Wealth management: The nine biggest issues facing the sector in 2016
From Brexit to buy-to-let, this year looks set to be a turbulent one from a wealth management perspective. Ian Harper lifts the lid on the salient facts.
The coming year could be volatile for politics, economics and the financial markets. How might this volatility, together with a range of tax and regulatory issues, affect the work of wealth managers in the year ahead?
1. UK interest rates in 2016
Will they, won't they and if they do rise then how much?
Interest rates were one of the hottest dinner party topics of 2015, but as top fund manager Neil Woodford argues, the UK economy, with its continued reliance on debt-fuelled consumer spending, is far from strong and looks vulnerable to even a modest rate rise.
The advisers we talked to, however, appear more sanguine than that. According to Alan Steel, MD of Alan Steel Asset Management: "History suggests unless interest rates explode from here to say 5 per cent or more, the expected mild increases over the year will have no effect on our clients."
Craig Hendry, MD of Johnston Carmichael Wealth, says: "An interest rate rise can often have a negative impact on the investment market. The latest rise in the US, however, was due to belief that the US market is in a growth phase, and therefore it had a positive effect. Given it is unlikely there will be a [UK] rate rise until later on in 2016, this will be a gradual process and the impact for investors is likely to be minimal."
2. Odds shortening on Brexit
Who would have laid money, only a couple of years ago, on a British exit from the European Union?
Now, however, public opinion appears finely balanced, with neither side so far coming up with clear-cut financial or economic arguments. Furthermore, could a 'Brexit' spark renewed calls for Scottish devolution and, with it, the potential breakup of the UK itself?
Leading fund manager Colin McLean, MD of Scottish Value Management, says:"As the year progresses, there will be more concern about Brexit on the part of international investors. They were concerned about the Scottish referendum and UK general election, and the market was weak in the run-up [to those events]. It could pose a risk for sterling and gilts, in particular, as the vote approaches."
The wealth managers we spoke to were split down the middle. Alan Steel says: "Brexit? Probably it would, initially, be seen to be bad news. Most changes are. But given we have funds invested in overseas markets and UK funds with businesses where most of their earnings are overseas, we're not bothered right now."
For Ian Williams, chairman of Campbell Dallas, the consequences of Brexit would be 'terrible'. He explains: "Most of our clients find it difficult to comprehend a life outside of the EU. Scotland sits on the edge of the world and our aim should always be to foster closer ties with Europe on which to build stronger business relationships."
Craig Hendry says the big problem is uncertainty: "The one thing financial markets dislike is uncertainty. We saw significantly higher volatility in currency and stock markets as the Scottish referendum approached, followed by a more settled period when the outcome became clear. If the polls indicate an uncertain outcome in the European referendum, we can expect more volatility."
3. China and the Middle East
While the talk is of China's growth slipping below 7 per cent, many believe the official figure wildly overstates reality and that growth has already slowed significantly. This is not all negative, however. The positives include lower raw material and energy prices worldwide, and reduced costs for companies whose products are built in China. And while Chinese stock markets are highly volatile, few non-Chinese investment funds have a direct exposure to them.
The Middle East is potentially more dangerous and the political problem the EU faces from the refugee influx is huge. However, instability has not raised the price of oil. The current low price owes more to Saudi determination to counter cheap US shale oil production and a desire to sell oil now while there is still a demand for fossil fuels.
Shorter term, Hendry warns: "The oil price and wider political situation in the Middle East are likely to remain a key theme, with tensions across the region having the potential to unsettle markets and contribute to wider volatility.
On China, he adds: "Alongside the US economy, this is an area investors will need to watch closely. A great deal of faith and trust is being put in the Chinese Government's ability to continue to manage this difficult process."
Alan Steel advises a steady hand: "I subscribe to the view that you should ignore the supposed economic outlook and invest in businesses that can grow no matter what, especially those that grow their dividends year after year. Tax planning and good investments have no correlation to ‘expected' economic scenarios. In any case most economists are miserable and usually wrong."
4. More pension regime changes
Two things loom large this year. First is 'pensions freedom' which came into force in 2015, making it easier and less costly to withdraw money from pension funds. Second is the prospect of a change in the tax treatment of pensions for high earners, including the removal of higher rate tax relief on contributions.
On pension freedoms, Craig Hendry says: "People still need to be aware of the income and IHT [inheritance tax] implications on taking pension benefits as lump sums. Regarding annual allowance tax charges, with this now at £40,000 many in defined benefit schemes are affected so clients may want to investigate whether remaining in a scheme is best for them going forward and those earning over £150,000 need to revisit employer contributions to defined contribution schemes. And with the lifetime allowance falling to £1m from April more people will be caught by this tax charge. Some may benefit by crystallising benefits early (though be wary of IHT implications) or investigating pension protection options."
More significant, for high earners, will be pension tax changes. Zane Hunter, MD of French Duncan Wealth Management, says: "The restrictions due to come into place will force higher earners to pay large amounts of additional tax, which is clearly to the benefit of HM Government.
There is effectively a last chance to take advantage of income tax relief which might be available at 45 per cent before April 2016. With the changes to pension death benefits providing a positive counter-balance, essentially allowing an individual to use their pension fund as a form of IHT vehicle, higher earners would be well advised to capitalise on this opportunity, either from personal funds or from a business source.
Wealthy investors are likely to consider branching out into Enterprise Investment Schemes (EIS) in search of tax relief. EISs represent a much higher risk than pension funds, however, and extreme caution would be necessary."
Jonathan McDowall, financial planning consultant at Henderson Loggie Financial Services, says the annual allowance cut for high earners will reduce tax relief and create additional annual allowance tax charges for many people. He adds that the other main consideration for high earners or individuals with large pension savings is the reduction in the lifetime allowance to £1m as of April 2016: "This will push many people who may not even feel they are high earners into this position and subject their pension pots in excess of the limit to a tax charge on crystallisation."
5. Taxation of dividends
A new dividend taxation regime takes effect on 6 April. It means that the first £5,000 of dividend income in each tax year will be tax free. Sums above that will be taxed at 7.5 per cent for basic-rate taxpayers, 32.5 per cent for higher-rate taxpayers and 38.1 per cent for additional-rate taxpayers. No tax will be deducted at source and taxpayers must use self-assessment to pay any tax due.
But how will this impact wealth management?
According to Zane Hunter: "This is likely to be of significant benefit for wealthier individuals, but only if they can orchestrate their affairs to take advantage of the new tax-free allowance. Otherwise, for most there is likely to be a slight increase in the tax payable. Many investors receive their dividend income from a portfolio arrangement, and in many cases the income stream will be minimal, so it may be worth reorganising the holdings to be able to take advantage of the new position. This needs to be considered carefully as there are likely to be costs involved as well as the potential for CGT [capital gains tax] on reorganisations."
Jonathan McDowall says the new regime will reduce some of the complexity surrounding dividend taxation: "The new rules will be of significant benefit to higher and additional-rate taxpayers receiving dividends of £5,000 or less per annum as these will now be tax free. The new rules, in certain circumstances where individuals receive much larger dividend income, will result in greater tax liabilities. Clients who receive income in the form of dividends, for example shareholding company directors, should review the structure of their income for 2016 onwards."
According to Alan Steel: "The dividend changes will expose advisers who have not been proactive in utilising annual CGT exemptions et cetera to build exposure to ISAs, bonds or pension funds unaffected by the move. Anyone with more than £200,000 in their equity portfolio, with an income stream, could end up paying more tax and being required to complete tax returns when they didn't need to before."
6. IHT planning
Ian Williams points to potential moves towards holding more IHT-efficient 'business' assets: "HMRC have reported record levels for the tax take from IHT. People in business who have independent wealth outside of those businesses face the prospect of IHT at 40 per cent on their non-business assets. Where possible, and there are lots of opportunities, they are now looking to move their non-business assets back into business. Areas to consider would include: farming, commercially managed forestry, premises for occupation by their business, renewables, and EIS [Enterprise Investment Scheme] investments."
Alan Steel warns that: "IHT planning is something too few investors consider until it's too late." He adds: "Mind you, too few don't even bother with a will, never mind understand how effective a well-organised pension fund can be versus income tax and IHT. And with trusts subject to higher levels of all taxes, too few are aware of the benefits of well-written offshore investment bonds. Maybe it's the year for investors to take second opinions."
7. Buy to let in 2016
Buy-to-let homes have become a popular investment asset for the better off, but from 1 April anyone buying one in England and Wales will be hit with a 3 per cent increase in stamp duty land tax (SDLT). The extra charge applies above the current SDLT rates and means stamp duty will be 3 per cent (currently zero) to pay on homes costing up to £125,000, 5 per cent (up from 2 per cent) on homes costing £125,001 to £250,000, and 8 per cent (currently 5 per cent) on homes worth £250,001 to £925,000.
Zane Hunter says: "This is likely to be significant as it will deter people from establishing or augmenting property portfolios. Despite the potential risks of concentrating significant value into essentially illiquid investments, many wealthy investors see property as a sensible means of establishing an income stream for their retirement."
Jonathan McDowall adds: "The increase in stamp duty for buyers of second properties will certainly create an issue for clients considering property as a buy-to-let investment."
The Scottish Government has said it will introduce a similar surcharge for second homes, also from April, but details were still awaited at the time of going to press.
8. Personal savings allowance
Another change affecting taxation will be the introduction in April of the personal savings allowance. Jonathan McDowall says: "This will provide a benefit to savers, resulting in some or all of their deposit interest being free of tax. This allowance will also effectively help to boost the current low returns on deposit savings for taxpayers. With effective planning individuals can arrange their capital tax efficiently, taking advantage of the new personal savings allowance with their deposit savings as well as other investments that are taxed as savings income. In addition, with the use of the annual ISA [individual savings account] allowance, a significant amount can be placed in a tax-efficient environment for savers."
9. Commissions to advisers
From April, IFAs and wealth managers will no longer be able to accept commission payments from fund companies.
Zane Hunter says this will be a benefit for investors: "The likely corollary is that advisers will need to re-engage with their clients to reset how they receive their remuneration, which provides for a more transparent environment. If they are not already, advisers will need to become skilled at justifying how they render their fees so that the client can see value for money. Many clients will see this as an opportunity to take alternative counsel or a second opinion."
However, Alan Steel notes: "The Retail Distribution Review (RDR) had, I believe, an intention to replace commission with adviser charging, which would be transparent and shown explicitly on client valuations. However, there's no such process for insurance policies like investment bonds and pensions from insurance companies. So lazy advisers can sit with existing plans still receiving commission even though such plans may not be efficient for clients.
"The theorists assumed that, as a consequence of RDR, charges would fall to the benefit of savers. However, there are fewer advisers now and charges have increased. The average ongoing adviser charge is now 1 per cent and higher."