e-update winter 2011/12

e-Update Winter 2011/12

Taking a slice of the rent The tax rules for the income and profit earned by buy-to-let investments can be complicated, though the Chancellor of the Exchequer has introduced some proposals that aim to simplify the regime.

At present, buy-to-let investors pay income tax on the rental income they receive, and this will be charged at your marginal rate of tax. However, certain expenses can be offset against the rent, before the tax is calculated, including mortgage interest payments and the costs involved in the day-to-day maintenance of your property. You should keep careful records and take advice to find out exactly what can be offset.

Welcome to the latest edition of our newsletter, our update on developments in the world of financial services.

If you have any questions about the issues raised in this issue, please do not hesitate to contact us.

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When the time comes for you to sell a buy-to-let property, capital gains tax (CGT) at a flat rate of 18% is payable on any profit you might have made over and above your annual tax-free allowance (£10,100 for the tax year 2010/11). In addition to the original purchase price, the costs of acquisition and disposal and any money invested to improve the property’s value can be deducted from your profits to reduce the taxable gain.

If you wish – or are able – to move into your buy-to-let property, you can designate it your "principal residence", exempting the last three years of price gains from CGT. Moreover, if the property was ever your main residence in the past, the gain for those years is also automatically exempt. However, do remember that you will lose the benefit of rental income from tenants if you take up permanent residence there.

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How to build your portfolio The word 'portfolio' is simply a shorthand term for the collection of investments you own across all your accounts. Ideally this will be spread across a variety of assets - equities, bonds, property and cash - in a mix that has been determined by that your specific objectives.

The process of deciding how much to invest in each asset class is known as asset allocation. For example, equities have traditionally offered higher returns over the long term but at the price of increased risk while, at the other end of the scale, cash has offered both security of capital and stability but with a fluctuating income and no chance of capital growth.

Actual returns are dependant on many variables, such as the health of the economy in which you are invested, inflation, interest rates and market sentiment. The elements that impact each asset class vary and as a result, one asset might be doing very well at the exact same time another is doing badly. However, it is difficult to predict which one will be doing well - or badly at any one time. Hence, if you mix the asset classes together and have a little bit of exposure to each, this can help balance out the peaks and troughs of the individuals.

Your age, your financial position and your attitude to risk are all crucial considerations to make sure you get the proportions right and build the most appropriate portfolio. It is therefore helpful to speak to an expert who can more easily help you achieve the right mix.

What is an ISA? An Individual Savings Account (ISA) is a tax-efficient wrapper into which you can place a wide variety of assets to protect them from capital gains tax on growth and additional income tax on income. There are currently two types – the cash ISA and the stocks and shares ISA - and you can invest a combined total of up to £10,680 in these during the 2011/12 tax year. The cash ISA element allows you to invest up to £5,340 into a deposit account, National Savings or a qualifying cash fund then the balance between this cash investment and the full allowance can be invested in a stocks and shares ISA. The latter can hold various assets, including equities and bonds, and investment can be either direct or via collective investment funds.

What is the... ...difference between a unit trust and an OEIC? Both are collective investments that target a wide range of asset classes depending on their specific objective. However, a unit trust is unitised - that is, new units are created for new investors and cancelled when investors sell out. An OEIC (open-ended investment company) is set up as a limited company and investors buy shares rather than units. Most OEICs operate as umbrella funds, allowing the creation of different sub-funds, each with different aims, charges and investment requirements within the one structure. When all are run by the same asset management group, this can make switching between those funds a little easier.

Transfer or not?

Most people switch jobs several times during their working life; however, when you change employers, it is worth thinking about the pension pot that you have accrued. You might wish to consider combining your pensions into one pot. It is easier to keep an eye on fund performance if your pensions are all under one umbrella; moreover, a single pension pot will incur less paperwork and administration, and could also generate lower costs and better overall performance. Sounds like a no-brainer? In theory yes, however, there are some important issues to consider before taking the plunge.

Most occupational pension schemes and private schemes can be transferred, but there are restrictions and potential pitfalls. It is not usually worth transferring final-salary or public-sector pension schemes; the benefits are too good to lose. You should only transfer if you have actually left a company: if your current employer contributes to your existing occupational pension scheme, you should not switch. Also it is worth noting that the money in your pension can only be transferred from one pension scheme to another (until you have retired), and not every new pension scheme accepts inward transfers. If your pension pot is very small, it may not be worthwhile switching: you will have to pay charges when you transfer, and some providers impose harsh penalties if you leave their scheme. And, if you are relatively close to retirement, you might not have sufficient time to recover the costs incurred by transferring.

According to the Pensions Advisory Service, the Department of Work & Pensions (DWP) is set to publish a consultation paper examining the consolidation of small pension pots. Possible approaches could see your pension pot moving with you when you change your employer; alternatively, when you change your job, your pension pot could be left behind and – unless you decide to opt out – the cash would automatically be transferred to a central aggregator fund. The DWP believes the changes would increase the visibility of pensions saving: instead of seeing several small figures, each individual would be able to view one larger, consolidated figure.

Transferring and aggregating your pension pots might generate significant long-term benefits; however, any decision to do so should be taken for the right reasons. Tread carefully and, above all, take expert advice before making an irreversible decision. Your financial adviser is well-placed to help you with this.

An interesting start When your new born child finally arrives, the very last thing you are probably thinking is how much they are going to cost you. However, according to the Liverpool Victoria Cost of a Child survey (2011), you are looking at a 21 year bill of over ÂŁ210,000. One way to deflect some of the larger future commitments you might find yourself facing is to consider a regular savings arrangement.

In many cases, at least to start with, deposit accounts are the first port of call and most banks even offer childspecific accounts. The benefit of these is they can allow irregular payments of spare money and you always know that your capital value is safe. However, the return you get is purely interest so you might want to seek out the highest rate you can find.

Covering your income Income protection is an insurance policy that provides you with an income if you are unable to work as a result of accident or illness. Most policies will then pay a regular monthly amount until you have made a full recovery, until retirement age, for a fixed term - or death if earlier.

Income protection can be useful as a supplement to state benefits, as these generally prove insufficient to maintain the lifestyle you are able to enjoy on your current earnings. It is traditionally used to cover your salary and the maximum amount you can insure for will enable you to broadly match the after-tax earnings you would otherwise lose.

Costs vary depending on your circumstances, your medical history, the time for which you defer payments but also on the provider. The more you are covered for, the higher the premium. However, cheaper is not necessarily better and therefore, as with all forms of insurance and protection, it is imperative you read the small print on your income protection policy to ensure you know what is covered.

Finally, it is also essential that you are open about any previous medical conditions, regardless of whether or not you think they are significant. Non-disclosure remains one of the most common reasons for claims being declined by providers and will probably only arise right at the moment you most need the money. Financial advice is therefore highly recommended to help ensure you find the plan most suitable for you.

The benefit of advice The mortgage market is highly competitive and lenders constantly bring out new deals.

They are required to provide Key Facts and illustrations, but many can only provide information – they cannot give advice on whether their loan or another provider's is best for you. In the UK, residential mortgage advice is regulated by the Financial Services Authority.

Advisers use their research skills and sourcing systems to keep up to date with details of all the latest mortgage products so they can find the best rates and deals - and explain which one will best suit your requirements. So, if you want someone to do the hard work, ask an independent expert.

YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON

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The contents of this newsletter do not constitute advice and should not be taken as a recommendation to purchase or invest in any of the products mentioned.

Before taking any decisions, we suggest you seek advice from a professional financial adviser.