Income in a Post-Budget environment
Taha Lokhandwala is an Investment Adviser of Fidelity
With tax changes aplenty in the most recent Budget announcement, what does this mean for investors seeking income? Taha Lokhandwala investigates.
This year’s Budget brought around another fresh set of amendments for financial advisers to absorb – with a further stripping down of tax breaks likely to hamper client income strategies.
Many revelled in 2015 when the then chancellor George Osborne announced the creation of a £5,000 dividend tax-free allowance, implemented last April.
However, his successor, Philip Hammond, broke hearts as he reduced it to £2,000 less than a year later.
The change will affect those taking dividends outside of tax-free wrappers, and could cause a headache for advisers planning client income strategies where such wrappers’ tax allowances are exhausted.
HMRC is cracking down and becoming far better on every facet of tax avoidance – Ben Yearsley
The reduction in allowance – which comes into force in April 2018 – could force advisers to restructure how to provide clients with equity income strategies, a favoured method given where bond yields stand.
Planners could shunt investors into tax wrappers where possible, however, others may have to consider lower-yielding investments to avoid triggering a tax liability.
“Creating a tax efficient structure isn’t particularly easy”, says Wealth Club founder Ben Yearsley. “Dividends are becoming more heavily taxed now, and HMRC is cracking down and becoming far better on every facet of tax avoidance.”
“With the change in the dividend tax rules, I wonder whether there will be a move to effectively take more income from capital and be charged capital gains tax at 20 per cent rather than income at up to 45 per cent,” he added.
Mike Horseman, managing director of advice firm Cockburn Lucas, believes the Budget has forced the hand of advisers into creating more innovative strategies to secure client income as efficiently as possible.
“Tax optimisation has never been more important,” he said.
Mr Horseman explains his own strategy is based around three pillars: tax, investment strategy and withdrawal policy.
This includes using the full range of capital vehicles, such as Isas, open-ended funds, pensions accounts and alternatives, such as venture capital trusts, enterprise investment schemes and maximising business property relief.
“Demonstrating your worth will require an in-depth knowledge of both the client’s objectives and tax position both now and modelled into the future, so you can ensure the client receives maximum income receipt utilising all available tax wrappers,” he says.
“It is entirely possible to legitimately save tens of thousands of pounds of tax, using both personal allowances and the new dividend allowance as well as taking advantage of capital gains tax allowances.”
Advisers will have to move quickly to create such structures, however, with the government keen to minimise transition periods where it ends up haemorrhaging revenue.
Room for manoeuvre
The Office for Budget Responsibility acknowledged the government’s decision to “preannounce” its previous package of dividend taxation reforms had cost the Treasury £800m in revenue, as taxpayers reduced their prospective liabilities in the intervening nine-month period.
There is less room to manoeuvre on this occasion. However, those overseeing portfolios do have some breathing space.
A rising Isa allowance allows investors to shelter a larger amount, while transferring holdings to other vehicles such as Sipps could also be an option.
In the UK the expectation of significant increase in investment has been a damp squib --- Gavin Haynes
Specialists have pointed to the so-called “bed and Isa” or “bed and Sipp” strategies, where investors sell holdings and immediately buy them back via a tax wrapper.
Gavin Haynes, managing director of Whitechurch Securities, agrees with Mr Horseman. He says it was now “more important than ever” to maximise other forms of tax efficiency. He also suggests the greater use of capital gains tax allowances.
“Given the change, investors who had been taking advantage of the £5,000 break but don't need to maximise their income would be encouraged to reduce their focus on income generating investments and look for growth where they can still use their capital gains tax allowance,” he says.
However, the tax changes announced in the Budget was not the only area to affect clients and advisers’ desire for income. Since the new UK government came in last summer, and Donald Trump’s US presidential election victory in November, investor expectations for infrastructure spending has rocketed.
General rhetoric in markets has been one of fiscal and government balance sheet expansion – with central bank interventional becoming a dated and accepted ineffectual policy.
Infrastructure’s ability to provide income and uncorrelated returns from equity markets has seen demand surge in the last 12 months. This year alone, the average premium of infrastructure investment trusts – the favoured vehicle – has gone from 13.9 per cent in January peaking at 15.9 per cent in March.
Yet the Budget was Mr Hammond’s second opportunity to provide funding and detail on any potential infrastructure plan – but investors were left wanting, potentially damping the sector’s prospects.
“Certainly in the UK the expectation of significant increase in investment has been a damp squib as the fiscal stimulus discussed by the Chancellor post referendum has been put on the back-burner,” says Mr Haynes.
Mr Yearsley warned advisers turning to the “very expensive” sector for income strategies to be wary of what they’re going into, specifically if on the back of government rhetoric.
He said: “Everyone has been chasing the assets they have clearly become more expensive. So what was once a cheap niche diversifier has become far more mainstream and more expensive.
“You also need to differentiate between spending plans that say both Mr Hammond and Mr Trump have given speeches on, and ones already generating income.
“New plans, if they ever come to fruition, will not generate income for at least the next decade.”
Mr Haynes agreed. He added: “It is going to be important to be selective as valuations are not cheap given the huge demand for income producing assets.”