be considered carefully, bearing the above points in mind. HM Revenue & Customs has the power to deny relief for capital losses arising after 05 December 2006, where they perceive that the loss arose as a result of transactions which were carried out with a main purpose of creating a tax advantage. At present, it is not yet known how widely this power will be used.
Emigration
iii) ‘Bed and ISA’ – sell the shares in order to realise your annual exemption and buy them back (again on the open market) through an ISA. It is, however, unlikely that you will be able to utilise the whole annual exemption in this way.
Some years ago it was possible, under certain circumstances, to be treated as non-UK resident immediately on departure from the UK.
iv) ‘Bed and Company’ – sell the shares and buy them back on the open market through a company.
Sadly, this facility is no longer available and a taxpayer generally remains liable to UK Capital Gains Tax on any gains arising during the tax year in which they emigrate.
Utilising Capital Losses Capital losses are, in the first instance, automatically set off against capital gains arising in the same tax year. Any surplus is carried forward for set-off against future gains. Generally speaking, capital losses may not be carried back. This has a couple of important practical implications: > Losses must be realised by the tax year end in order to be set off against current year capital gains; and 52
Hence, if you were intending to avoid UK Capital Gains Tax on a gain due to arise in 2009/10 by emigrating abroad, you would have had to have left the UK by 05 April 2009 at the latest. Furthermore, to avoid a clawback of Capital Gains Tax on your return, you will need to remain non-resident in the UK for at least five complete UK tax years. Those emigrating during 2009/10 to avoid UK Capital Gains Tax need to plan on staying away until at least 06 April 2015.
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Non-residence can sometimes be maintained despite some limited return visits to the UK, not exceeding: > 182 days in any one UK tax year; and
But these basic rules are just the beginning. They in effect represent just a preliminary test which a taxpayer must pass before we can even begin to consider if they might be non-UK resident.
> 90 days per UK tax year on average. From 06 April 2008, any day on which you are present in the UK at midnight is counted for the purpose of these tests, unless you are merely in transit from one foreign country to another. It is important to understand, however, that the tests given above are intended as basic guidelines only.
54
Recent case law suggests that a much harsher view is now being taken on the question of emigration. In practice, it is not sufficient just to meet the basic ‘non-residence’ rules set out above – the taxpayer’s overall situation must be reviewed to determine if they can genuinely be regarded as non-UK resident. •
Inheritance Tax
Chapter 10 Inheritance Tax
Not everyone pays Inheritance Tax. It is only due if your estate – including any assets held in trust and gifts made within seven years of death – is valued over the current Inheritance Tax threshold (£325,000 in 2009/10). The tax is payable at 40% on the amount over this threshold. Inheritance Tax is usually paid on an estate when somebody dies. It’s also sometimes payable on trusts or gifts made during someone’s lifetime. Most estates don’t have to pay Inheritance Tax because they are valued at less than the threshold. Since October 2007, married couples and registered civil partners have been permitted to increase the threshold on their estate when the second partner dies – to as much as £650,000 in 2009/10. Their executors or personal representatives must transfer the first spouse or civil partner’s unused Inheritance Tax threshold, or ‘nil rate band’, to the second spouse or civil partner when they die. Inheritance Tax is payable by different people in different circumstances. Typically, the executor or personal representative pays it using funds from the deceased’s estate.
The trustees are usually responsible for paying Inheritance Tax on assets in, or transferred into, a trust. Sometimes people who have received gifts, or who inherit from the deceased, have to pay Inheritance Tax – but this is not common. Generally speaking, effective Inheritance Tax planning should be carried out on a long-term basis. However, it is worth remembering the following points, which should be considered on an annual basis:
Annual Exemption The first £3,000 in gifts made by any individual in each tax year is totally exempt from Inheritance Tax. Furthermore, if last year’s annual exemption has not been fully utilised, it may still be used to exempt gifts in excess of £3,000. Hence, if an individual has not made any gifts during this or the previous tax year, the first £6,000 in gifts made between now and the end of the tax year will be fully exempt. As with Capital Gains Tax, each partner in a married couple or civil partnership has their own annual exemption. 55
Small Gifts Exemption
Habitual Gifts Out Of Income
Gifts of up to £250 per tax year, made to any one individual, are also exempt from Inheritance Tax and do not count towards the annual exemption. The donor may make as many such gifts as he or she wishes (all to different donees). The annual exemption may not, however, be used for further gifts to the same donee or donees in the same tax year.
There is a general exemption from Inheritance Tax for habitual gifts out of income. In order for such gifts to be ‘habitual’, they should be made regularly for a number of years.
56
Hence, it is very important to remember to make any such gifts once again this year. •
Chapter 11
Non-UK Domiciled Taxpayers
Opting Out
A UK resident but non-UK domiciled individual is entitled to claim exemption from UK Income Tax and Capital Gains Tax on income or capital gains arising abroad unless, and until such time as, the relevant income or sales proceeds are remitted to the UK.
Each individual may ‘opt out’ of the remittance basis, on a year by year basis, in order to avoid the £30,000 charge and retain the benefit of the Income Tax personal allowance and the Capital Gains Tax annual exemption.
This is known as the ‘remittance basis’ and is also available to a person who is UK resident at present, but is not ordinarily resident in the UK. Unfortunately, however, as from 06 April 2008 onwards, the remittance basis now comes at a heavy price. From 2008/9 onwards, any UK resident claiming the remittance basis who has unremitted overseas income and capital gains of £2,000 or more in the tax year will lose their personal allowance and their Capital Gains Tax annual exemption. Worse still, any adult claiming the remittance basis who has been UK resident for more than seven of the last ten years, is also subject to an additional annual charge of £30,000. This charge does not apply, however, where an individual has less than £2,000 of unremitted overseas income and capital gains for the year.
Opting out applies for one year only and does not affect the individual’s underlying non-UK domiciled or nonordinarily resident status. This means that for the next year, or any subsequent year, they may claim the remittance basis once again if this becomes more beneficial. This introduces a significant amount of choice for non-UK domiciled or non-ordinarily resident individuals resident in the UK, and gives rise to some useful tax planning strategies. The question of ‘in or out’ – i.e. whether to opt out of the remittance basis or not – needs to be considered differently at various different levels of overseas income and capital gains. The matter is further complicated by the fact that each individual can only make one overall decision, for each tax year, and this is whether to claim the remittance basis on both their overseas 57
Residence & Domicile
Residence & Domicile
income and their overseas capital gains. In practice, many people will have a mixture of both income and capital gains and will need to work out the best course of action in their own particular circumstances. What follows is therefore merely a set of rough guidelines to consider when deciding whether to opt out of the remittance basis for 2009/10. It is important to note that the guidelines set out below relate to the individual’s UK tax position only, and are therefore subject to the impact of any double tax relief which may be available. Income under £2,000 Where the overseas income and capital gains for the year totals less than £2,000, the remittance basis can be claimed without incurring any extra tax charges in the UK. This enables a non-UK domiciled or non-ordinarily resident individual to accumulate up to £1,999 a year in tax-free overseas income, producing a saving of up to £799.60 a year. This creates an opportunity for non domiciled individuals to keep their cash savings in an offshore account and, as described above, if the accrued interest doesn’t go over the £2,000 de minimus limit and this interest isn’t remitted back to the UK, tax will be avoided. Care must be taken to choose an offshore bank that understands the requirements of a nondomiciled individual, and keeps separate capital and interest accounts. Income between £2,000 and £8,034 Where the total overseas income and the capital gains for the year lie in this bracket, the same saving of up to £799.60 58
can be preserved by remitting all but £1,999 of the overseas income and gains back to the UK during the tax year. Gains should be remitted in preference to income, since these will either be covered by the annual exemption or, at worst, will be taxed at just 18%. In fact, capital gains of up to the amount of the annual exemption could often effectively be remitted back to the UK tax free, if this reduces the total unremitted overseas income and gains for the year to less than £2,000. All of the above is technically still possible where the £30,000 charge is applicable. However, unless you’re absolutely certain of your figures, it wouldn’t be wise to risk it and you should perhaps decide to opt out of the remittance basis instead. Income between £8,035 and £81,035 Where a non-UK domiciled or non-ordinarily resident individual has unremitted overseas income of over £8,035, but is not subject to the £30,000 charge, it will generally be worth claiming the remittance basis since the tax saved will more than compensate for the loss of the personal allowance. The loss of the Capital Gains Tax annual exemption must also be taken into account, however, as this may create additional liabilities of up to £1,728 (£9,600 at 18%) on any capital gains on UK assets in the same year. Where the £30,000 charge does apply, it will not usually be worth claiming the remittance basis where the unremitted overseas income does not exceed £81,035 (subject to any potential Capital Gains Tax liabilities on unremitted overseas gains.
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*By market capitalisation and assets Standard Bank Jersey Limited is regulated by the Jersey Financial Services Commission to take deposits and provide investment business. Standard Bank Isle of Man Limited is licensed by the Isle of Man Financial Supervision Commission to take deposits. The Isle of Man has a financial Services Ombudsman Scheme covering disputes relating to financial services offered in or from within the Isle of Man to individuals. Standard Bank Isle of Man Limited is a member of the Depositors’ Compensation Scheme as set out in the Compensation of Depositors Regulations 2008.The Isle of Man has a Financial Services Ombudsman scheme covering disputes relating to financial services offered in or from within the Isle of Man to individuals. Standard Bank Isle of Man Limited places funds with other parts of its group and thus its financial standing is linked to that of the group. Depositors may wish to form their own view on the financial standing of Standard Bank Isle of Man Limited and the group based on publicly available information.The latest report and accounts are available at www.standardbank.com/wealth The above entities are wholly owned subsidiaries of Standard Bank Offshore Group Limited whose registered office is 47-49 La Motte Street, St Helier, Jersey, JE4 8XR. Telephone calls may be recorded. 2009.149
Income between £81,035 and £102,755 Where the individual is not subject to the £30,000 charge, they will definitely benefit from claiming the remittance basis. Where the £30,000 charge does apply, the position will depend on the level of UK income and capital gains which the person has.
does depend on the level of unremitted overseas income which also arises in the same UK tax year. Where an individual has an unremitted overseas capital gain in excess of £191,678, however, the remittance basis will definitely be worth claiming.
Saving or Deferral?
Income over £102,755 Once the overseas income reaches this level, the remittance basis will be preferable in all cases.
Capital Gains The position on overseas capital gains is slightly different, as these are subject to a Capital Gains Tax rate of just 18% when taxable in the UK. As indicated above, overseas capital gains of up to the amount of the annual exemption may be remitted back to the UK tax free, where the individual has no UK capital gains in the same tax year and has other overseas income and gains of less then £2,000. Where an individual has overseas capital gains slightly above the amount of the annual exemption, it may be preferable to either remit them back to the UK or to opt out of the remittance basis in order to preserve the individual’s personal allowance. However, an individual who is not subject to the £30,000 charge and has overseas capital gains in excess of £25,011 will generally be better off claiming the remittance basis. For those who are subject to the £30,000 charge, a much larger overseas capital gain will generally be required before it is beneficial to claim the remittance basis, although this 60
It is worth remembering that the remittance basis may sometimes only defer UK tax on foreign income and gains. If the funds are brought into the UK at a later date while the investor is still UK resident, then tax will arise at that time. Hence, it will generally only be worth claiming the remittance basis if the overseas income and gains are to remain offshore permanently, or if the investor will cease to be UK resident before the funds are remitted to the UK.
Planning Under the New Regime Non-UK domiciled and non-ordinarily resident individuals can reduce the impact of the new regime in a number of ways. The £30,000 charge can be avoided by ensuring that you are non-UK resident for three years out of every ten. Those who are in their seventh year of UK residence might wish to consider realising capital gains on all of their overseas assets now, before the £30,000 charge comes into force. Capital gains on overseas assets can be ‘realised’ by selling the asset to an unconnected third party or by transferring it to a trust, a company or another individual such as an unmarried partner or adult child (but not to your spouse or civil partner).
can be avoided on unremitted overseas income and capital gains for the price of just one lost personal allowance, Capital Gains Tax annual exemption and £30,000 charge, where applicable.
There are opportunities to utilise offshore investment platforms to manage portfolios (or even actively trade), so that gains or income are strictly kept offshore. Some of these offshore platforms are extremely cost efficient, flexible and allow for the trading of direct equities and even currencies.
In some cases, it will also make sense for the couple’s overseas assets to be transferred to the one who has been UK resident for fewer years (where both of them have not yet been UK resident for seven years or more).
Elsewhere in the handbook we have discussed the planning opportunities that exist around the use of offshore bonds – if used correctly as a wrapper for these types of platforms, they can become an extremely tax-efficient tool for the more active investor.
When you come to live or work in the UK, the UK Income Tax you’ll pay depends on how long you’ll be here and whether you intend to live here permanently. There are special rules for entertainers, students, teachers, sports people, Irish citizens and Irish income. The UK Income Tax you’ll pay depends on whether you’re ‘resident’, ‘ordinarily resident’ or ‘domiciled’ in the UK. You can be more than one of these – or none.
Wealth Warning When realising capital gains on overseas assets for UK tax-planning purposes, it is essential to take any potential foreign tax liabilities into account. If the £30,000 charge already applies to you, it may be beneficial to ensure that all, or several, of your capital gains on foreign assets fall into the same UK tax year. In this way, UK Capital Gains Tax can be avoided on all of your disposals for the price of one £30,000 charge, rather than several.
Couples
Income Tax When Arriving in the UK
Resident If you’re in the UK for 183 days or more in a tax year, you’re resident for that year for tax purposes. If you come to live in the UK permanently, or remain here for three years or more, you’re resident from the date of arrival. You’re also treated as resident if you’re in the UK for an average of 91 days or more in a tax year – worked out over a maximum of four consecutive tax years. Ordinarily resident
When both members of a couple are UK resident but either non-UK domiciled or non-ordinarily resident, it may make sense to transfer all or most of their overseas assets to one of them. In this way, UK tax
If you’re resident in the UK year after year, you will normally be treated as ordinarily resident. You’re treated as ordinarily resident in the UK from the 61
Residence & Domicile
The capital gain arising at this stage will escape UK tax by claiming the remittance basis, and any subsequent taxable gain will be limited to the asset’s future growth in value.
date you arrive, if it’s clear that you intend to stay for at least three years.
> People who receive pensions from overseas countries.
Domiciled
If You’re Resident But Not Ordinarily Resident
Your domicile is normally acquired at birth, but this is a general law concept covering a range of factors.
If You’re Both Resident & Ordinarily Resident
If you’re resident but not ordinarily resident, you’ll pay tax on all your UK income. You can usually pay tax only on overseas income you bring into the UK. But you’ll still pay tax on:
You’ll pay Income Tax on all income earned via:
> All your income from investments in the ROI;
> Work you do in the UK;
> 90% of a pension from the ROI – unless it’s an Irish government pension; and
> UK pensions; and > UK investments. If you’re UK domiciled, you’ll also pay tax on all your overseas income – but you may be entitled to a 10% deduction from the amount due on overseas pensions. If you’re not UK domiciled, you’ll usually pay tax only on overseas income you bring into the UK. But you’ll still pay tax on:
> Earnings for work done abroad that you bring into the UK.
If You’re Not Resident You’ll pay tax on your income from: > Work you do in the UK; > UK pensions;
> All your earnings if you work overseas for a UK employer; > All your earnings if you do some work in the UK for an overseas employer; > All your income from investments in the Republic of Ireland (ROI); > 90% of a pension from the ROI – unless it’s an Irish government pension and you are a UK national.
> UK investments; and > Rental income from UK property. You won’t, however, pay tax on any of your overseas income, even if you bring it into the UK.
Income Tax Allowances All UK residents get personal tax-free allowances to help reduce their tax.
There are special tax allowances for: > Seafarers who spend long periods of time outside the UK; and 62
If the income you pay tax on is more than your allowances, you may be able to pay the tax through PAYE (Pay As You Earn) if
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you’re employed. If you’re unemployed, you’ll need to complete a tax return. When you come to the UK part way through a tax year, you’ll normally only pay tax on income you get after you arrive if:
The same applies to your spouse, civil partner or (marriage) partner.
> You come to the UK to stay for at least two years or to take up permanent residence; or
If you’re leaving the UK you must tell HM Revenue & Customs (HMRC). Your Tax Office will give you a P85 ‘Leaving the United Kingdom’ form, enabling you to apply for any tax refund you’re owed and to work out if you’ll become non-resident. If you still need to complete a tax return after you leave, they will let you know.
> You weren’t ordinarily resident in the UK before you arrived. Otherwise, you may have to pay UK tax on your income for the whole year. Either way, you’ll always get your full year’s Personal Allowance. The UK has ‘double taxation agreements’ with many other countries to make sure that you don’t pay tax twice on the same income. Even if there’s no agreement, you can usually still claim a reduction for any overseas tax you’ve paid.
Income Tax When Leaving the UK If you go to live or work abroad and become non-resident in the UK, you might still have to pay UK Income Tax – but only on your income from the UK. If you do need to pay, you may need to complete a Self-Assessment tax return. You’ll be treated as non-resident from the day after you leave, if you can show:
Contacting your Tax Office when you leave the UK
If you become non-resident, you won’t pay UK tax on your income from working overseas. Working partly in UK If you’re non-resident but work partly in the UK, you’ll pay UK tax on the part of your earnings allocated to that work. You usually allocate your earnings by looking at the number of days you work in the UK and the number of days you work abroad. Special rules for certain employees There are special rules for: > Crown employees; > Seafarers; > Oil and gas workers;
> You left the UK to go abroad permanently, or your absence and full-time work abroad lasts at least the whole tax year; or > Your visits to the UK are less than 183 days in a tax year, and average less than 91 days a tax year over a maximum of four consecutive years. 64
> Entertainers and sports people; and > Students.
Tax on UK Pensions If you’re non-resident, you’ll pay UK tax on your UK pensions – including your
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State Pension. You may not pay UK tax if the country you live in has a double taxation agreement with the UK. Tax on UK government service and local authority pensions Wherever you live, you’ll usually pay UK tax on a government service or local authority pension. But if you live in Australia, Canada, New Zealand or Cyprus you’ll pay tax on it there.
Tax on UK Bank & Building Society interest If you’re non-resident, the only UK tax you’ll usually pay is the tax deducted before you get the interest. If you’re also ‘not ordinarily resident’ (you normally live outside the UK), you can get your interest without tax deducted by giving a R105 form to your bank or building society. In either case, if tax has been deducted from interest, you might be able to claim a refund using form R43.
Tax on UK Investment Income (Excluding Rental Income) If you’re non-resident, UK tax is still due on your other UK investment income. However, if the country you live in has a double taxation agreement with the UK, you may be exempted or get relief. But you can never reclaim/reduce the 10% tax credit on dividends from UK companies.
Tax on UK rental income UK tax is due on your income from rental property. If you’re non-resident and you get rent from UK property paid directly to you, your tenant must deduct UK tax at the basic rate – currently 20%. If you use a letting agent, they’ll deduct 66
the tax from the ‘net rent’ – after any allowable expenses they’ve paid. You can apply to have the rent paid to you without a tax deduction if you don’t think you’ll have to pay any UK tax, or if your tax affairs are up to date. But you’ll still need to declare the rent on a Self-Assessment tax return if HMRC sends you one. If the country you live in has a double taxation agreement with the UK you may be able to get relief there for UK tax paid.
UK Tax on Overseas Income If you’re non-resident and get overseas income, no UK tax is due. But if it’s paid or collected by a UK agent – e.g. a bank – they normally deduct tax at source. You’ll need to complete a PA1 or CA1 to prevent this. If you’re normally taxed on income brought into the UK – remittance basis In the tax year when you leave the UK, you’ll pay UK tax on the smaller of: > What you brought into the UK; or > The same proportion of the whole year’s income, as the proportion of the year you were in the UK.
Tax-free Allowances for Non-residents If you’re a Commonwealth or European Economic Area citizen, or a current or former Crown employee, you’ll still get your tax-free allowances to reduce the UK Income Tax due.
Double Taxation Relief The country you move to may want to tax your worldwide income – except if it has a double taxation agreement with the UK. •
Chapter 12
National Insurance is a complex area of the UK tax system and is one least understood (many suspect that the government deliberately keeps it so!). In the section below, we would like to explain two specific areas: The opportunity presented by doing an NI Rebate
For an average person working on a salary of £30,000, the rebate will be around £1,645. For foreigners this is a no brainer since this rebate will be far more beneficial than expecting to receive a pension from the UK government when you eventually retire, and aren’t even living in the country.
How NI Contributions Work
How NI contributions work, in detail
What the Opportunity of Doing an NI Rebate Presents Many people are unaware that you can claim back National Insurance Contributions while working in the UK. This is different from a tax rebate which you can only do when arriving and leaving. An NI Rebate can be claimed at any time and only needs to be done once (from there onwards, it is automatically done for you each year). So what is an NI Rebate? Much of your National Insurance goes towards the State Second Pension. This is a voluntary scheme and any individual working in the UK can choose to take this money for themself, instead. The money can’t be given to you in cash but is rather put into your own personal pension.
You pay National Insurance Contributions (NICs) to build up your entitlement to certain social security benefits, including the State Pension. The type and level of NIC you pay depends on how much you earn, and whether you’re employed or self employed. You stop paying NICs when you reach State Pension age. You pay NICs if you are an employee or self-employed, and if you are aged 16 and over, providing your earnings are more than a certain level. You stop paying NICs at State retirement age. This is currently 65 for men and 60 for women, but will gradually increase to 65 for women over the period 2010 to 2020. Your National Insurance number is your own personal account number. The number ensures that the National Insurance contributions and the tax 67
National Insurance
National Insurance
you pay are properly recorded on your account. It also acts as an important reference number for the whole social security system. The only people you should ever give your NI number to are: > HM Revenue & Customs (HMRC); > Your employer; > Jobcentre Plus, if you intend to claim a Jobseeker’s Allowance; and > Your local council, if you claim a Housing Benefit Entitlement to many benefits depends on your National Insurance contribution record, so it’s very important not to give your number to anyone else. You will also be required to provide your NI number if you open an Individual Savings Account (ISA). If you don’t already have an NI number, you must apply for one: > As soon as you start work; or > As soon as you or your partner claims a benefit.
arrange for you to undertake an ‘evidence of identity’ interview. The interview will usually be conducted on a one-on-one basis (unless, for e.g. you need an interpreter). The interviewer will ask you questions about your background and circumstances, and may ask you to fill in an application form. If you haven’t got any official documents, you still have to go to the interview. You might be able to prove your identity with the information you give at the interview.
If You’re Employed The following amounts will apply for the 2009/10 tax year: > If you earn above £110 a week (the ‘earnings threshold’) and up to £844 per week, you’ll pay 11% of this amount as ‘Class 1’ NICs; > You also pay 1% of earnings above £844 per week, as Class 1 NICs; and > You will pay a lower amount as an employee, if you are a member of a contracted-out pension scheme.
If You’re Self-employed > You pay ‘Class 2’ NICs at a weekly flat rate amount of £2.40;
To be able to apply you must be: > Over 16 years of age; and > Resident in Great Britain (England, Wales or Scotland). To apply for a NI number you will need to telephone the Jobcentre plus NI allocation service helpline, on 0845 600 0643. They will make sure you need a number and 68
> You also pay ‘Class 4’ NICs as a percentage of your taxable profits – you pay eight per cent on annual taxable profits between £5,715 and £43,875, and one per cent on any taxable profit over that amount; and > If your earnings in the 2009/2010 tax year are expected to be less than £5,075, you may be entitled to the
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National Insurance Rebates AVERA GE AM
£1645O!U*NT:
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Small Earnings Exception (SEE), meaning you don’t have to pay any Class 2 NICs Your entitlement to the following benefits and/or the amount you can get will depend on you (or your spouse or civil partner’s) NIC contributions: > Contribution based Jobseeker’s Allowance (Class 1 NICs only); > Incapacity Benefit (if you can’t work for long periods due to illness or injury);
or before 05 April 1950. The State Pension age for women born on or after 06 April 1950 but before 06 April 1955 is rising from 60 to 65 between 2010 and 2020. The State Pension age for women born on or after 06 April 1955 but before 06 April 1959 is 65. State Pension age will increase for both men and women from age 65 to 68 between 2024 and 2046. You qualify by building up your ‘qualifying years’ before State Pension age. What are qualifying years?
> Contribution-based Employment and Support Allowance (ESA).
State Pension The same point applies to the following: > Additional State Pension (Class 1 NICs only);
A qualifying year is a tax year where you have sufficient income to pay National Insurance Contributions (NICs), or are treated as having paid or being credited with NICs.
> Widowed Parents’ Allowance;
In the 2008-2009 tax year, you need to have £4,680 or more of such earnings if you are an employee, or £4,825 or more if you are self-employed.
> Bereavement Allowance; and
How many qualifying years do you need?
> Bereavement Payment.
Currently men normally need 44, and women 39 qualifying years to get the full basic State Pension.
Understanding the basic State Pension The basic State Pension is a governmentadministered pension. It is based on the number of qualifying years gained through National Insurance contributions (NICs) you’ve paid, are treated as having paid or have been credited with throughout your working life. Do you qualify for the basic State Pension? If entitled, you can get the basic State Pension when you reach State Pension age. This is 65 for men born on or before 05 April 1959, and 60 for women born on 70
However, if you reach State Pension age on or after 06 April 2010, you will need 30 qualifying years for a full basic State Pension. If you’ve been a parent or carer If you haven’t paid enough NICs because you’ve been looking after children or caring for someone longterm, you may be eligible for Home Responsibilities Protection. If you reach State Pension age before 06 April 2010, Home Responsibilities Protection
If you reach State Pension age on or after 06 April 2010, Home Responsibilities Protection is being replaced with National Insurance credits. Years of Home Responsibilities Protection built up before 06 April 2010 will count as qualifying years of NI credits. If you’ve been claiming benefit If you’ve been receiving certain ‘contribution-based’ benefits (that is, you’ve paid sufficient National Insurance contributions), in the form of a Carer’s Allowance, Jobseeker’s Allowance, Incapacity Benefit or Employment and Support Allowance, you’ll have automatically received National Insurance credits for the weeks when you’ve been claiming.
How Much Is A Basic State Pension? In 2008-2009, the full basic State Pension is £90.70 a week for a single person and £145.05 a week for a couple, but your individual circumstances may affect the amount you get. A State Pension forecast will tell you the current value of your State Pension and the amount you may get at State Pension age. If you don’t qualify for the full basic State Pension If you reach State Pension age before 06 April 2010 If you don’t qualify for the full basic State Pension, but have 25% or more of the qualifying years, you’ll get a weekly basic State Pension between the minimum (£22.68 in 2008-2009) and the
maximum (£90.70 in 2008-2009). If you have fewer than 25% of the qualifying years, you’re not normally entitled to receive any basic State Pension. However, you can get a ‘noncontributory’ or ‘Over 80 Pension’ if you’re aged 80 or more and meet the residency conditions. This works out to £54.35 per week for 2008-2009. If you reach State Pension age on or after 6 April 2010 If you don’t qualify for the full basic State Pension, but have some qualifying years, you will get one thirtieth of the full amount for each qualifying year. You can get more information from your local pension centre.
Understanding the Additional State Pension The additional State Pension, or State Second Pension, is paid in addition to the basic State Pension. Recent changes to the additional State Pension Until April 2002, the additional State Pension for employees was called the State Earnings-Related Pension Scheme (SERPS). The amount of SERPS pension you received was based on a combination of the amount of your National Insurance contributions, and how much you earned. In April 2002, SERPS was reformed and the additional State Pension is now known as the State Second Pension. It gives a more generous additional State Pension to low and moderate earners, and certain carers and people 71
National Insurance
can reduce the number of qualifying years you require to qualify for the basic State Pension.
with a long-term illness or disability. By around 2030 or shortly afterwards, the State Second Pension will become a simple, flat-rate weekly top-up to the basic State Pension. How the change-over to the State Second Pension affects SERPS pensions Any SERPS entitlement you have is protected – so if you built up an entitlement to an Additional State Pension before April 2002, you will keep it, whether or not you’ve already reached State Pension age.
Spouse or Civil Partner Inheritance of the Addditional Pension State Second Pension A widow, widower or surviving civil partner can only inherit a maximum of 50% of their spouse’s or civil partner’s State Second Pension. SERPS If you contributed to SERPS, the maximum percentage of your SERPS pension that your widow, widower or surviving civil partner could inherit lies on a sliding scale depending on when you were born and your retirement age. The percentages range from 50% for men born on or after 06 October 1945 or women born on or after 06 July 1950, up to 100% for men born on or before 05 October 1937 or women born on or before 05 October 1942. You can check the maximum percentage of SERPS pensions for a surviving spouse or civil partner in The Pensions Service booklet, ‘Inheritance of SERPS’. 72
How the State Pension helps disabled people and carers If you are a carer, on low earnings, or have long-term disabilities, you can now benefit from an improved additional State Pension. If you don’t work or if you earn less than the annual NI lower earnings limit (£4,680 in 2008-2009), you can still build up an entitlement if you: > Look after a child aged six or less, and you are the person who claims and gets Child Benefit; > Take care of someone who is ill or disabled, and you qualify for Home Responsibilities Protection; or > Are entitled to a Carer’s Allowance (even where you don’t get this because you get a benefit that pays more). How to claim the additional State Pension Your entitlement to the additional State Pension (whether from SERPS or the State Pension) is calculated when you claim the basic State Pension. The Pension Service will normally send you the forms and invite you to make a claim about four months before you reach State Pension age. For men this is 65, and 60 for women born on or before 05 April 1950. The State Pension age for women born on or after 06 April 1950 will increase from 60 to 65 between 2010 and 2020. It will increase for both genders from age 65 to 68, between 2024 and 2046. If you don’t receive a letter inviting you to claim your pension, call The Pension Service on 0845 300 1084. The hours are 8.00 am to 8.00 pm week days (except bank holidays), and 9.00 am to 1.00 pm on Saturdays. •
Chapter 13 Property Matters
Part 1 – Buying a Property Buying a home – things to consider Buying a home is probably the biggest financial decision you will ever make, so it is worth taking time to consider whether it is the right choice for you. You will become responsible for all the costs of maintaining the property, including major structural repairs, routine repairs and improvements.
As part of the process of buying a house or flat you may also need to pay for: > A solicitor or licensed conveyancer; > An independent survey; > The mortgage to be arranged; > The Land Registry fee; and > Stamp Duty.
You also need to take the following costs into consideration: > Mortgage repayments; > Mortgage protection insurance for if you fall ill or lose your job; > Life assurance to enable your family to pay off the mortgage if you die; > Contents insurance against the risk of theft, fire, flood or other accidents;
As a tenant, you may be able to claim a housing benefit to help you with the rent. As an owner-occupier, you will not receive any housing benefit to help with your mortgage costs. You may be entitled to income support to assist with housing costs, but this is not usually payable for nine months after you first claim it.
Registering Title to Land and Obtaining Details of Individual Properties
> Gas, electricity, telephone, etc; and
The aim of registering title to land is to create and maintain a register of landowners whose titles are guaranteed by the State. Basically, it makes the transfer and mortgaging of land easier.
> Ground rent and any service charges that may apply.
Registration is compulsory following the sale, assent or mortgage of land.
> Council tax and water charges;
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What costs are involved?
What is a registered title? A registered title is the legal evidence of a title, which has been registered at the Land Registry. A registered title provides an up-to-date, official record of the legal ownership – and certain other matters – relating to the property or piece of land in question. Advantages of registering land > Legal title is guaranteed; > An accurate plan of the extent of the ownership is created; > An up-to-date public record of the ownership is created; > Rights of way are clearly identified;
> The charges register gives details of things like mortgages or rights that may affect the property adversely. The Land Registry also produces a title plan, showing the location and extent of the property. The plan does not normally show who owns the boundary features. Can I get information on individual properties from the Land Register? Yes, you can obtain details of individual properties in England and Wales from the Land Register Online website of over 19-million registered records for a small fee, payable by credit or debit card. These represent the majority of English and Welsh properties. It does not provide details of any that are not registered. You can also contact the local Land Register offices by telephone and fax.
> Covenants/mortgages are recorded; > Risk of fraud is greatly reduced; > Simple forms replace any complicated title deeds;
The Land Register information will generally include: > A description of the property; > Who owns it;
> Repeated examination of title deeds is unnecessary; and > Disputes can be resolved more easily.
> Mortgage lender (if any); > Price stated (if registered since 01 April 2000);
What is the Land Register? The Land Register is a record of all land registrations in England and Wales. Each register of title has its own number (the title number) and is split into three parts:
> Rights of way (not public, though) or other rights affecting the property; and > Restrictions or other conditions. Why is this information useful to me?
> The property register describes the property;
Typically, you...
> The proprietorship (ownership) register records who owns the property; and
> Want to look at the register and/or title plan of a property you own;
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> Want to discover the extent of a property; > Are interested in buying an unoccupied property you have noticed and wish to approach the owner; or > Lease or rent a property and need to contact the landlord.
Information on House Prices The Land Registry Residential Property Price Report, issued quarterly free of charge, provides information on average house prices. The report contains average prices, by county, for four housing categories; detached, semi-detached, terraced and flat/maisonettes. The information is drawn from the large numbers of residential housing transactions lodged at the Land Registry, and is available by accessing the Land Registry website. However, further information can be obtained from the Property Information Centre (telephone: 0151 473 6010; email: enquiries.pic@landreg.gov.uk).
What about Unregistered Land? The owner of a piece of unregistered land will have a bundle of deeds, which form a record of previous sales, mortgages and other dealings with the land. However, if the land is mortgaged, the lender normally holds the deeds as security for their loan. There is usually no public record of the information contained in the deeds.
However, in Middlesex and the Yorkshire Ridings, Deeds Registries were set up prior to land registration. These registries kept records of certain land transactions, but the deeds were registered against the names of the people involved, rather than by address. To make a search of a Deeds Registry you need to know the name of a previous, or the current, owner of the property. The Land Charges Department maintains a record of restrictive covenants, rights and mortgages relating to unregistered land. These are registered against the name of the land owner at the time the entry was made, rather than against the land or property. For e.g. if you want to find out about a restrictive covenant registered before you bought your piece of property, you will need to search against the name of the owner at the time the covenant was registered.
Local Land Charges - A Personal Search Property Matters
> Want to find out who it is that owns a specific property;
You can contact your local authority and carry out a search of the local ‘land charges’ register. Anyone can request a search and there may be a fee attached to this service.
Estate agents and Making an Offer Whether buying or selling, you will probably use the services of an estate agent. Although they don’t need to be registered to set up in business, many do belong to the National Association of Estate Agents (NAEA) and the Ombudsman for Estate Agents (OEA). 75
Choosing and Working with an Estate Agent You may wish to choose an estate agent that is registered with the NAEA or the Ombudsman, as this will mean that they have to abide by a code of practice. You can find one in the area in which you are interested by searching on the NAEA website. All estate agents are bound by the Estate Agents’ Act, whether or not they are registered with a governing body. If you have a complaint about the conduct of an estate agent, you can contact the Ombudsman for Estate Agents. The OEA provides an independent service for dealing with disputes between estate agents who are members of the Ombudsman Scheme, and consumers who are actual or potential buyers or sellers of residential property in the UK. The OEA will advise on alternative routes to take if the estate agent you wish to complain about is not a member. You can also contact the trading standards department of your local council.
Making an Offer ‘Gazumping’ occurs when a property is sold at a higher price after an offer has already been accepted. If you make an offer on a property, make sure that it is ‘subject to contract’ – this means you can pull out of the deal if there are any problems. Under the Estate Agents’ Act, an estate agent is legally bound to present any offer to the vendor. Unlike in Scotland, a buyer’s offer is not legally binding in England and Wales, even if accepted by the seller. 76
Once your offer is accepted, ask for the property to be taken straight off the market for the duration of the sale. The seller may be reluctant to do this if you haven’t already sold your property. It is not in an estate agent’s best interests to allow ‘gazumping’ to occur, as they rely on their reputation; however, a determined buyer may go straight to the seller with their offer.
Solicitors and Conveyancing Conveyancing is the legal process by which ownership of a property is transferred from the seller to the buyer. Whether you are a buyer, a seller or both, in most cases you will want to hire a solicitor or licensed conveyancer as it can be complicated process. The Law Society is the professional body for solicitors in England and Wales, and they are bound by their code of practice. You can find a solicitor in your area that specialises in conveyancing on the Law Society website. Licensed Conveyancers are regulated by the Council for Licensed Conveyancers (CLC) in England and Wales.
Exchange of Contracts and the Deposit At this point, all the solicitors in the chain will exchange the contracts they have drawn up for each property and thereafter a date is fixed for the completion of the sale. This is the date that the property is legally yours and you can move in. Normally, 10% of your property purchase price will be needed in advance, and paid at the exchange of contracts. You are also bound to go through with the purchase – or lose the deposit.
Arranging the Move Once you have the completion date, you can arrange the day of the move. A removal company may often be the best way to move all your belongings, but do check your contract with them. If you can’t get anyone to recommend a firm to you, contact the British Association of Removers.
E-conveyancing Many people are dissatisfied with the present house-buying system which can be plagued with delay and anxiety. The Land Registry is developing ‘e-conveyancing’, an electronic system for the buying, selling and registration of land and property in England and Wales to improve the process.
Viewing a Property You Are Thinking of Buying
do not waste time seeing something that does not meet your needs. When you are ready to view, if you can, take someone else with you, preferably someone with different tastes who may spot things that you miss. Make sure you view the property during the day, when you will be able to see better and spot any problems. If you really like a property, try to arrange to view it again at a different time of the day – this will give you a different perspective. Remember, it’s your money you are spending so don’t be afraid to ask direct and blunt questions about the property. Take your time, be nosy and don’t be pressurised by the estate agent or vendor into making an offer. Try not to view too many properties in one day. The house Things to look out for inside the house and questions to ask: > Does the property need updating – if so, how much will this cost;
Here is some advice which you might find helpful, and a checklist of things to look out for and questions to ask about the property and its location.
> Is the property in a conservation area or is it a listed building, and could this restrict any future alterations you may wish to do;
Preparation
> Are the rooms big enough for your needs – your furniture will fit, etc;
Before you go to view a house, try to do as much background research as you can on the property and the area, so that you
Property Matters
One of the key stages of buying a house is the viewing. However, it is not always easy to know how to prepare for this, what to look for, what questions to ask and how to ensure you have the full picture.
> What is included in the sale – land, garage, furniture, fittings, etc; 77
> Are the views good enough;
> How much storage space is there;
> What is the cost of Council Tax and the average costs of other utility bills, such as electricity, gas, water;
> Are there sufficient power points, and how old do they look; and > Does it feel like it could be your home?
> Why are the sellers moving; The location > Does the house have full central heating? If so, how old is it; > How is the water heated? Combination boiler or tank, etc; > Have there been any problems with the boiler – when was it last serviced by a Corgi engineer; > If there is a loft, has this been insulated? If so, how long ago; > Does the property have cavity wall insulation; > Has the property been altered in any way, and if so are the relevant planning and building-control consents available to inspect it;
You should also make sure that the location meets your requirements, so here are a few things to think about: > Nearby main roads, or pubs, clubs or restaurants – they can be handy, but also very noisy; > Nearby railway lines – or overhead flight paths; > The feel of the community – does it seem friendly; > The aspect of the house – does it get enough light; > Is the property well maintained; > The age of the property;
> Is there any sign of subsidence (for e.g. major cracks in the walls or the doors sticking);
> The garden size; > The condition of nearby properties;
> Is there a smell of damp or any other sign, such as the walls feeling damp, the wallpaper peeling/paint bubbling, watermarks or mould; > Do the window frames have cracking paint? (If you can press your fingers easily into the wood, it’s sure to be rotten); > Has a room recently been refurbished? If so, why (a problem might lie underneath); 78
> How good or near is public transport; > Are the local schools good; > Are there any known plans for development in the area; > What are the local amenities like – shops, hospitals, leisure facilities, etc; > What is the crime level like in the area;
> Has there ever been a dispute with the neighbours (or anyone living nearby)?
Building Surveys When you are buying a home, it is important to get a surveyor’s report about the property’s overall condition. A surveyor is a qualified building inspector who can identify any problems or weaknesses with the structure of your prospective purchase.
What to do if things go wrong If you find your new purchase has a problem that you feel should have been spotted by your surveyor, you can take it up with the RICS, if the surveyor happens to be a member.
HIPs: A Buyer’s Guide
Types of survey
Once you are interested in a property, you should ask to see the Home Information Pack (HIP). The HIP will give you all the important information on a property, before you decide to make an offer. HIPs are only available in England and Wales.
There are three main types of survey:
What are HIPs?
Valuation: This will be carried out by your mortgage company if you need a mortgage to buy the property;
Before HIPs were introduced, buyers usually had to wait until after they had made a formal offer before they saw essential information on the property. The HIP gives you a chance to see these important documents before you make an offer.
Homebuyer: This is a basic survey that will give you a general overview of the property; and Full structural: Recommended for older properties and those in need of work, or simply for peace of mind. Although expensive, it is worthwhile.
The seller must have commissioned an HIP by the time a property is put on the market. What is in a HIP?
You can contact the Royal Institute of Chartered Surveyors (RICS) to find a suitable surveyor in your area.
New Properties If you buy a house that is less than 10 years old, it may be covered by the National House Building Council (NHBC) Buildmark Scheme, or a similar warranty. This warranty will transfer to the new owner and will only cover defects that appear after the house has been sold.
The HIP is made up of required (compulsory) and authorised (optional) items. There shouldn’t be any marketing or advertising material in the pack, so make sure it contains official information only. Listed below are all the compulsory documents that should be included: > Home Information Pack Index; > Energy Performance Certificate (EPC); 79
Property Matters
> What are the neighbours like? Are they noisy; and
> Sustainability information (required for newly built homes only); > Sale statement; > Evidence of title; > Standard searches (local authority, drainage and water); > A copy of the lease for leasehold properties; and > Commonhold documents, where appropriate. What do you need to do? Just ask whoever is advertising the property for sale, for a copy of the HIP. This is usually an estate agent, but could be another business or individual. They must give you a copy of the HIP free of charge if you ask for it (although they may make a reasonable charge to cover the costs of copying and posting it). You should get your copy of the HIP within 14 days of the request being made. When is an HIP available? The HIP must be commissioned and paid for (or arrangement for payment made), before the property is marketed for sale. Checking the HIP You should check to see if any of the compulsory documents are missing. If any documents are indeed missing, make sure that there is a satisfactory explanation and an assurance that the missing items will be provided as soon as possible. 80
Check to see if a Home Condition Report has been included by the seller. The seller does not have to include a Home Condition Report in the HIP, but it could speed up the buying process if they have included one. Should you choose to enter into negotiations to buy a property, you should pass the HIP to your solicitor who will find it useful in their precontract enquiries. How much will an HIP cost? If you’re a buyer, nothing: you’ll get a copy of the HIP free on any property you’re interested in (although you may be asked to pay copying and postage costs). With HIPs, the overall costs of buying and selling a home are similar to the costs before they were introduced, but are now spread more evenly between the buyer and seller. The Energy Performance Certificate is a compulsory part of the HIP, and is paid for by the seller. What can you do if a HIP/EPC isn’t provided? Sellers have to provide the pack within 14 days of a request from a buyer. A seller can refuse to provide a copy – in limited cases. This is usually when a seller believes that the person making the request: > Could not afford the property; > Is not really interested in buying the property; or > Is not a person whom the seller would wish to sell the property to (but this
getting you on the board in the and property game
mortgage
Sable Property brings you focused expertise in the mortgage finance and property arena. Whether your requirements are as simple as a remortgage or as complex as offshore property or development finance, Sable Property has the knowledge to help you.
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For further information, call us on 0808 141 1607 or visit our website at www.1stcontact.com/property Sable Property is an Authourised Representative of Sable Private Wealth Management. Your home may be repossessed if you do not keep up payments on your mortgage There may be a fee for mortgage advice. The precise amount will depend upon your circumstances but we estimate that it will be ÂŁ10.
does not allow them to unlawfully discriminate against anyone). If you believe that you are being denied a copy of the pack unlawfully, local authority-trading standards officers can help you.
Exposure to Property as an Asset Class Increasingly, investors are looking to get exposure to property as an asset class rather then just as a residential home. There are now many providers who assist individuals in buying second properties in the UK and abroad. The use of property funds is also becoming increasingly popular (this is dealt with in more detail in the Savings & Investments chapter).
Part 2 – Mortgages
How mortgages work > You take out a loan based on how much you can afford and the value of the property, for a length of time agreed between you and the lender; > You are charged interest on the loan, which is reviewed regularly; > You pay the mortgage back in one of two ways, repayment or interest-only; > You can choose different deals for your interest rate, such as fixed or discounted; and > If you’ve had financial problems in the past and are finding it difficult to get a mortgage, you should consult with Sable Property who have experience in dealing with these situations.
Mortgages Made Clear
Types of Mortgage
Whether you’re a first-time buyer, moving home or staying put and remortgaging, you will need to understand the mortgage process in some detail.
You can choose to pay your mortgage back in the following ways:
It is best to do this with the help of an independent mortgage adviser. Sable Property specialises in this area (in particular sourcing mortgages for expats and contractors) and so would certainly be able to help you.
> Interest-only; or
> Repayment;
> A combination of the two. You’ll need to decide which is best for you. Repayment mortgages
What is a mortgage? A mortgage is like any other kind of loan – you borrow money, and you pay it back with interest over a period of time. But it has one key difference: it’s secured against your home. So, if for any reason you can’t repay it, the lender can sell your home to recover their money. 82
Every month, your payments to the lender go towards reducing the amount you owe as well as paying the interest they charge. So each month you’re paying off a small part of your mortgage. The pros: It’s a simple, clear approach – you can see your loan getting smaller.
The cons: In the early years your payments will be mainly interest, so if you want to repay the mortgage or move house in the early years, you’ll find that the amount you owe won’t have gone down by any significant amount.
end of the term you’ll have enough money to pay off the loan. If it doesn’t grow as planned, you’ll have a shortfall and will need to think of ways of making this up. The pros: Because you’re only paying off the interest – and not the loan itself – your monthly payments will be lower.
Interest-only mortgages As the name suggests, your monthly payment only pays the interest charges on your loan – you’re not actually reducing the loan itself. This is why it is very important that you arrange some other way to repay the loan at the end of the term; for e.g. through an investment or savings plan.
The cons: That the debt is not going to go away. Throughout the life of the mortgage, you’ll need to check that your investment or savings plan is on track to repay your loan at the end of the term. If you can’t repay it at the end of the term, you could lose your home.
If you choose this option you will need to check that your investment or savings plan grows accordingly, so that at the
So, choosing a repayment or interest-only mortgage is one decision. The other will be to choose the interest-rate deal.
Interest rate deals Types of deals
How they work
Early repayment charges
What it means for you?
Standard variable rate
Your payments move up or down at the lender’s discretion. The lender may not reduce, or may delay reducing, their variable rate even if the Bank of England rate goes down.
Not usually, but check and see.
Usually you can leave your lender without any penalties or problems.
It moves with interest rates. So if the lender decides to increase the rate, your monthly payments will increase. It may be expensive compared to other deals. The lender may not reduce, or may delay reducing, their variable rate even if the Bank of England rate goes down.
Tracker rate
A variable rate loan with an interest rate that’s equal to or a set amount above or below the Bank of England or some other base rate, set independently from the lender. It tracks (moves up or down with) that rate.
Sometimes during any special deal period and maybe even after the period, too.
It can pay to go for a tracker if you can afford to pay more when interest rates go up, in exchange for benefiting when they go down. It’s not a good choice if your budget won’t stretch to higher monthly payments.
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Property Matters
You’re in control. You can usually pay back extra amounts (and cut your interest costs) without a penalty.
Types of deals
How they work
Early repayment charges
What it means for you?
Discounted interest rate
Your monthly payments can go up or down, but you get a discount on the lender’s standard variable rate for a set period of time. At the end of the deal, you usually change over to the full standard variable rate.
During the special deal: yes, almost always. They can apply even after the end of the ‘special deal’ period, as well.
It gives you a gentler start to your mortgage, at a time when money may well be tight. But you must be confident that you can afford the payments when the discount ends. The discount period is limited, so don’t get used to those early low repayments. You may not be able to make overpayments and pay off the loan early, without penalties The lender may not reduce, or may delay reducing their variable rate, even if the Bank of England rate goes down.
Fixed interest rate
Your payments are set at a certain level for an agreed period. At the end of that period, they’ll usually switch you to the standard variable rate.
During the special deal period: yes, almost always. They can apply even after the special deal period, too.
Your payments will stay the same in that period, even if interest rates go up. This gives you the security of knowing that you can afford your payments and will make it easier for you to budget. If rates go down, you won’t benefit. Your payments will stay at the higher rate. You may not be able to make overpayments and pay off the loan early, without penalties.
Capped rate
Your payments are variable and often linked to a base rate, but fixed not to go above a set level (the ‘ceiling’ or ‘cap’) during the period of the deal. At the end of the period, you are usually charged the lender’s standard variable rate.
During the special Useful if you want the security of knowing deal: that your payments can’t rise above the set yes, almost level, but still benefit if rates fall. always. They can apply even after the end of the special deal period, too.
Collared rate
May be used in conjunction with a capped rate or a tracker (or both). Your payments are variable, but will not fall below a set level (the ‘collar’).
Not usually, unless it is used in conjunction with a capped rate or a special-deal tracker rate (or both). But check and see.
How Mortgage Endowments Work With a repayment mortgage your monthly payments gradually pay off the amount you borrowed (the capital), as well as the interest over a set period (the term). 84
It may be part of another interest-rate deal which otherwise appears attractive. But note that if the rate payable is only just above the ‘collar’ and you think rates will fall, you may not get the full benefit of a reduced payment.
But with an endowment mortgage, your monthly payments only cover the interest on the loan. They do not pay off any of the capital. At the end of the term, you need to pay off the capital using the money from your endowment policy.
However, as investments can vary in value, there is usually no guarantee that the policy will pay out enough to repay the mortgage at the end of the term. If you have an endowment mortgage and are worried, don’t make any hasty decisions. Check the facts first. Never cash in your policy or stop your payments without taking proper advice. You could lose out if you do.
Mortgage Features Mortgages can have different features. For e.g. you’ll find: > Cashback mortgages; > Flexible mortgages; > Offset mortgages; and > Current account mortgages.
Cashback Mortgage This may be offered with an interest-rate deal. The lender pays you a substantial sum (for e.g. three to five per cent of the amount you borrow) shortly after you take up the loan. If you move to another lender in the early years, you’ll have to repay some or all of the cashback. Is it right for you? Possibly yes, if you need a large cash sum – for e.g. to buy furniture, or you expect
the sum to more than compensate for any higher interest rate you may have to pay during the penalty period. Possibly not, if you can manage without the cashback now and can get a better overall deal elsewhere.
Flexible Mortgage A flexible mortgage gives you some scope to change your monthly payments to suit your ability to pay. It’s also useful if you want to pay off your loan more quickly. Several flexible features are becoming common, and they aren’t limited to mortgages with ‘flexible’ in their name. Here are some flexible features: Overpayments – you can pay more than your normal monthly mortgage payment or pay off a lump sum, or both. Underpayments and payment holidays – you pay less than the normal monthly payment for a limited period (say six or 12 months). You may even be able to stop making payments altogether (a payment holiday). This could be useful if, say, you lose your job or take time off to care for a child. Borrow extra (loan drawdown) – you can borrow extra without further approval from your lender, provided the total loan does not go above an overall limit. Alternatively, you may be able to ‘borrow back’ against earlier overpayments. Is a flexible mortgage right for you? Possibly, yes, if you are likely to use these features, for e.g. if you’re selfemployed and have an income that varies from month to month. 85
Property Matters
An endowment policy is an investment plan that you usually pay into each month. Your money is invested – for e.g in shares or bonds – with the aim of making it grow enough to pay off the original loan when the mortgage term ends.
Possibly not, if you are unlikely to use these features. A less flexible mortgage may be cheaper or more suitable for you.
Offset Mortgage With an offset mortgage your main current account or savings account (or both) are linked to your mortgage and are usually, but not always, held with the mortgage lender. Each month the amount you owe on your mortgage is reduced by the amount in these accounts, before working out the interest due on the loan. So as your current account and savings balances go up, you pay less on your mortgage. As they go down, you pay more.
Current Account Mortgage A current account mortgage is similar to an offset mortgage, in that it offsets the balance of your savings against your mortgage. However, in this case, rather than your mortgage and current account being separate pots of money, they are usually combined into one account. This means that the account acts as one big overdraft. Is an offset or current account mortgage right for you? Possibly, yes – if you are a higher-rate taxpayer, have substantial savings to offset and like the idea of built-in flexibility to make overpayments and underpayments. Possibly not – if after paying your deposit you don’t have much left in savings and if other mortgages have a lower interest rate or other features that are more important to you. 86
Part 3 – Selling Property Using an Estate Agent – Selling a Property If you are selling your property and want to use an estate agent, it is worthwhile reading up on your rights. An estate agent doesn’t have to be registered to practice, although many are registered with the National Association of Estate Agents (NAEA) and the Ombudsman for Estate Agents (OEA). This means that they have to abide by a code of practice. All estate agents are bound by the Estate Agents’ Act, whether or not they are registered with a governing body.
The Contract and Fees When you use an estate agent to help you sell a property, you have to sign a legally binding contract. Before signing, read the contract carefully and make sure you understand it. Find out whether you have the right to cancel the contract. Check how long it will run. It should allow a reasonable length of time to market your property and find potential buyers. Beware of contracts that tie you to an estate agent for a very long period of time. If you are unsure, get advice from a solicitor or your local Citizens’ Advice Bureau. You may come across some unfamiliar terms in a contract. Make sure you understand what you are agreeing to. The terms ‘sole agency’, ‘sole selling rights’ and ‘ready, willing and able purchaser’ must be explained in writing.
Complaints If you have a complaint about the conduct of an estate agent, you can contact the OEA. The OEA provides an independent service for dealing with disputes between estate agents who are members of the Ombudsman Scheme, and consumers who are actual, or potential, buyers or sellers of residential property in the UK. The OEA will advise on alternative routes to take if the estate agent you wish to complain about is not a member. You can also contact the council’s trading standards department.
Moving to Your New Home There is so much to organise in just packing for the move that often things are over-looked, but use this checklist to make sure that you’ve got everything covered. But don’t notify anyone of your change of address until the contracts have been exchanged, as the sale can still fall through leaving you to contact everyone again.
Making Sure You’ve Covered Everything Change of address service You can inform many different organisations of your new address,
including gas and telephone companies and government offices, by using the website ‘I am moving’. Have you contacted your Council Tax office? Contact your local council’s Council Tax office to let them know the date you move out of your current property and when you move into your new one, so they can bill you correctly. If you receive benefits, have you told your benefit provider? Give your details to the local Jobcentre Plus office or, if you don’t yet have Jobcentre Plus in your area, contact your Jobcentre or social security office. You can use the Jobcentre Plus link to find your nearest Jobcentre Plus, Jobcentre or social security office. Have you redirected your post to your new address? You can download the form from the Post Office website. It can take up to 10 days to set up, and there is a charge involved. Have you told the utility providers (gas, water, electricity)? You need to tell them at least 48 hours in advance that you are moving. Pass on the details of your current supplier to the people moving in. On your moving day, you will need to read the meters in both properties so that the correct bills can be issued. When you move in to your new home contact who you want to supply your utilities, so they can register you as a new customer and start billing you from that day. 87
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Estate agents charge fees to sellers, not buyers, so make sure you understand how much you will have to pay, when and under what circumstances. Remember that Value Added Tax (VAT) will also be added, so take account of this in your calculations.
Have you updated your driving licence and vehicle registration documentation?
You can search for the latest house prices by:
You must inform the Driver and Vehicle Licensing Agency (DVLA) immediately of any changes to your name, address or both. You must also inform the DVLA if either the name and/or address details shown on the registration certificate are incorrect.
> Property type and postcode;
Have you updated your details on the Electoral Register? The register is updated every month and you need to be included on it to vote. A form is available from the Electoral Commission’s ‘About my vote’ website. You can complete the form online, or download and send it to the Electoral Registration Office which is based at your local council. What about your TV licence? Your television licence will need to be transferred to your new address. You can arrange this online, or by calling 0870 241 6468.
Property Value and Valuations How much you can sell your current home for will be crucial when deciding on your next move. It pays to do some research to make sure you achieve the best price in the shortest time.
> County; or > Unitary authority. You can also find out average prices within Greater London by individual London boroughs. Having your property valued However you decide to sell your home, you can get the property valued without obligation by local estate agents. It is best to get three valuations for a balanced view. If you do want to sell through an estate agent, it may not always be best to choose the one that gave the highest valuation. You should get to know the local property market and sales prices before you make your choice. This will give you a realistic idea of how much your property could be sold for, and will avoid any delays in the selling process
Part 4 – Renting Property Private landlords
So how much is my home worth?
Private landlords will normally rent their property at the market rate, and their right to increase the rent depends on the type of tenancy. Make sure that you get a tenancy agreement and read it carefully before committing to it.
You can get an idea of the prices in your area before you sell, by visiting the Land Registry website. Here you can see what is actually happening to average prices of property in England and Wales.
A private landlord will normally ask for a deposit. You should make sure that the condition of the property and any items of furniture are recorded in an inventory, and that the tenancy agreement states:
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> How much the deposit is and who holds it;
Shorthold Tenant, as your rights may be different, for e.g.:
> When money can be deducted from the deposit (for unpaid rent or damage to property); and
> If you live with your landlord as a lodger and share living accommodation, this may be known as a Non-Excluded Tenancy or Licence;
> When you will get the deposit back.
Private Rent and Tenancies A tenancy agreement is a legal agreement in writing that sets out the rights and responsibilities of both landlord and tenant. It will contain details such as the length of the agreement, the rent payable, and what is and isn’t allowed at the property, such as pets.
Types of Tenancy Agreement There are different types of tenancy agreements. Some provide the tenant with more rights than others, and most people have one of three types: Assured Shorthold Tenancy (AST) The AST is one of the most common in the private rented sector. If your tenancy began, or was agreed, on or after 28 February 1997, it is likely to be an Assured Shorthold Tenancy. Tenancies starting, or agreed, before that date but after 15 January 1989, are more likely to be Assured Tenancies. However, it is important to know if you are not an Assured, or an Assured
> If you landlord has divided a property into flats and the tenant occupies a different flat from the landlord, this may be known as an Excluded Tenancy or Licence; and > If you rent a property where the combined rent is over £25,000 per year, this is known as a Bare Contractual Tenancy. Bare Contractual Tenancies tend to occur in large households where many people will occupy a property, for e.g. a student household. It only takes five people paying £100 a week each in rent for the annual rent to be above £25,000 a year. You should check to see how your circumstances will define your tenancy agreement.
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You can contact your local council to see if they have a list of accredited landlords in your area. You can also search on their website for a letting agent who is registered with the government-backed National Approved Letting Scheme.
Assured tenancy This type of tenancy agreement is usually issued by a housing trust or housing association. They offer some security in that as long as you do not break the terms of the agreement, you may continue to live at the property. Regulated (or ‘protected’ tenancy) If you moved into the property before 15 January 1989, you may have a Regulated or Protected Tenancy. This type of tenancy 89
offers the most protection against rent increases or eviction. The type of tenancy you have depends on when it was taken out. More details can be found in booklets published by the Department for Communities and Local Government, for e.g.: > Assured and Assured Shorthold Tenancies: A Guide for Tenants; > Regulated Tenancies; and > Letting Rooms in Your Home: A Guide for Resident Landlords.
Private Landlords Private landlords will normally rent their property at the market rate, and their right to increase the rent depends on the type of tenancy. Tenants who have a fixed term of three years or more, are legally entitled to a written tenancy agreement. However, where there is no written tenancy agreement, a tenant with a shorthold tenancy, starting on or after 28 February 1997, has a right to ask for a written statement of any of the following main terms of the tenancy: > The date the tenancy began; > The amount of rent payable and the dates on which it is due; > Any rent review arrangements; and > The length of any fixed term.
Deposits When you move into your home, it is likely that you will have to provide the 90
landlord or letting agency with a deposit. This should be requested to cover any unpaid rent or damage to the property. Sometimes, when a tenant decides to move on, there maybe disputes concerning the returnable amount. When you sign your tenancy agreement always check the details to see what your deposit will cover and how it will be returned. You should also ask for an inventory of the property’s contents when you move in. Ensure that you agree with the terms and conditions of the tenancy, before you hand any money over.
Tenancy Deposit Protection To help end the problem of a tenant’s deposit being unfairly withheld by landlords and agents, Tenancy Deposit Protection Schemes have been introduced. All deposits taken for an assured shorthold tenancy must be protected by a government-authorised scheme.
Help with Your Rent If you have a low income, you may be able to get a Housing Benefit to help you pay your rent. Your savings as well as your income will be used to work out whether you can get benefit and, if so, how much. You can find out more from your local council or the Department for Work and Pensions, where you can also download a Housing Benefit claim form.
Health and Safety in Rented Accommodation Landlords are generally responsible for the maintenance and any major repairs to a property. This includes repairs to the
Housing Standards A property should be safe and healthy for occupiers, so responsibility should be taken to ensure that: > The dwelling is capable of providing adequate heating, which ideally means controllable central heating and insulation, with equipment and the fabric of the building in good repair; > Electricity and gas supplies, and the sanitation (drains, basins, sinks, baths and WCs) are all in working order; > There are no fall or trip hazards; > Water heating equipment is in working order; and
By law, your landlord must ensure that the electrical system and any electrical appliances supplied with the let such as cookers, kettles, toasters, washing machines and immersion heaters are safe to use. If your landlord supplies new appliances, he or she should also provide any accompanying instruction booklets.
Fire Safety The 2004 Housing Act requires that the landlord of a property does several things about fire safety: > There has to be an adequate means of escape; and > Depending on the size of the property, there may have to be smoke alarms and fire-extinguishing equipment.
Gas and Electrical Safety
If the property is a considered to be a House in Multiple Occupation (HMO) by your council, which is subject to licensing, your landlord must also comply with licence conditions in relation to fire safety.
Your landlord must ensure that:
By law, your landlord must:
> All gas appliances and installations are maintained in good order;
> Make sure that all the gas appliances they provide are maintained in good order, and that a Corgi-registered plumber carries out a safety check each year;
> The property is free from damp.
> Gas boilers get an annual safety check, carried out by someone who is registered with CORGI (the Council for Registered Gas Installers); and > A record of the safety checks is kept, and issued to you within 28 days of each annual check.
> Maintain all electrical installations (i.e. fixed wiring) and any electrical appliances they provide (i.e. cookers, kettles), and make sure that they are safe to use; and
The occupier is responsible for maintaining the gas appliances which they own, and can take them when they leave.
> Make sure that any furniture and furnishings they provide meet the fire-resistance regulations.
Property Matters
structure and exterior of the property, heating and hot water installations, basins, sinks, baths and other sanitary installations.
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Your council’s Environmental Health Officer will be able to give you more details about your landlord’s obligations, and can force your landlord to provide adequate fire precautions. For practical advice to greatly reduce the chances of a fire happening in your home, visit the ‘Fire Kills’ website.
Where a complaint is received, the council’s housing officers will endeavour to ensure that the required information is provided. However, in the case of persistent failure to provide the information, a prosecution will be considered.
Problems with Your Landlord – How the Council Can Help
If your gas, water or electricity supplies have been or are likely to be cut off because of your landlord, the council can help. Under the Local Government (Miscellaneous Provisions) Act 1976 your council can arrange to restore utility services for its residents.
The vast majority of landlords are responsible and fair. In the unlikely event that you experience trouble with your landlord, your council has some legal powers it can use to help. Harassment and unlawful eviction Harassment and illegal eviction, as defined in The Protection from Eviction Act 1977, are criminal offences. Your council has the power to prosecute people who commit offences. Housing officers from the council will investigate complaints, and mediate between the two sides wherever possible. Your council will consider bringing a prosecution where there is enough evidence to indicate that it will be successful, and where it is in the public interests. Failure to meet Landlord and Tenant Act requirements The council has powers to prosecute landlords who fail to meet their obligations under the Landlord and Tenant Act 1985 (as amended). Such matters include the failure of landlords to provide rent books, and the failure of freeholders to give long leasehold tenants information concerning service charges and insurance. 92
If your utility services have been cut off
These powers will only be used as a last resort for emergency cases, and then only when young children or elderly people are affected. In every case, the council will work closely with the suppliers and wherever possible try to get the suppliers’ support and assistance.
Housing Standards in Rented Accommodation If you rent your home, major repairs are generally the responsibility of your landlord. This includes repairs to the structure and exterior of the property, heating and hot water installations, basins, sinks, baths and other sanitary installations.
Standards in Your Home A property should also be free of serious health and safety hazards – your landlord should ensure that problems in the home are dealt with before they lead to poor health or accidents. Hazards can arise in the home because of its design, wear and tear, or a lack of maintenance. The most common hazards involve:
> Inadequate heating, insulation and disrepair; > A lack of handrails, steep stairs and pool lighting which lead to falls;
> Landlords and letting agents who do not protect tenancy deposits will have to pay their tenant back three times the deposit. How does it work?
> Damp and mould growth; Start of a new tenancy > Problems with personal and domestic hygiene; and
Pay your deposit to your landlord or agent as usual.
> Fire. Within 14 days In practice, the landlord should check that the home is a warm and safe environment for the people who live there.
Getting Help If your home has any problems which could be a hazard, you can ask your landlord to put things right. If your landlord doesn’t do anything to improve the situation, you can contact an environmental health officer at your local council.
Tenants Tenancy deposit law was introduced on 06 April 2007, and provides protection for tenants by preventing landlords and letting agents from unfairly withholding a deposit. The scheme protects all Assured Shorthold Tenancies in England and Wales (covering most tenancies since 1997). What is it? Tenancy Deposit Protection is designed to ensure that: > You get all or part of your deposit back, when you are entitled to it; > Disputes between you and your landlord/agent will be easier to resolve; and 94
Within 14 days, the landlord or agent is required to give you details of how your deposit is protected including: > The contact details of the tenancy deposit scheme; > The contact details of the landlord or agent; > How to apply for the release of the deposit; > Information explaining the purpose of the deposit; and > What to do if there is a dispute about the deposit. If you don’t get this information, ask your landlord or agent the simple question – ‘how is my deposit protected?’ You have a responsibility to return the property in the same condition that it was let to you, allowing for fair wear and tear.
What If Your Landlord Isn’t Protecting Your Deposit? You can apply to your local county court. The court can order the landlord or agent to either repay the deposit to you or
Moving Out At the end of the tenancy, check whether you are leaving the property and its contents in the condition in which it was let to you – allowing for fair wear and tear – and that you have paid your rent and any other expenses. Then agree with your landlord or agent how much of the deposit should be returned to you. Within 10 days, you should have received the agreed amount of the deposit.
Renting a Room If you are renting or thinking of renting a room in someone’s home there are some important issues to be aware of. It’s worthwhile finding out what the issues are and being aware of your rights.
Knowing Your Rights In law, a resident landlord letting is where the landlord and the tenant live in the same building. This includes conversions where they live in different parts of the same property (however long ago the property was converted), but excludes purpose-built flats with landlord and tenant in different flats. Resident landlord lettings differ from other types of tenancy in two ways: rent and security of tenure.
It is worthwhile reading all the information provided in the leaflet Renting rooms in someone’s home, and taking legal advice if you are unsure of anything.
Living in Shared Accommodation If you live in a property in which three or more people live, at least one of whom is unrelated to the others and where you share facilities, your council will call this type of accommodation a ‘House in Multiple Occupation’ or HMO. Special rules apply to the management of HMOs, and some may need a property licence. Do I live in an HMO? If you live in a property with two or more people who are not related to you or a partner, and at least one of you pays rent, shares kitchen, bathroom or toilet facilities, you probably live in an HMO. The following types of accommodation are often described as an HMO: > Some shared houses or flats;
Property Matters
protect it in a scheme. If your landlord or agent has not protected your deposit, they will be ordered to repay three times the amount of the deposit to you.
> A house converted into bed sits; > Some hostels; > Some guesthouses; > Some bed and breakfast establishments and hotels; and
This means that tenants: > Do not have a right to challenge the level of rent he/she has agreed to pay; and > Can be given less notice to leave if the landlord wants to end the letting.
> Some types of houses converted into flats. Certain types of shared accommodation are not considered HMOs. Examples include: 95
> A house or flat occupied by only two persons; > A house or flat with a resident landlord, plus two other occupants; > Houses converted entirely into self-contained flats with appropriate Building Regulations approval, where at least two thirds are owner occupied; > A house or flat managed by the council or a registered social landlord; > A house or flat registered under the Care Standards Act 2000; > Accommodation managed by certain higher-educational establishments; and > Accommodation for health, police or fire authorities.
What are the Standards? Your landlord is responsible for making sure your home is kept in repair and is suitable for multiple tenants. If your home has to be licensed, the local housing authority can impose conditions to ensure that the property is occupied by no more than the permitted number of persons. Your council will also check to ensure that it is properly managed. Whether or not the HMO in which you live is licensed by the council, your landlord must comply with management regulations. Your home should also be free of any hazards likely to seriously impact upon your health and safety. If you think there is a hazard in your home, you can contact the council. In all rented properties utilities, like gas, must comply with safety regulations 96
and all furniture should pass fire-safety standards. The landlord has a duty to ensure that a gas-safety check is performed annually and a certificate issued, which you are entitled to see.
Licensing Requirements & Exemptions As of 06 April 2006 it is compulsory to license shared accommodation of three or more storeys, occupied by five or more people, who live in two or more separate households. A household may consist of a married couple or civil partners, may be made up of people related to each other, or include nannies or other domestic staff living with the family. Local authorities also have power to operate additional HMO licensing schemes to apply to properties with less than three storeys, and which are occupied by less than five people per area. If you are not sure about any of the licensing issues surrounding your accommodation, contact your council. Your landlord is not allowed to evict tenants in order to bring the number of occupants below the threshold for licensing it. If he threatens you with eviction, you should contact your council immediately. Your council will have details of emergency contact numbers. Contact your housing advice centre for full information on the support services available to you. If you think you are living in a property that should be licensed but isn’t, you can report your landlord to the council. How do you apply for a licence? The responsible person, i.e. the landlord, or person managing an HMO or other
What if standards aren’t being met? If you think your home is below an acceptable standard, you should approach your landlord and voice your concerns. If this is not possible, speak to your council. The council has the power to take action against a landlord to ensure that all standards for shared housing are met; including physical and management issues. The following links will let you enter details of where you live and take you to your local authority website, where you can read about council inspections.
Repairs – Short Lease Tenants Short leases are leases for periods of less than seven years. They can be granted by private landlords, registered housing associations or local councils. They include periodic tenancies, where the tenant does not have a fixed-term agreement and occupies property on, for e.g. a weekly or monthly basis. In some cases, the arrangement will involve a licence.
The landlord can seek possession where the tenant or someone living with him or her has damaged the property. Apart from your duty to take care of the property, you generally only have to do repairs if the terms of your tenancy agreement say that you must. However, whatever the tenancy agreement says, you can’t be made to do repairs for which the landlord is by law responsible. For more information, read the following housing booklets from the Department for Communities and Local Government: A Better Deal for Council Tenants – Your Right to Repair, Assured and Assured Shorthold Tenancies – A Guide for Tenants and Regulated Tenancies. What happens if there is no written tenancy agreement? A verbal agreement is subject to the law on repairs, just like a written agreement; the same provisions apply. But get any agreement in writing if you can. What about licensees?
> Turn off the water if there is a risk of burst pipes when they are away;
Licensors do not have the same obligations as landlords to keep a property in good repair. However, local councils require property to meet certain standards of health and safety – they can order your licensor to carry out work or repairs to make sure that it meets these standards. The Environmental Health Department of your local council has more information.
> Unblock the sink when clogged up; and
Repairs & Rights
> Do not damage the property and make sure that family and guests do the same – the tenant may be responsible for any damage that his or her guests cause.
It does not matter what repairs you have done. The security of your tenure depends on the type of lease you have, not on your repairing obligations. •
What obligations does the tenant have? Under common law, tenants must use the property they rent responsibly. For e.g.:
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Property Matters
property, will need to apply to the local council for the licence and pay the approprivate fee. As of 06 July 2006, it is an offence to operate an HMO without this.
Chapter 14 Savings & Investments
Types of Savings Products The main types of savings products are: > Bank and building society savings accounts; and > National Savings and Investments. You may also have heard about cash or deposit ISAs (Individual Savings Accounts); these are a type of savings account available from banks, building societies or National Savings and Investments. Banks and building societies in the UK must be regulated by the FSA to be able to take your money and hold it.
Savings Accounts Savings accounts generally pay higher interest rates than current accounts. You can find them at banks, building societies and through National Savings and Investments (NS&I). They are generally low-risk investments, suitable for short to medium-term savings. Savings accounts are deposit-based. This means you’ll usually get back the money you have put in plus interest, unless the bank or building society collapses. But if this happens and, as long as the firm 98
is regulated by the FSA, the Financial Services Compensation Scheme may be able to pay compensation to customers, up to a set limit. Save regularly You can ask your bank to arrange for a set amount of money to be paid regularly from your current account into a savings account – this method is usually called a standing order. You don’t have to save with the bank you have your current account with; you can shop around to find a better interest rate. Is it right for you? If you are saving for the short to mediumterm, say under five years, or you want a low-risk home for your savings, consider a savings account. Bear in mind, however, that over the longer term your money may lose its value because of inflation. So, if you have decided that a low-risk product is right for you, here are some of the questions you should ask yourself: > Can I manage my account online or by telephone? If so, you may get a better interest rate;
> Should I get an account with a passbook? Some people like having the certainty that a passbook offers, but accounts with passbooks may have lower interest rates than other types of savings accounts. > Is it likely I’ll need to get at my money quickly? If so, stick to instant access or easy access products. > If not, can I get a better interest rate if I tie up my money for a set term or have to give notice to get it out? > Do I want a fixed interest rate or am I happy for it to vary? > What is the best return I can get after deducting tax? Remember that some products pay tax-free interest which
boosts your return if you are normally a taxpayer. > Is it absolutely essential that my original capital remains intact? Whatever you decide, make sure that you shop around to find the best account for your purposes and review your decision regularly, especially when interest rates change. See the table below for the main types of savings accounts.
National Savings and Investments National Savings and Investments (NS&I) provides savings products and investments issued on behalf of the government. As a result, any money you
Type of account
Features
Access
Benefits
Deposit
Usually pays higher interest than current accounts.
Instant or easy access.
You usually get back at least what you put in. Non-taxpayers can arrange for interest to be paid gross (before tax).
Cash ISA
The maximum you can put in is £3,600 Instant or easy, per tax year. Usually pays higher interest but some have than normal deposit accounts, and this notice periods. is not taxed. You can put money into it each tax year up to the limit, or you may switch to another ISA account if the new provider accepts transfers.
You usually get back at least what you put in. Interest is tax-free.
Fixed notice
You have to give notice if you want to take your money out, for e.g. after 60 or 90 days.
There is a penalty if you withdraw your money without giving sufficient notice.
You usually get back at least what you put in.
Fixed-rate bond (term account)
You usually have to leave your money in the account for one year or more (the term). Often a minimum deposit, for e.g. £1,000.
Might be difficult or You usually get back could involve a penalty at least what you if you withdraw during put in. the term.
High-interest regular savings
Your current account is with the same provider as your savings account. You regularly transfer a set amount each month into the account, for a set period.
Usually, interest is only paid yearly, and you can only withdraw on a yearly basis.
You usually get back at least what you paid in. You get a high interest rate.
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Savings & Investments
The main types of saving accounts are:
invest is totally secure. There are lots of different types of products – for e.g. some are aimed at particular sorts of taxpayer, some are for people looking for income, while others provide growth.
save for themselves, NS&I has a range of investments to choose from.
ISAs Individual Savings Accounts
All NS&I products are ‘deposit-based’. This means you can get back at least the money you paid in – and you will get back more if you leave it there and let the interest grow. This makes them a good home for savings you don’t want to take risks with. It’s also a good idea to compare NS&I with similar deposit-based products from banks and building societies, before deciding where to save. NS&I offer the following products: Tax-free investments As well as its two ISAs, NS&I has a range of investments with no UK income tax or Capital Gains Tax to pay on the returns. Guaranteed returns Suitable for savers who want the certainty of guaranteed returns with a choice of investment terms, from one to five years.
By using an ISA, you can invest in cash or longer-term investments such as stocks and shares or insurance and not pay tax on most of the income (this is why they are called a tax wrapper). As at 06 April 2009, the ISA rules are: > The annual investment allowance is now £7,200. Up to £3,600 of that allowance can be saved in cash with one provider. The rest can be invested in stocks and shares with either the same or a different provider; > You can invest in two separate ISAs each tax year – a cash ISA or a stocks and shares ISA; > Mini and maxi ISAs no longer exist: > Mini cash ISAs, TESSA-only ISAs and the cash part of a maxi ISA automatically became cash ISAs; and
Income products A choice of fixed-rate or variable-rate investments, paying the interest as a monthly income. Simple savings accounts Straightforward savings accounts for any purpose.
> Mini stocks and shares ISAs automatically became stocks and shares ISAs. > Personal Equity Plans (PEPs) automatically became stocks and shares ISAs; and
Investments for children
> You can transfer money saved in a cash ISA to a stocks and shares ISA – but you can’t transfer money the other way.
Whether you want to invest for a child’s future or encourage them to
The ISA limit will be raised to £10,200 (£5,100 of which can be invested in cash)
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A competitive market Providers compete hard to get you to take up your ISA allowances as soon as possible, or to persuade you to switch existing ISAs to them. You often see bigger and better deals, with some extreme headlines. Some firms may offer very generous interest rates for cash ISAs, but beware of any strings attached: > Getting that rate may depend on you buying another product or service from them, which may not be as competitive as the ISA rate; > If the other product offered isn’t a cash product, it may carry a higher risk – so make sure you understand what this might be; and > Sometimes the higher rate may only be for a fixed period of time, after which the interest rate drops to a less competitive level. These are just some examples, but the bottom line is to be careful of any ‘hidden’ or partially misleading catches before you sign up.
Types of Investments You may have heard of all sorts of investments – ISAs, shares, property, unit trusts – the list goes on. However, the best way to understand investments is to think about investing as having three ‘layers’. 1. The underlying investment itself will fall into what are referred to as asset classes. There are four main asset
classes – shares, bonds, property and cash deposits. You can invest in each of these directly if you wish. 2. Pooled investments. This is when you put your money with other investors to invest in one or more of the above asset classes. This spreads your risk and saves on costs. Open-ended investment funds, investment trusts and life-assurance bonds are the most common pooled investments. 3. Tax wrappers. These are tax breaks that you can – subject to certain rules – wrap around your investment, to shield it from either some or all tax. The wrapper can be around either the underlying investment or the pooled investment. The two most common tax wrappers are ISAs and pensions.
Shares You can buy shares as part of a pooled investment or directly, when you buy through the stockmarket. Shares are also known as equities or stocks. When you buy shares directly in a company, you are buying a part of that company, and you become a shareholder which usually means you have the right to vote on certain issues. You can either buy new shares when the company starts up and sells them to raise money (through an Initial Public Offering), or buy existing shares which are traded on the stockmarket. The aim, of course, is for the value of your shares to grow over time as the value of the company increases in line with its profitability and growth. In addition, you may also receive a dividend, which is an income 101
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for those aged 50 and over from 06 October 2009, and for all ISA investors from 06 April 2010.
paid out of the company’s profits. Longer established companies usually pay dividends, while growing companies tend to pay lower, or no, dividends – with these you would typically be hoping for better capital growth. Risk The level of a stockmarket goes up or down as the prices of the shares, that are the constituents of that market, go up or down. The main factor determining the price of a share is the perception of its current value to its owner. One factor that could affect the price of a share is a change in opinion as to how well the company itself is performing or could perform in the future. This opinion is frequently based on predictions about the economic conditions in which a company is operating, which is why it might seem that stockmarkets go up or down depending on economic conditions. Shares are generally the most volatile of the four asset classes – their value goes up and down more than the others. However, risk and reward tend to go hand in hand and – in the long run – the hope is that these investments would provide better returns than the other asset classes (but this is not guaranteed). If you are investing in shares you should expect the value of your investment to go down as well as up, and you should be comfortable with this. Holding shares is high risk. If you have put all your money into one company and that company becomes insolvent then you will probably lose most, if not all, of your money. In the short term, shares will go up and down in value and this can occasionally 102
be very significant. However, remember that if you have a wide range of shares (a diversified portfolio) you reduce the likelihood of losing all or most of your money. It is important to stress that you need to be looking to the long term when investing in shares – at least five years, but preferably longer. Shares are risky in the short and medium term but if you hold your shares for over, say, ten years, then the risk of you ending up with less than you started with decreases – so long as you have a good spread of shares (for e.g. through pooled investments). Buying and selling Before you make any decisions about buying or selling shares, you should find out as much as you can about the company – either by doing your own research or by taking advice. If you are contacted ‘out of the blue’ by somebody inviting you to invest in shares, beware – these may be share scams, also known as ‘boiler room’ scams. For a list of stockbrokers and more information about the services they offer, contact the Association of Private Client Investment Managers and Stockbrokers (APCIMS), the London Stock Exchange or speak with a Sable advisor.
Bonds A bond is a loan to a company, government or local authority. Generally, interest is paid to you as the lender and the amount of the loan is repaid at the end of the term (usually ten years or less). There are many other names for this type of investment, for e.g.:
> Fixed interest; > Debt securities; > Gilts (loans to the government); and > Corporate bonds (loans to companies). The main benefit of these investments is that you normally get a regular, stable income. They are not generally designed to provide capital growth. Bonds have a nominal value. This is the sum that will be returned to investors when the bond matures at the end of its term. Most bonds have a nominal value of £100. However, because bonds are traded on the bond market, the price you pay for a bond may be more or less than £100. There are several reasons why the price might vary from the nominal value, for e.g.: > If a bond is issued with a fixed interest rate of, say, eight per cent and the general interest rates then fall well below eight per cent, then eight per cent will look like a good yield and the market price of the bond will tend to rise – perhaps from £100 to £110 or £120. > The reverse is also true. If interest rates rise, the fixed rate of a particular bond might become less attractive and its price could fall below £100. > Ratings agencies might take the view that a particular company’s bond no longer qualifies for a high rating – perhaps the company is not doing
as well as it was when the bond was issued. If this happens, then the market price of the bond might fall. On the other hand, the company’s rating may be improved leading to a price rise. > The inflation rate might start to creep up, and the interest rate on some bonds might look less attractive compared with other investments. Risk Bonds are generally less risky than having a share in a company. One of the main risks is that the company you have lent money to can’t pay the interest due or cannot pay the money back at the end of the term (for e.g. if it has gone bust). It is generally considered that these risks do not apply to gilts – a government is expected always to pay in full – though there have been instances of certain countries having been unable to repay. Bonds issued by governments will usually pay a lower rate of interest, as a result of the perception that they are less risky. Companies have different credit ratings; a company with a high credit rating is regarded as a safer bet than a company with a low credit rating. Companies with a low credit rating will have to offer a higher rate of interest on their bonds than companies with a higher credit rating, simply to attract investors and to compensate for the higher risk. Bonds can be bought and sold in the market (like shares) and their price can vary from day to day. A rise or fall in the market price of a bond does not affect what you would get back if you hold the bond until it 103
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> Loan stock;
matures. You will only get back the nominal value of the bond in addition, of course, to any coupon payment to which you’ve been entitled during your ownership of the bond, irrespective of what you paid for it.
investment that invests in a range of properties. These normally invest in commercial properties.
This only applies if you buy a single corporate bond. It doesn’t apply to bond funds (pooled investments). Because bond funds invest in many different bonds, there is no single maturity date for your investment.
The commercial property market is different to the residential property market in terms of what causes the prices to change. Commercial properties are let out to companies and tend to be on long leases, often up to 25 years. As a result, the value of the property will often be increased as a result of the length of the remaining lease and the perception of the financial strength of the company paying the rent. If there is a long lease and a financially strong company paying the rent, then the owner of the property has a reasonably safe long-term rental income.
Buying and selling
Risk
If you want to buy bonds directly, you can do this through a stockbroking firm; you will pay charges for this similar to buying shares. Alternatively, you can buy bonds through a pooled investment.
Even though we have had a property boom in the last decade or so, it is important to remember that property prices can – and do – go down as well as up (for e.g. now!). Also, there is the risk of not having a tenant to pay the rent.
If you paid less than the nominal value, then you will have made a capital gain when the bond matures and a capital loss if you paid more than the nominal value.
Property With a property investment you are often looking to receive rent from a tenant – whether this is a private person in a buy-to-let or a sub-letting arrangement, or a company in a commercial property – and also to acquire capital growth as the value of the property increases.
If you are investing in property directly then there are various other risks including, for e.g. the risk of interest-rate rises if you are borrowing to buy, the risk of problems with tenants and the risk of needing costly repairs. Investing directly is a major undertaking and you should do your homework first. Buying and selling
If, for e.g., you choose to invest directly in a buy-to-let, you will be tying your money up and, unlike shares, bonds and cash, it can be difficult to get at your money quickly as you will need to sell the property first. You can, however, invest in a pooled 104
If you have invested in a property directly then it can take some time to sell and there are costs involved. If you invest in property through a pooled investment then you can usually sell much more quickly, although pooled investments
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often reserve the right to delay payment by up to six months to allow time to sell the properties, if needed.
Collective Property Investments
risk you do not get the income you are expecting if, for e.g. a company can’t afford to pay the interest on a bond, or if you own a property and there is a gap between tenants.
Increasingly individuals want exposure to property as a standalone asset class or as an investment in its own right, without the liquidity and cost issues of buying a single property. This has given rise to the collective property investment. These range from large, open-ended funds to companies that facilitate groups of individuals buying a single property. There are also solutions across the full spectrum of property investments from residential, industrial and commercial.
These risks can be reduced, but not eliminated by diversification. Diversification simply means spreading the risk of investing over a range of investments – in other words, not putting all your eggs in one basket. There are two main advantages to this: minimising the impact of individual losses and spreading your investment.
The important factors one should consider when evaluating property investments include the following:
Simply put, if you use all your money to buy shares in a single company and the company goes bust, you are going to lose a lot – or all – of your money.
Minimising the impact of individual losses
> Investment track record; > Scale and bargaining power of the company; > Cost structure; > Do they provide the full back-end servicing of properties, or is this outsourced? > Liquidity; and > Minimum and maximum investment sizes.
Diversification There are different risks for the different asset classes. Usually, when we talk about risk, we are referring to the risk of losing money – the capital value of your investment going down. There is also the 106
If you use your money to buy shares in many different companies, assuming you invest an equal amount of money into each one, and one of the companies goes bust, this will not have as much of an effect on your overall investment as if you had only invested in one or two companies. If you have a lot of money then you can invest directly and create a wide spread. However, most investors need to use pooled investments to achieve a good spread. This is the key way to reducing the risks of individual investments (whether shares, bonds, property or cash). However, it may have little impact on the risk of wider economic problems. As we have explained in the section on shares, the price of shares is likely to be affected by the outlook for the economic
Spreading your investment
and overseas markets, between large and small companies, and so on.
Asset Allocation There are many factors to achieving a good return on your investments, for e.g.:
This is the key to successful investing and is called asset allocation. Asset allocation simply means how you spread your money across the asset classes – how much you have in shares, bonds, property and cash respectively.
> Picking the right individual investment(s);
If you choose to invest in pooled investments it is also certainly worth considering spreading your risk across those holdings, too. For e.g. a fund which invests only in one industrial sector, such as technology, will invariably be more risky than funds that invest across the whole range of companies in a market.
By far the most important of these is asset allocation.
The asset classes all work differently and are largely independent of each other. If one is going up, another might be going down. It would be very unusual for all asset classes to be going down at the same time. For e.g. between 2000 and 2003 many shares went down significantly. However, property values increased significantly (and bonds and cash also went up). If you had just invested in shares, then the value of your investment would have reduced significantly, whereas if you had invested across the asset classes then the loss would have been much less. You can also diversify within an asset class. Each asset class is made of different types of investments. For e.g. you can spread your investment in shares between the UK
> Judging when to invest; and > Asset allocation.
The right asset allocation for you will depend on what you are trying to achieve with your money, how long you are prepared to invest, and your attitude towards risk. Speak to a Sable Adviser if you would like further information in this regard.
Pooled Investments A pooled investment is one where lots of people put different amounts of money into a fund, which is then invested in one or more asset classes by a fund manager. They are sometimes called collective investments. The main benefits of pooled investments are: > Professional expertise – you arrange for an investment expert to pick investments for you, to watch those investments daily and judge when to sell them. > Spreading your risk – even if you have small amounts to invest, you can spread your money 107
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environment in which companies operate. If an economy goes into recession, this may affect the share price of many companies and the value of an investment, even across a broad range of companies, may go down.
across a wide range of investments. You reduce the impact on your investment if, say, one company performs badly. Pooled investments will invest in one or more asset class. > Reduced dealing costs – if you want to buy a range of different investments directly, you would probably only be able to invest a small sum in each. This means dealing costs could eat into your profits significantly. By pooling your money, you make savings because of bulk buying. > Less administration – the fund manager handles the buying, selling and collecting of dividends and income for you. They also deal with foreign stock exchanges and brokers, which can be tricky and time consuming. > Choice – there is a very wide choice of funds so that you can pick one, or many, that suit you individually. There are several types of pooled investments but the main three are: > Open-ended investment funds; > Life-assurance investments; and
For e.g. a FTSE100 tracker would aim to replicate the movement of the FTSE100 (the index of the largest 100 UK companies). They might do this by buying the equivalent proportion of all the shares in the index. For technical reasons the return is rarely identical to the index, in particular because charges need to be deducted. Trackers tend to have lower charges than actively managed funds. This is because a fund manager running an actively managed fund is paid to invest, so as to do better than the index (beat the market) or to generate a steadier return for investors than tracking the index would achieve. Of course the fund manager could make the wrong decisions and under-perform in the market. You don’t get this beating, or under-performance, of the market with trackers (other than the effect of the charges), but they are not necessarily less risky than activelymanaged funds invested in the same asset class. Open-ended investment funds, lifeassurance investments and investment trusts can all be trackers.
Open-ended Investment Funds
> Investment trusts. Investment strategy Most pooled investment funds are actively managed. The fund manager researches the market and buys and sells assets to try and provide a good return for the investors. Trackers, on the other hand, are passively managed – they simply aim to track the market in which they are invested. 108
Open-ended investment funds are often called collective investment schemes and are run by fund management companies. There are many different types of funds, including these: > Unit trusts; > OEICs (Open-Ended Investment Companies, which are the same as ICVCs – Investment Companies with Variable Capital);
> FCPs (Fonds communs de placement). This list includes certain European funds called UCITS schemes, which are permitted under European legislation to be sold in the UK. There are many funds to choose from and some are valued at many millions of pounds. They are called open-ended funds as the number of units (shares) in issue increases as more people invest, and decreases as people take their money out. As an investor, you buy units/shares in the hope that the value rises over time as the price of the underlying investments increase. The price of the units depends on how the underlying investments perform. You might also get income from your units through dividends paid by the shares (or income from the bonds, property or cash) that the fund has invested in. You can either invest a lump sum or save regularly each month. You can buy funds directly from the investment management company (although this is generally an expensive route), or through a financial adviser. IMA collects and publishes monthly and quarterly statistics for UK open-ended investment funds on their website. You can also view fund management companies by the size of the funds that they manage. Risk Open-ended investment funds generally invest in one or more of the four Asset
classes – shares, bonds, property and cash. Most invest primarily in shares but a wide range also invest in bonds. Few invest principally in property or cash deposits. Some funds will spread the investment and have, for e.g. some in shares and some in bonds. This can be useful if you are only taking out one investment and – remembering that asset allocation is the key to successful investment – you want to spread your investment across different asset classes. The level of risk will depend on the underlying investments and how well diversified the open-ended investment fund is. See ‘Asset Classes and Diversification’. For e.g. a fund which invests only in one industrial sector, such as technology, will invariably be more risky than funds that invest across the whole range of companies in a market. Similarly funds are grouped in categories, such as UK Equity or Gilt and Fixed Interest, to make your selection process easier. Some funds might also invest in derivatives, which may make a fund more risky. However, fund managers often buy derivatives to help offset the risk involved in owning assets or in holding assets valued in other currencies. Any money in an open-ended investment fund is protected by a trustee or depository, who ensures at all times that the management company is acting in the investors’ best interests. Charges When you buy units in a fund, you usually pay an initial charge. How the charge is shown depends on how the price is worked out. 109
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> SICAV (Société d’investissement à capital variable); and
For some funds, you buy units at the offer price and sell them at the bid price. The bid price is lower than the offer price and the difference is called the bid/ offer spread. These funds are referred to as being dual priced. The initial charge is usually part of the bid/offer spread, which can often be around five per cent – so effectively five per cent of your investment is taken in charges at the outset. Some funds have no initial charge, but there may be an exit charge instead when you withdraw your money by selling units. For many funds, there is no difference between the buying and selling price of units. Because of this, the funds are referred to as being single priced. If there is an initial charge, it is added to the single price when you buy units and there may also be an exit charge when you sell units. Between them, these charges are likely to represent around five per cent of your investment, so you may end up paying the same level of charges in a single-priced fund as in a dual-priced fund. The fund management company takes an annual management charge directly from the investment fund. There are also other costs – buying and selling within the fund, custodian fees etc. These costs, along with the annual management fee, are called the total expense ratio (TER). The TER is therefore an estimate of the total ongoing costs of the investment. It is very important that you fully investigate and understand the charging structure on a portfolio comprising funds. You should ensure that your adviser explains all the details to you. 110
Tax For income, there is a difference in the tax position between funds investing in shares and those investing in bonds, property and cash: > Income (dividends) paid by shares within an open-ended investment fund is assumed to be paid after taking 10% tax (the tax credit). These dividends, when paid out of the fund to you, are not subject to any tax if you are a basic-rate, lower-rate or non-taxpayer. If you are a higher-rate taxpayer then you have an overall tax rate on dividends of 32.5% of the gross dividend (but you can deduct the 10% tax credit). Non-taxpayers cannot reclaim this 10% tax credit; and > Income paid by bonds, property or cash within an open-ended investment fund is paid net of 20% tax. For funds investing principally in these asset classes, no further tax is due if you are a basic-rate, lower-rate or nontaxpayer. If you are a higher-rate taxpayer then you will have to pay an additional 20% tax. However, unlike funds investing in shares, if you are a lower-rate or non-taxpayer then you can reclaim the appropriate amount of tax paid. Whichever type of open-ended investment fund you have, you can reinvest the income to provide additional capital growth, but the taxation implications are as if you had received the dividend income. No capital gains tax (CGT) is paid on the gains made on investments held within the fund. But, when you sell, you may have to pay capital gains tax.
Please note that this is only a summary of the tax position at April 2009. You should be aware that tax legislation changes constantly and you should always aim to find out the most current position.
Fund Supermarkets Fund supermarkets are increasingly playing an important role in the fund industry, and this trend is going to become increasingly important. By providing an aggregation service to advisers, the fund supermarket is able to place pressure on the fund providers to reduce their costs. The large fund supermarkets are normally able to reduce the cost of a fund portfolio, via an adviser, to significantly lower then an individual would be able to directly. A good fund supermarket platform will also allow for much easier management of a portfolio, including cost-efficient switching between funds, asset allocation tools, aggregated valuations and a wide choice of fund types.
Structured Products (or Guaranteed Products) These are usually share-based investments from banking, life-assurance or investment management firms. So they can be offered as open-ended investment funds, life-assurance investments or even (technically) cash deposits. Your investment could do as well as planned, or maybe better. But if it doesn’t, you could lose some or all of the money
you put in (your capital). These types of products are generally expensive, due to the high fees written into structure by the banks that provide the guarantees. It is debatable whether they perform any better then standard investment products, once these fees have been taken into consideration. Capital-at-risk investments, high-income investments or guaranteed stockmarket investments are all types of structured products. Capital-at-risk investments are usually offered as a special investment available for a limited time, typically a couple of months. They usually have a fixed term, often around five or six years. Each investment works in a different way, but there are two main formats. High income – These investments offer a high level of income, usually more than a bank or building society account. This income is usually fixed for the term. However, the money you put in – your capital – is not guaranteed. You would usually only get all your money back so long as, for e.g. the stockmarket had not gone down more than a stated amount. If the stockmarket falls by more than the stated amount, you will get back less than your original investment at the end of the term. This can sometimes be a lot less, so make sure you read the full details of the investment. Stockmarket growth – This works in almost exactly the opposite way. With these investments, your original investment is usually guaranteed at the end of the term. You do not get income; you get capital growth only. The part that is not guaranteed is how much growth you get. This is 111
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However, bearing in mind that taper relief and the personal CGT allowance (£10,200 for the 2009/2010 tax year per individual) is available, it is often possible to avoid all CGT.
usually based on stockmarket returns, for e.g. you may get back the rise in the FTSE100 index (the index of the top 100 UK firms). However, you don’t receive the dividend income that you would receive if you owned the shares in the stockmarket directly – or through an investment in another type of pooled investment. Remember, you could lose some or all of the money you put into these products so make sure you understand the risks involved before investing.
Life-Assurance Investments As well as providing life-assurance policies, life-assurance companies and friendly societies also offer pooled investments. The investment you have with the life-assurance company or friendly society is called a policy. Like open-ended investment funds, you can invest by making regular contributions (called premiums) or by investing a one-off lump sum (a single premium). When you have a policy with regular premiums, there is usually a fixed term, and cashing in before the end of the term can involve penalties. Some single premium policies also have a fixed term, but most are open ended. When you invest in a life-assurance policy, a proportion of your contribution will be used to buy life assurance that pays a fixed sum of money if you die before the end of the policy. For regular premium policies, the amount of life assurance can be quite high and there can be different levels to suit different requirements. For single premium policies, the amount of life assurance is usually minimal. 112
On either kind of policy, the company will spend part of each contribution you make to meet its costs. How does it work? As with open-ended investment funds, a life-assurance investment company pools its money and invests in one or more of the asset classes. The company promises to pay you part of the money it makes from that investment. The company organises its investments into funds, and it will usually allow you to decide which fund you want to share in. There are usually a number of funds to choose from within the policy, for e.g. shares (UK and overseas), bonds, property and cash deposits. Similarly, there are usually funds which invest across different asset classes and these are usually called managed funds. With life-assurance investments, there is often an option of a with-profits fund which is not available with any other type of pooled investment. See ‘With-profits Funds’ on the next page. Most life-assurance policies allow you to switch between funds once a year, without charge. Some companies make a charge for more than one switch per year, while others allow several switches without charge. You can buy life-assurance investments direct from the company or through a financial adviser. There are some differences between regular premium and single premium products: Single premium Single premium products are often called investment or insurance bonds. Don’t confuse this use of the word ‘bond’
with the normal use – see ‘Bonds’ (page 102). Here, an investment or insurance bond is simply another expression for a single premium life-assurance investment. They can also be called life-assurance bonds and with-profits bonds. Your single premium (after any costs) buys units, which give you the right to share in the return from your chosen fund(s). The return you achieve, and the risk you take, will depend upon the amount of costs taken from your contribution, the quality of the insurance company’s investment management and on the underlying investments – the asset classes chosen.
money – for e.g. in shares or bonds – with the aim of making it grow sufficiently to provide you with a lump sum at maturity. Mortgage endowment policies, which are set up specifically to pay off an interest-only mortgage at the end of the mortgage term, work on largely the same basis but have a higher level of life-assurance cover. Endowments purely for general investment purposes would either be qualifying or non-qualifying. The rules for a policy to be qualifying are complex, but require the policy to be run for a minimum time and to include a certain amount of life-assurance cover.
Risk
Regular premium Regular premium life-assurance investments are usually called endowment policies, and these do have a fixed term. An endowment policy is an investment plan that you usually pay into each month. The life-assurance company accumulates money from you and other policyholders. It gives you a policy that promises certain things, such as to provide life assurance if you die before the end of the policy. The company also promises to invest the
The advantage of qualifying endowment policies is that you do not pay any tax when they mature, even if you are a higher-rate taxpayer (although some tax is still paid within the policy, see below). With a non-qualifying policy you may be subject to income tax on maturity, if you are a higher-rate taxpayer. With-profits funds Life-assurance companies and friendly societies often provide with-profits funds. Policies that are linked to these are generally long-term investments. People usually invest in them either: > To produce a lump sum at a known date in the future (for e.g. endowment policies linked to a mortgage); or > To provide an income from your investment with the possibility of investment growth. With-profits policies usually include some life-assurance cover. 113
So Savings What & Tax Investments Do We Pay
The risk to your money is similar to the risk with open-ended investment funds. Most single premium life-assurance bonds are open ended – they don’t have a fixed term. However, it is generally best to hold them (and any open-ended investment funds) for at least five years. Some lifeassurance bonds do have a fixed term, and this is likely to mean penalties if you cash in early. Even if there is no fixed term, you may still be charged penalties if you cash in early (often within the first five years).
For more on how with-profits policies work, see ‘With-profits Funds’ (page 113). Charges Like many open-ended investment funds there is normally a bid/offer spread, typically of five per cent, which is the effective cost. However, life-assurance investments also have an allocation rate. An allocation rate of 100% means that all of your investment is put into the contract. An allocation rate of 102% means that you get an extra two per cent. However, the bid/offer spread will still be taken from your investment. In addition, an annual management charge will also be taken from the fund to pay for the management of your investment. Some policies have penalties if you cash them in early (often within the first five years). For regular premium policies there may be other charges, such as: > Capital units (units bought by the premiums in the first year or two, which are subject to a higher annual management charge); and > A monthly policy fee. Policies often have additional charges if you cash them in before the maturity date. Charges on with-profits funds can be more complicated than other pooled investments. As well as the charges mentioned above, there may also be other charges to do with the running of the business and the bonus policy. Tax Any income or capital gain within a lifeassurance fund is taxed at different rates 114
depending on the type of investment. If you withdraw your money and are a basic-rate, lower-rate or non-taxpayer, then you are not subject to further taxation. Higher-rate taxpayers will have to pay an extra 20% tax on the gains. Lower-rate and non-taxpayers cannot reclaim the tax paid within the fund. You are able to withdraw five per cent of the original investment each year without any immediate tax liability, and so may defer the payment of tax for up to 20 years. Higher-rate taxpayers, therefore, may receive a five per cent per annum income each year (for up to 20 years) which has only been taxed at the basic rate. The tax deferred will not be paid until the policy is finally cashed in. Please note that this is only a summary of the tax position at April 2009. You should be aware that tax legislation changes constantly and you should always aim to find out the most current position.
Investment Trusts An investment trust is a company with shares. Unlike an open-ended investment fund, an investment trust is closed ended. This means that there are a set number of shares available, and this will remain the same no matter how many investors there are. This can have an impact on the price of the shares and the level of risk of the investment trust. Open-ended investment funds create, and cancel units, depending on the number of investors. You can invest a lump sum by buying investment-trust shares direct from the investment-trust company or through a financial adviser, stockbroker or private client manager. Alternatively, you can save on a regular monthly basis
Risk The price of the investment-trust shares depends on two main factors: > The value of the underlying investments (which works in the same way as an open-ended investment fund); and > The popularity of the investment-trust shares in the market. This second point applies to investment trusts, but not to open-ended investment funds or life-assurance investments. The reason is because they are closed-ended funds. The laws of economics say that if there is a high demand for something, but limited supply, then the price goes up. So, if you own some investment-trust shares and there are lots of people queuing up to buy them, you can sell them for more money. On the other hand, if nobody seems to want them, then you will have to drop the price until someone is prepared to buy. The result is that investment-trust shares do not simply reflect the value of the underlying investments – they also reflect their popularity in the market. The value of the investment trust’s underlying investments is called the net asset value (NAV). If the share price is exactly in line with the underlying investments, then it is called trading at par. If the price is higher because the shares are popular, it is called trading at a premium and, if lower, it is referred to as trading at a discount. This feature may make them more volatile than other pooled investments (assuming the same underlying investments).
Gearing There is another difference that applies to investment trusts – they can borrow money to invest. This is called gearing. Gearing improves an investment trust’s performance when its investments are doing well. On the other hand, if its investments do not do as well as expected, gearing lowers performance. Example If the investment trust is made up of £50-million of investors’ money and £50-million of borrowing, then the total fund available for investment is £100-million. Say the value of the fund goes down by 10% as a result of losses in the stockmarket – the value of the overall fund falls from £100-million to £90-million. However, bear in mind that the borrowing is still £50-million; therefore, the remaining £40-million belongs to the investors. So, although the overall fund went down by 10%, the investors’ money part has actually gone down by 20% (that is, from £50-million to £40-million). Gearing boosts gains, but it also magnifies any losses.
Not all investment trusts are geared, and deciding whether to borrow and when to borrow is a judgement the investment manager makes. A gearing figure of 100 means that an investment trust is not geared. Any figure over 100 shows the proportion of its total investments that is borrowed. For e.g. a gearing figure of 120 means that borrowed money amounts to one-sixth of a trust’s total investments. An investment trust that is geared is a higher-risk investment than one which is not geared (assuming the same underlying investments). 115
So Savings What & Tax Investments Do We Pay
through the investment-trust company (investment-trust savings scheme).
Split-capital investment trusts (splits) Splits are a type of investment trust that sell different sorts of shares to investors, depending on whether they are looking for capital growth or income. They run for a fixed term. The shares will have varying levels of risk, as some investors will be ahead of others in the queue for money when the trust comes to the end of its term. Charges You usually pay dealing charges when you buy and sell investment-trust shares, and the difference between the prices at which you buy and sell (the bid/offer spread) is effectively another charge.
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There is also an annual management fee which comes out of the investment fund. Tax The tax position is largely the same as for open-ended investment funds. You should be aware that tax legislation changes constantly and you should always aim to find out the most current position.
Pensions We have covered ‘Pensions’ in previous chapters on tax, and so won’t go into any detail here. It is, however, worth pointing out that pensions are one of the most efficient ways to save for the long term – everyone should seriously consider them in a tax-efficient financial plan. •
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Chapter 15 Borrowing Money & Insurance
Borrowing Money & Insurance
Bank Overdraft
Types of borrowing
A bank overdraft can be authorised or unauthorised.
There are a number of ways you can borrow money for the short to medium term. These include:
Authorised overdraft
> Credit cards, store cards and in-store finance; and
You arrange this with your bank in advance and agree a limit up to which you can borrow. The money is drawn from your current account. There is no minimum repayment and you can take the money up to your overdraft limit, using any usual withdrawal method.
> Other borrowing.
Unauthorised overdraft
When you apply to borrow money in any of these ways, you’ll be asked to complete an application form. Your answers help the lender to predict how big a risk they’re taking by lending you the money. This is called a credit score.
This is where you haven’t agreed on an overdraft facility with your bank and have drawn more money out than you have in your account, either deliberately or accidentally. You will pay extra charges if you do this and these can build up.
> A bank overdraft; > A personal loans;
You’ll be charged interest on what you borrow, usually monthly. The interest rate varies depending on the type of loan you take. You can use the APR (Annual Percentage Rate) to help you shop around for the best deal. The APR tells you the cost of the loan, plus the interest on the loan and other charges. All lenders have to tell you what their APR is. 118
How do they work? Some banks offer an interest-free overdraft for a certain period, but generally interest rates are higher than personal loans and you may have to pay arrangement fees too. Charges can also be high if you go over your limit.
difficulties repaying the loan, the lender could repossess your home and sell it to get their money back.
Credit cards Unsecured loan These are a common way of paying for goods and services instead of using cash or cheques. You apply for a card in the same way as you apply for a loan and if you’re successful, you will be given a limit up to which you can spend. Credit means you can buy today and pay tomorrow, but at a charge if you don’t pay off your bill each month. Store cards and in-store finance Many big stores offer finance deals or store cards. Store cards These are like credit cards. You fill in an application form and are given a spending limit based on your credit worthiness. They tend to charge higher rates of interest than most other loans. And you can usually only use them in that store or group of stores. In-store finance These deals may be useful to help you pay off expensive purchases – such as furniture or large electrical goods – over time. Some may offer 0% interest for a fixed period.
Personal Loans
If you fail to pay the loan, the lender cannot repossess your home. Even so, you are legally obliged to pay back the loan as you agreed. How do they work? You borrow a fixed amount and usually have to repay it in fixed instalments over a set period (the term). The interest you pay is also usually fixed. Rates for secured loans are usually lower but there could be extra fees, and of course you could be putting your home at risk. Important points to check Charges for early repayment Ask whether there are any penalties if you choose to pay the loan off early. For e.g., check how much interest you will be expected to pay with your final payment and any other charges that may be due. Charges for late payments Most lenders ask you to make your monthly payments by direct debit from your bank account. This way they’ll be sure to get their money on time. If you’re late with your payments, you’ll be charged by your bank – find out from your bank how much the costs are.
Personal loans can be secured or unsecured.
Other Borrowing
Secured loan
Sub-prime lenders
You can only apply for a secured loan if you are a home owner, using your home as security. This means that if you get into
Sub-prime lenders are licensed lenders who are willing to make loans to people who are unable to get credit from 119
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Credit Cards, Store Cards & In-store Finance
mainstream lenders, because of a poor credit record. They often charge a much higher rate of interest than banks and building societies. Doorstep lenders (sometimes known as ‘home credit’) Money lent to you by ‘doorstep lenders’ (such as salespeople who come and knock on your door) can be expensive. If you do consider taking out a loan from them, then as well as checking the APR, you should: > Ask to see their lender’s licence or other authorisation. If they don’t have one they are operating illegally, so don’t use them; > Be clear about the amount you are borrowing, how much you must repay and for how long you will be making the repayments;
What is APR? APR stands for the Annual Percentage Rate of charge. You can use it to compare different credit and loan offers. The APR includes important factors such as: > The interest rate you must pay; > How you repay the loan, the length of the loan agreement (or term), the frequency and timing of instalment payments and the amount of each payment; > Certain fees associated with the loan; and > Premiums for payment protection insurance that the lender chooses to make compulsory.
> Make sure you understand what will happen if you can’t keep up the repayments.
All lenders have to tell you what their APR is before you sign an agreement. It will vary from lender to lender. Generally, the lower the APR the better the deal, so if you are thinking about borrowing, shop around.
Loan sharks
Example 1:
> Ask how much in total the loan is going to cost you; and
Loan sharks are unlicensed lenders. They operate illegally and will lend you money when nobody else will, but: > Their rates are very high and it may be difficult to keep up the repayments;
If you borrow £1,000 for one year at 20% interest, and at the end of the year you repay a lump sum of £1,200:
> You will be paying an interest rate of 20%; and > The APR will also be 20%.
> You may be forced to get a second loan to pay off the first, causing your debts to spiral out of control; and > They may use violence or intimidation to collect the debt. 120
Example 2: If you borrow £1,000 for one year at 20% interest, and pay throughout the year in equal monthly instalments (12 x £100 = £1,200):
> The APR, however, will be roughly 40%. Example 2 is more expensive because you are paying back the £1,000 gradually throughout the year. In Example 1 you have the benefit of being able to access the £1,200 for the whole year, which you could invest and earn interest on. By paying in instalments you’re losing out; this increases the cost of the loan – hence the higher APR.
For e.g. do you have a choice about how and where you make the repayments? If you suddenly have spare money, can you pay the loan off early – without penalties? Can you afford the monthly payments? A more expensive loan (with a higher APR) could have lower monthly payments if they are spread out over a longer period of time. That might suit you better if your budget is tight, even though you would pay more in the long run.
Questions To Ask the Lender
Insurance Made Clear
If you find a deal with a low APR, ask the lender the following questions:
Why do you need insurance? Because the unexpected sometimes happens. If you’re burgled, insurance can pay for you to replace the things that were taken. If you need medical treatment, it can pay for private healthcare and replace some of your income if you can’t work. If you die, insurance can pay a lump sum to the family you leave behind.
Does the interest included in the APR vary, or is the rate fixed? If the rate is variable, your repayments could go up or go down. If the rate is fixed, your repayments will stay the same. Are there any charges that are not included in the APR?
What is insurance?
> How much you would have to pay;
Insurance is a way of protecting yourself and your belongings against a particular adverse event, for e.g., a burglary, or losing your income because of illness. If this happens insurance will pay out an agreed amount, or an amount to cover the damage, as appropriate. Of course, it may not happen, but you have to decide whether you’re willing or able to take that risk. Some insurance, like motor insurance, is compulsory – you have to have it if you drive.
> When you would have to pay; and
How does it work?
> What are the conditions of the loan or credit – do they suit you?
The amount you pay for insurance will be based on the information you give
This could include charges for services, such as optional payment protection insurance. If so, make sure you understand the following: > What the charges are; > Whether you really need the services offered;
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Borrowing Money & Insurance
> You will still be paying an interest rate of 20%; but
the insurance company (the underwriter) and the type of risk you want to insure. Insurance companies use underwriting criteria, for e.g. where you live, if you smoke or what type of activity you would like to be covered to help them work out the price (premium) of the insurance.
Types of Insurance What are pure protection and general insurance? Pure protection insurance includes: > Term assurance (life insurance);
You might find that some insurance companies may not be able to give you a price for the cover you need. This could be because that particular insurance company doesn’t offer insurance for the type of risk you want to insure (for e.g. things like antiques or vintage cars). If you want this type of insurance, you might have to go to a company that specialises in this type of cover. The insurance company agrees to pay out if the event that you’re insuring against happens. For e.g. your travel insurance policy may pay out for loss of luggage. It is important that you give the insurance company the correct information when buying insurance, as incorrect information might affect your claim.
> Critical illness insurance; > Income protection insurance; and > Payment protection insurance – includes elements of pure protection and general insurance. General insurance includes: > Motor insurance; > Household insurance; > Travel insurance; > Health cover; and > Pet insurance.
You pay either a sum for the whole year (or sometimes longer), called a single premium, or a regular premium, usually monthly, for the policy. You can choose which company’s policy to buy yourself or you can go to an insurance broker, who’ll help you choose. Most insurance lasts for one year at a time and you can renew your policy when it ends, or go somewhere else for a better deal. But make sure you don’t lose out by switching, and always check that a new policy covers what you need it for. Always compare what’s covered by a policy, not just the price. Some might be cheaper than others, but they may not offer the same level of protection. 122
Buying Insurance You don’t have to take out most types of insurance, but for peace of mind you may wish to consider some. Firms selling insurance and those providing insurance cover (underwriting the risk) have to be regulated by the FSA, or be the agent of a regulated firm. Regulated firms and their agents are put on the FSA Register and have to meet certain standards. Always make sure that the firm you use is on the register, before handing over your money. You can buy insurance directly from insurers over the phone, on the internet or by mail, but you can also buy
individual financial
protection where you need it most
Sable, specialists in insurance and other financial services for contractors and freelancers. Our services include, Professional Advice on Income Protection (PHI), Private Medical (PMI), Key Man, Professional Indemnity, Accident, Sickness, Mortgage Protection, Investments, Pensions, Tax.
For further information, call us on 0808 141 or email us at info@sablecontractor.com
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www.1stcontact.com/contractor Authorised & regulated by the Financial Services Authority (FSA). The Financial Services Authority does not regulate all the services provided by Sable Private Wealth Management.
insurance from other types of firms such as banks, building societies, insurance brokers, financial advisers, mortgage brokers or supermarkets.
fail to do so, you could lose your home if it’s under mortgage or your loan is secured on it. It could also affect your credit rating.
Get the facts
> Ensure the firm is authorised by the FSA to sell insurance;
Sometimes, however, the unexpected happens. For e.g. you might lose your job through redundancy, or find yourself unable to work due to long-term sickness. By law, an employer must pay most employees statutory sick pay for up to 28 weeks, though this will probably be a lot less than full earnings. After that, you would probably have to fall back on State benefits. These are limited and means-tested, which may mean you won’t qualify. If you are self-employed you have no employer to help, so you would have to turn to the State.
> Disclose the full facts when applying for insurance – if you don’t, you could invalidate your policy and the insurance company will not pay out in the event of a claim;
This is when insurance to protect you or your family’s income or borrowing can be useful. Listed in the table on page 125 are some examples of products and why you might find them useful.
> Read the key policy information for exclusions – to ensure that you choose the right policy for you;
Life Insurance
> Check for excess charges – some policies make you pay a certain ‘excess’ amount before they pay out on claims, and some policies charge an excess per clause rather than one overall; and
Life insurance is about providing some financial security for people who depend on you, in the event of your death. (So if you don’t have a partner, spouse or civil partner, children or other dependants, you may not need life cover.)
Insurance differs in what it covers and what it doesn’t (the exclusions). Read the key policy information that the insurance company will give you to find out exactly what you’re getting, and use it to shop around and compare other policies. Whatever type of insurance you decide to take out, always:
> Shop around to ensure you get the best deal for you. Some policies might be cheaper than others, but they may not offer the same level of protection.
Protecting Income or Borrowing Once you take out any kind of loan, it’s very important that you make all the repayments in full, and on time. If you 124
Protecting your family and dependants
To make sure you buy the right amount of cover, with the right terms and conditions, you should consider getting some advice. The adviser assesses what your family would need, and shops around for the cover that suits you best. Always answer questions as best you can and disclose any existing medical conditions when asked. If you don’t give the full facts, you could
What’s it for?
What do you need to know?
Critical illness (CI)
Pays out a lump sum if you’re diagnosed with a critical illness, such as cancer, a stroke, MS, a major organ transplant, coronary artery bypass, heart attack or kidney failure. You can use the payout to pay for medical treatment, pay off your mortgage or anything else.
> You need to read your insurer’s terms carefully, not just for the range of illnesses they cover but also their type. For e.g. while a heart attack may be covered, a cardiac condition such as angina may not; also, not all types and stages of cancer are covered.
Mortgage payment protection (MPPI) – also called accident, sickness and unemployment insurance
A typical policy will start to pay your mortgage repayments one month after your income stops due to redundancy, an accident or illness, and continues to pay for 12 months.
> You don’t have to have this type of cover at all (unless it’s a condition of your loan) and you certainly don’t have to buy it from your own lender, so shop around for the best deal for you.
Payment protection insurance (PPI) – also called accident, sickness and unemployment insurance
To help you keep up your loan repayments, for e.g. on a loan or credit card, in the event you can’t work because of redundancy, accident or illness. A typical policy will start to pay an agreed amount one month after your income stops due to redundancy, an accident or illness, and continue to pay for a set time – usually 12 or 24 months.
> You don’t have to have this type of cover at all (unless it’s a condition of your loan) and you usually don’t have to buy it from your own lender, so shop around for the best deal for you.
Pays out a lump sum if you die.
> With some types of cover, called Pension Term Assurance (PTA), you used to get tax relief on the premiums paid into it. This may no longer be available on policies taken out after December 2006.
Life insurance
Mortgage Pays off the mortgage loan if protection life cover you die. (term insurance)
Income protection (or Permanent Health Insurance – PHI)
> For a claim to be successful, you normally have to survive for a month following the diagnosis.
> Check if any medical problems you may have had in the past would be excluded if they cropped up again.
> If you do buy it, look at the conditions carefully. For e.g. what if you wanted to cancel the cover after a few months? > And if a medical problem you’ve had before crops up again, will they still pay out? > Also, check whether you’ll have to pay interest on your single premium. This happens where the single premium is added to your loan, which means you will be charged interest on it as well.
> Endowment mortgages automatically include life cover. > If you have a repayment mortgage (so the amount you owe gets smaller over the years), you can buy cover that reduces as the debt reduces.
Replaces part of your income > It continues to pay out until you can return to if you are unable to work for some kind of paid work or reach retirement, whichever a long period of time because is sooner. of illness or disability. > PHI products have a waiting period before they start to pay out. The longer you agree to wait, the lower your premiums, so it is important to find out what income you’ll get from your employer and what other insurance (i.e. MPPI) you’ll get in the event of illness or disability. > This cover might not be available to you if you have existing health problems or a dangerous job.
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Type of insurance
invalidate your policy and the insurance company won’t pay out.
> Increasing policy (where cover and premium rises over the years);
There are two main types of life insurance:
> Decreasing policy (where cover and premium falls over the years);
> Term insurance; and > Whole-of-life insurance. Term insurance (also called term assurance) pays out only if you die within a certain term, and whole-of-life insurance pays out whenever you die. Some whole-of-life policies also contain an investment element to them, but such investment-type policies cost a lot more than protection-only insurance. If you want investments, consider the full range of products (not just life insurance) which might meet your circumstances and needs.
Term Insurance This is the simplest and cheapest type of life insurance, and is known as term insurance because you choose how long you’re covered for – say, 10, 15 or 20 years (the term). Term insurance only pays out if you die within the term you’ve agreed. If you live longer than the term, you get nothing. As a couple, you can also take out term cover in both your names, with the policy paying out if either of you die during the term. Things to look out for > What type of policy do you want? For e.g. a family income benefit (a policy which pays out income rather than a lump sum); 126
> Renewable policies (which let you extend the original term); > Check for exclusions – in other words, when the policy won’t pay out. For e.g. most do not cover death due to alcohol or drug abuse. You might not be covered while taking part in risky sports. If your health is poor when the policy starts, some causes of death might be excluded or you might be refused cover altogether; > Premiums shown are usually fixed for the whole term. There are also contracts where premiums are reviewable after a certain period, usually five years; > How flexible is the contract? Can you reduce or increase cover easily as your circumstances change? Are there extra charges for doing this? Does cover stop immediately if you miss a payment or is there a period of grace; > By paying extra, you can usually include a waiver of premium. It pays the premiums if you can’t work because of a long-term illness, so that your cover is not interrupted; > If you want to change insurer, check the level of premiums for the new contract before switching (premiums may have gone up because of older age or because you have developed medical conditions). Also, check the new level of cover compared to the previous one. Different benefits may
> The policy can be set up under trust. This means that in the event of death, proceeds of the policy are paid directly to dependants of your choice. Provided that a trust is set up properly, there may be benefits to doing this. However, using a trust may not be suitable for everyone and because of the complexities, we recommend that you seek financial and legal advice. What does it cost? This depends on several factors, such as the amount of cover you want and the length of the term. Naturally, it’s also based on the likelihood of your insurer having to pay out: if you’re a smoker and do a dangerous job, you’ll pay more than a non-smoking office worker. Term life cover also costs more for men because, on average, they don’t live as long. Always compare what’s covered by a policy, not just the price. Some might be cheaper than others, but may not offer the same level of protection.
Whole-of-life Insurance Whole-of-life insurance pays out an agreed sum when you die, whenever that is. What does it cost? These policies will cost you more, partly because they will pay out whenever the
event (death) happens, but also because of the various charges associated with them. The cost also depends on your lifestyle: if you’re a smoker and do a dangerous job, you’ll pay more than a non-smoking office worker. Life cover also costs more for men because, on average, they don’t live as long as women. Always compare what’s covered by a policy, not just the price. Some might be cheaper than others, but may not offer the same level of protection.
Income Protection How does it work? If you’re an employee and you fall ill, your employer might pay you your full pay for a few weeks or months. By law, an employer must pay most employees statutory sick pay for up to 28 weeks, though this will probably be a lot less than your full earnings. After that, you would probably have to rely on State benefits. However, some employers arrange group income protection insurance for their employees as a perk of their job, which can pay out an income after the statutory sick period. So check what you are entitled to. If you are self-employed, you won’t have this option. State benefits are not generous. You would probably see a substantial drop in your income if you were out of work for more than a few months because of illness or disability. Insurance aims to put you back to the position you were in before you suffered a loss. But it does not allow you to make a profit out of your misfortune. So the maximum amount 127
Borrowing Money & Insurance
be available, and different exclusions may be applied – for e.g. you may not be covered for medical conditions that have developed before the switch, even if these were covered under the previous contract. If you do decide to change, make sure you do not cancel your original cover until you are fully covered by the new contract; and
of income you can replace through insurance is broadly the aftertax earnings you have lost, less an adjustment for State benefits you can claim. This usually translates into a maximum of, say 50% to 65% of your before-tax earnings.
Private Medical Insurance These types of polices are different from standard insurance contracts in that they generally don’t pay out a lump sum or compensate you directly, but rather cover your costs if you see a medical specialist directly rather then going via the NHS. While this sort of cover isn’t crucial, it is very useful for those who value their flexibility and don’t want to be reliant on the NHS and their notoriously long waiting times. For those who are time poor or paid by the hour, Private Medical Insurance (PMI) works particularly well if it is combined with private GP services. The latter can refer you directly to specialists and can see you at your convenience, rather than you being dictated to by the NHS doctor waiting times.
Professional Indemnity Professional Indemnity cover is very important for those who operate as contractors or provide services to other companies. Most agencies demand that contractors have this before they take them on. The policy provides cover for any claims brought against the policy holder, due to professional negligence.
Income Protection Insurance If you can’t work because of illness or disability, income protection insurance 128
(also called permanent health insurance) pays out a tax-free income. Example of working out how much cover you need: Sue is single and earns £26,000 a year before tax and other deductions. She estimates that, if she was ill for a long time, her budget would be affected as shown in the table below. Sue's budget calculations in the event that she couldn't work
Her estimates
Income she would lose: Her take-home pay
£18,000
Deduct income she would gain: Approximate long-term incapacity benefit
£4,000
Deduct expenses Sue would save: Work-related costs, mortgage interest payments if covered by mortgage payment protection insurance
£3,000
Add extra expenses she would pay: £2,000 Allowance for, say, cost of special equipment or treatment, cost of heating her home for longer EXTRA INCOME NEEDED
£13,000
Sue reckons she would need around £13,000 a year to maintain her lifestyle. This is half her before-tax pay of £26,000. Sue also works out that as a perk of her job, her employer will pay her half a salary for 52 weeks after the statutory sick pay period of 28 weeks. She therefore arranges for her policy to pay out after 80 weeks of incapacity (see ‘Waiting Period’, below). More details on how protection insurance works are set out below: Cost You pay a monthly premium throughout the term of the policy. Cost depends on:
e f i L r u o y h e v i ur healt L ge yo
ana m s u t Le
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> Your age – at the time you start the policy. Older people are more likely to suffer an illness, so they pay more; > Your sex – gender can have an affect on the premium you pay; > Your health – at the time you start the policy. If you have existing health problems, you might be refused cover or have to pay more; > Your job – some are more likely than others to contribute towards illness. For e.g. a bank clerk is deemed to have a very safe job but a deep sea diver runs high risks and has to pay more; > Hobbies and lifestyle – for e.g. smoking makes you more likely to become ill, so you’ll pay more; and > Waiting period – once you claim, there is a delay before payments start. You choose how long this is – for e.g. from four weeks to 104 weeks. The longer the waiting period, the less you pay. Access If your health is poor or your lifestyle is considered risky, you may be refused cover or have to pay more than normal. Terms > Check whether you already have protection in place in case you get incapacitated, and for how long that protection would last. For e.g. your employer may have an income protection scheme in place that you can benefit from, or you may have a payment protection insurance that covers your mortgage; > Check whether the policy reduces what it pays out if you receive State benefits 130
or claim money under any other insurance policy; > Some policies only pay out if you can’t do any work, but you would have to be seriously incapacitated for you not to be able to work at all. Others cover being unable to do any work for which you are suited. The best pay out simply if you can’t do your normal job, but premiums tend to be more expensive; > Most policies would pay out until you reach age 65 or when you have chosen the cover to end; > Check how different occupations are treated. Different insurers put the same job in different risk categories; and > Does the cover increase in line with inflation. Some advisers suggest that critical illness cover (CIC) – which pays out a tax-free lump sum if you are diagnosed with a lifethreatening condition listed in the policy – is a cheaper and simpler alternative to income protection insurance. But there are lots of common situations when CIC would not pay out – for e.g. if you had back problems or a stress-related illness. Additionally, not all occurrences of the critical illnesses listed are covered, for e.g. some early stages of cancer are not covered.
Critical Illness Cover What is it? Critical illness cover (CIC) pays out a lump sum if you’re diagnosed with an illness. The illnesses covered are specified in the policy, along with any exclusions – these differ between insurers.
heart attacks, the insurer will need to have medical evidence of the severity of the condition before paying a claim;
Who is likely to buy it? Many people buy CIC when they take on a major commitment such as a mortgage. This is something you can discuss with a mortgage adviser. Otherwise, you can buy CIC: > Through a financial adviser, who advises on CIC, taking account of your wider financial circumstances; or > Directly from insurance companies. Not all firms will give you advice about whether CIC is suitable for you. They should tell you whether they will be offering advice and recommending a policy, or giving you information only. If they only give information, you will need to make your own decision as to whether the product is right for your needs.
> CIC does not cover simply any sickness that affects your ability to work – it is specific about which illnesses are covered; > Some insurers exclude all pre-existing conditions but others will decide on the basis of your personal medical history; > A CIC policy differs from other types of protection insurance, such as income protection or payment protection, so make sure you understand what it does and whether it is right for you; > Before you take out the cover, the firm should give you either a Policy Summary or a Key Features document. This will set out the key features and benefits, as well as any significant or unusual exclusions. If you have any queries, ask the salesperson to explain the cover in more detail;
What are the main features? Before you take out cover, here are some points to consider: > Critical illness cover pays you a lump sum if you are diagnosed as suffering from one of the specified illnesses; > Policy summaries will often set out a list of illnesses covered, but this is only a guide and full details will be in the policy document. This will also set out the criteria that have to be met before the insurer will pay a claim; > In the case of cancer, not all cancers or stages of cancer are covered. And for
> Many insurers now provide a ‘plain English’ guide to the illnesses covered. Ask the salesperson if they have one that explains the policy that they have recommended; > If the insurer imposes any other conditions, perhaps because of your own or family medical history, you should be told what they are before you take out the policy; and > Detailed terms and conditions will be provided in the document the insurer will send you after you take out the cover – make sure you read it, so that you know what you’re covered for. 131
Borrowing Money & Insurance
CIC policies usually only pay out once, and so are not a replacement for income.
If you’ve decided CIC is right for you: > It’s essential that you give full, honest answers to questions you are asked about both your own and your family medical history. Giving incomplete or wrong information could invalidate your policy and any claim you make from it;
I cancel my existing policy and take out a new one?
> If you are not sure, it is better to mention things. Otherwise the policy may not pay out when you need it;
You might find that by replacing a policy you lose some of the benefits if you have developed any illnesses since you took out the first policy. Pre-existing conditions may not be covered under the new policy. You may be able to get cheaper cover if you switch to another company, but the cover might not be as good. So think very carefully before you replace or switch your policy.
> Many insurers will allow you to send medical information directly to their Medical Officer, so if you do not want to discuss personal or sensitive information with the sales adviser, ask about this;
Some policies allow you to increase your cover – particularly after lifestyle changes such as marriage, moving home or having children. Ask your insurance company or financial adviser for information.
> Bear in mind that the premium the salesperson quotes to you is only an estimate. The insurer will confirm the actual premium, and the terms, after it has considered your medical history;
If you cannot increase the cover under your existing policy, you could consider taking out a new policy just to ‘top up’ your existing cover.
> Make sure you understand what the policy covers, when it will pay out and when it will not; > Read the documents you are given and ask questions if you don’t understand anything; and > Remember CIC only pays a lump sum. If you want insurance to cover lost income or your mortgage repayments, ask if there are other types of insurance that might be more suitable for your circumstances. More information I already have CIC but want to change my mortgage and increase the cover. Should 132
Can I cancel the policy if I change my mind or I’m not happy with the cover it provides? You can cancel within 30 days of taking out the policy and get your money back – provided you have not made a claim. After that, you can still cancel the policy at any time under most contracts, but you may not be entitled to a refund of the premiums you have paid. Your cancellation rights should also be set out in the key policy information.
Protecting Your Possessions What would happen if your house was damaged in a storm, flood or fire; you were burgled; or a tile fell off your roof and injured a passer-by?
fittings, such as baths and kitchens, are often included, as well as sheds, greenhouses and garages.
There is insurance to protect your home inside and out as well as to protect your possessions. As with all insurance, it’s important that you:
You might be offered buildings insurance when you take out your mortgage, but you don’t have to take what’s on offer. Use the key policy information to shop around and get the best deal for you. If you purchase a leasehold property (such as a flat in a block) the freeholder may have arranged buildings insurance for the whole block, in which case you may not need your own buildings policy.
> Give the full facts; > Read the policy summary to check what’s covered and what isn’t; > Shop around to get the best deal for you; and > Always compare what’s covered by a policy, not just the price. Some policies might be cheaper than others, but they may not offer the same level of protection. You can choose from the following: > Buildings insurance; > Contents insurance;
What isn’t covered? Your cover is based on what your home would cost to rebuild. You can check whether you have enough buildings insurance through the Building Cost Information Service (BCIS) website. It has an online tool to help you calculate the sum you should insure your building(s) for, in case your home has to be entirely rebuilt. And you need to tell your insurer if you extend your property, for e.g. with a loft conversion or conservatory.
> Pet insurance.
Your belongings are not covered – these need to be covered separately with a contents insurance policy.
Buildings Insurance
Keeping costs down
What’s it for?
As always, shop around. You may also find that you get a better deal if you buy buildings and contents insurance together. Most policies have a standard excess charge which means you agree to pay the first part of any claim, for e.g. the first £50 or £100.
> Motor insurance; and
If you have a mortgage, your lender will insist that your property (and their security) is protected by buildings insurance. It usually pays out if your property is destroyed by fire, floods or subsidence (although you will need to check if you live on a flood plain). Damage to fixed
If you agree to pay a higher excess, you might get a cheaper policy. Always compare what’s covered by a policy, 133
Borrowing Money & Insurance
Do you have the right level of cover? What about your personal belongings or pets – are they covered?
not just the price – the key policy information will help you to do this. Some might be cheaper than others, but they tend to offer less in the way of protection.
Contents insurance
Your cover may also be affected or cancelled if you leave your home empty for a long period of time, or if you let it out. Damage to the building itself is also not covered; this needs to be covered separately under ‘Buildings Insurance’. Keeping costs down
What’s it for? It covers the loss of or damage to the contents of your home. This includes your furniture, electrical goods and other items within your home. But also items you take outside, for e.g. cameras, jewellery and briefcases. Different policies offer different levels of cover, but generally you’ll be covered against theft and fire and have the option to insure against damage you may cause by accident. If not already covered by your contents insurance, you may want to consider travel insurance for loss or damage to your personal belongings whilst travelling.
Many insurers will offer discounts if you have a burglar alarm, window locks or if you’re a member of a Neighbourhood Watch scheme. You may also get a good deal if you combine contents and buildings insurance. Most policies also have a standard excess charge, which means you agree to pay the first part of any claim, for e.g. the first £50 or £100. If you agree to pay a higher excess, you might get a cheaper policy. Always compare what’s covered by a policy, not just the price – the key policy information will help you do this. Some might be cheaper than others, but they tend to offer less protection.
What isn’t covered? Level of cover Anything beyond the maximum amount your insurer says they will pay, and it may pay a maximum amount on single articles. You’ll need to specify the value of the contents. Some companies have limits on the value of any one item under the general policy, so you’ll need to specify individual items such as expensive jewellery or camera equipment.
134
Some contents insurance policies offer new for old. This means they’ll replace old damaged appliances and possessions with new ones when you claim. Bear in mind that your premiums may increase the following year, or the insurance company may refuse to cover you for the same risk if it happens more than twice. •
Appendix
Appendix
UK Tax Rates & Allowances: 2006/7 to 2009/10 Rates, Bands, Allowances, etc. Income Tax
Personal allowance:
2006/7
2007/8
2008/9
2009/10
£5,035
£5,225
£6,035
£6,475
Starting rate band – 10%:
2,150
2,230
(1)
(1)
Basic rate band (2) – 20%:
31,150
32,370
34,800
37,400
Normal higher-rate threshold:
38,335
39,825
40,835
43,875
> Higher rate: 40%. National Insurance Contributions > Class 1 – Primary 11% and Class 4 – 8%, on earnings between the earnings threshold and the upper-earnings limit. 2006/7
2007/8
2008/9
2009/10
Earnings threshold
5,035
5,225
5,435
5,751
Upper earnings limit
33,540
34,840
40,040
43,875
> Class 1 – Secondary 12.8% – On earnings above the earnings threshold. > Class 1 & Class 4 1% – On earnings above the upper-earnings limit.
Class 2 – per week
2006/7
2007/8
2008/9
2009/10
2.10
2.20
2.30
2.40
Small earnings exception
4,465
4,635
4,825
5,075
Class 3 – per week
7.55
7.80
8.10
12.05
135
Pension Contributions 2006/7
2007/8
2008/9
2009/10
Annual allowance
215,000
225,000
235,000
245,000
Lifetime allowance
1.5M
1.6M
1.65M
1.7M
Capital Gains Tax Annual Exemption 2006/7
2007/8
2008/9
2009/10
Individuals
8,800
9,200
9,600
10,100
Trusts
4,400
4,600
4,800
5,050
Inheritance Tax 2006/7
2007/8
2008/9
2009/10
Nil Rate Band
285,000
300,000
312,000
325,000
Annual Exemption
3,000
3,000
3,000
3,000
Pensioners, etc.
Age allowance – 65-74
2006/7
2007/8
2008/9
2009/10
7,280
7,550
9,030
9,490
Age allowance – 75 and over
7,420
7,690
9,180
9,640
MCA – born before 6/4/1935
6,065
6,285
6,535
N/A
MCA – 75 and over
6,135
6,365
6,625
6,965
MCA minimum (3)
2,350
2,440
2,540
2,670
Income limit
20,100
20,900
21,800
22,900
Blind Person’s Allowance
1,660
1,730
1,800
1,890
Notes 1. For 2009/10, a 10% starting rate band of £2,440 (£2,320 2008/09) applies to interest and other savings income only. 2. Basic rate on income other than interest, dividends and other savings income is 22%, until 05 April 2008. The rate applying to dividends is 10%. 136
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