A new report from the Institute for Fiscal Studies (IFS) has claimed pensions are treated more generously by the tax system as a vehicle for inheritance than for retirement income. The IFS said that keeping savings in a pension tax wrapper can be a highly effective way of avoiding inheritance tax, and this is an anomaly that needs to be addressed. Their new “Death and Taxes and Pensions” study was funded by the Financial Fairness Trust and includes proposals to make the tax treatment of pensions on death fairer and more economically efficient. According to the IFS, the additional tax revenue generated by shifting to a different system could be substantial in the long term. The report said: “If the UK government did not want to raise the overall level of inheritance tax, then the revenue could be used to cut inheritance tax in ways that made the overall system fairer and more efficient. The report described the following problems with pensions: Inheritance tax. Any funds that remain in a pension at death (at any age) are not subject to inheritance tax. As such, there is a substantial incentive, for those who can, to use non-pension assets to fund their retirement while preserving their pensions for bequests. To give the most extreme example: a married couple could each leave £1,073,100 in their pensions free of inheritance tax (i.e. £2,146,200 in total), whereas if they both bequeathed the same amount in other financial assets instead there could be a total inheritance tax bill approaching £600,000 (or more). Income tax. Pension contributions are already free from income tax, but usually money received from a pension is taxed instead. Income tax is payable on money received from a pension pot inherited from someone who died at or after age 75. But when someone dies before age 75 funds remaining in their pension escape income tax entirely. For a basic-rate taxpayer, the difference in income tax between inheriting a £100,000 pension pot from someone who died the day before they turned 75 and someone who died the day after turning age 75 would be £20,000. For a higher-rate taxpayer receiving a £1,000,000 pension pot, this difference in income tax would rise to £400,000. More pension wealth is being passed down the generations due to growth in defined contribution pensions, the introduction of pension freedoms, and the substantial tax incentives for bequeathing pension wealth. The IFS wants pension pots to be included in the taxable value of estates on death, and therefore subject to inheritance tax. They argue that inheritance tax should apply equally across all forms of wealth. The body also wants basic-rate income tax to be charged on all funds that stay in pensions at death, or to see the current income tax rules extended to those inheriting pension pots from someone who dies before age 75. Isaac Delestre, author of the report, said: “Whether by accident, design or inertia, the tax treatment of pension pots at death has become increasingly eccentric. The coalition government missed the opportunity to fix the tax treatment of pensions at death when pension freedoms were introduced. It is not yet too late to act, but the longer the government delays, the more painful such reforms will become." By applying the recommendations in its report, the IFS believes it could raise around £1 billion a year in additional inheritance tax revenue, enough to reduce the rate of inheritance tax from 40% to 35% or to help fund the growing pressure on public services.

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 Hopefully, this headline will not come as a surprise to you. It is remarkable, though, just how relaxed some investors are about letting others dip their hands in their pockets to extract high fees. The problem has two root causes. The first is that in most walks of life, paying higher costs should help you to secure the best lawyer, architect or builder, yet when it comes to investing this relationship breaks down. The second is that costs of, say 1% p.a. do not sound very much, but unfortunately, they are when compounded over time as we shall see. Unfortunately, the vast majority of active managers, who promise to beat the market, fail to deliver on their promise as revealed by numerous studies and SPIVA reports across several markets and time frames. High costs are a contributory factor to this failure. Surprisingly to some, picking funds by their costs is one of the few useful metrics available to us. Research by Morningstar – a firm that makes a living providing star ratings for mutual funds – confirms this: ‘If there’s anything in the whole world of mutual funds that you can take to the bank, it is that expense ratios [i.e., ongoing charges figure or OCF] help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.’ A recent piece of research on US mutual funds by Dimensional Fund Advisors reveals that the relentless drag of costs makes a meaningful difference to investor outcomes. It ranked equity funds – over 20 years to the end of 2021 - into low and high-cost quartiles - of those with the lowest costs (0.84% p.a.), 31% were ‘winners’ (i.e. beat the benchmark) and of those with high costs (1.75% p.a.) only 6% were ‘winners’. Similar results were observed when funds were ranked by trading costs (incurred through buying and selling). In the UK, there is still a big gap between the ongoing charges figure (OCF) of active and passive (index) funds, and also reported trading costs, which recent research from Albion (2022) reveals. For instance, at the end of September 2022, actively managed global equity funds were 94 basis points higher on average, than passive funds; actively managed emerging market equity funds were 120 basis points higher on average; actively managed global property funds were 106 basis points higher; and actively managed global short-dated bond funds were 35 basis points higher! Now, if we were to construct a simple illustrative portfolio with 48% in global equities, 6% in emerging market equities, 6% in global property and 40% in global short-dated bonds, the portfolio level fees are 98 basis points for the ‘high cost’ active fund version and 26 basis points for the ‘low cost’ passive (index) fund version. With some straightforward maths, we can calculate the difference in wealth outcomes of investing in these two cost strategies over different time horizons. For the purposes of this exercise, we will assume that the two strategies earn the same return, which is favourable to the active funds, as most deliver a return lower than the market. After 10 years, your investment pot from the passive strategy would be 7.6% higher; after 20 years, 15.8% higher; and after 40 years, the passive strategy would be 34% higher. Wealth Planners like Wells Gibson, who adopt a systematic, evidence-based approach to investing, take costs seriously on their clients’ behalf.  

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If all you had to go by was the information presented in the financial media, you’d be forgiven for believing that to be a successful investor you needed to know which companies were best to own, and that you had to be able to forecast market cycles, predicting the tops and bottoms, which no one can. Fortunately, to enjoy a successful investment experience, either of these are true. 
At Wells Gibson, we believe that the most important financial decision you’ll make in your life is what portion of your assets you allocate to equities (in other words, the greatest wealth building asset). Indeed, extensive research has shown that your asset allocation decision is responsible for the majority of your portfolio’s return. Asset allocation refers to your decision about how much you allocate to fixed interest and equities assets, respectively. 
However before we proceed, let’s define these terms. Fixed income (or Bonds) are a form of lending to corporations/governments who need to raise capital for maintaining or expanding their operations. Usually, a fixed rate of return is agreed, hence the term “fixed income”. These investors do not own any share of the company (which costs them dearly over decades). Equities (or shares) is a part-ownership in a publicly listed business. Investors are rewarded if the company is successful in growing its revenues over time. This usually leads to an increase in share price. Investors are also rewarded in the form of dividends - company profits which management decide to payout to the owners. To the casual observer, both are forms of investments which provide returns over time. However, they are fundamentally different asset classes. The distinction is vitally important to understand. Investing in equities makes you an owner of a business. Investing in a diversified portfolio of said equities makes you an owner of the great companies of the world, the companies we all use each and every day. Now, that's a thought! Investing in bonds (or any fixed interest instrument) makes you a lender to these same businesses. You have no claim to their future profits. As an owner of a successful business, would you prefer to raise money by borrowing at a fixed cost, or would you give up a part of your business to access the cash? The answer may not be clear: if prospects were good you would borrow the money, all else being equal. Similarly, as an investor, would you prefer to own a share of a successful business, or would you prefer to lend money to them? The answer may again be self-evident. You want to own small pieces of the great companies rather than just loan them money. Owners beat lenders. As investors battling the financial dragon called inflation (the slow and steady increase in the price of goods), the only returns we are interested in are real returns - returns above inflation. History has shown us that equities have provided investors with a significantly higher real return than fixed interest assets. The numbers differ between regions and time periods, as could be expected. This makes sense when you understand the distinction we explained above. The best asset class to own in your fight against inflation is, therefore, equities or shares in the great companies of the world. Great news so far I hear you say... Who wouldn’t want the returns of being an equity investor? However, there’s a price of admission for earning higher returns. There’s no such thing as a free lunch, as they say. 

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Partial Transcript

In part-1 we considered the difference between tax evasion and tax avoidance and in particular the simple and effective ways to reduce tax via the annual pension and ISA allowances... Philanthropy makes it possible to reduce your liability to higher-rate or additional-rate tax by giving more to charity, an area we will consider more when the Purposeful Wealth podcast considers the subject of Giving.... For instance, if you’re earning over £100,000 a year, you lose your personal allowance by £1 for every £2 that your taxable income is over £100,000. In 2022/23, this means you lose your allowance if your taxable income is above £125,140. Your Financial or Wealth Plan might reveal you can afford to gift £20,000 to charity, perhaps your church, and because of Gift Aid, that charity receives a gift of £25,000. As you have gifted £20,000 and the charity has received £25,000, your adjusted income is now deemed to be £100,000; however, your net income has only reduced by around £9,500. Essentially, when you donate to charities, you can claim Gift Aid (if you’re a UK taxpayer) and when you do that you’re able to record your donation as a gift on your tax return, which reduces your liability to higher-rate and additional-rate tax, as well as potentially retaining your personal allowance. It’s an entirely legal way to avoid paying some of your tax, yet support causes you care about. 

 Now onto the subject of investing to reduce tax, however a word of caution, don’t put the tax cart before the investment horse though When it comes to tax it’s important to make sure that you don’t pay more tax than you need to and that you legally minimise the impact tax has on your wealth and financial future. However, the challenge comes in not putting the tax cart before the investment horse, so to speak. People can get so focused on reducing their tax liabilities that they make risky investment decisions and take investment risks, which their Financial Plan reveals they are not able to take and don’t need to take. For example, some people might put money into what I would call higher-risk tax planning products, like enterprise investment schemes and venture capital trusts. They do this for the very good reason that they want to reduce their various tax liabilities; however, I regard of most of these products as a fund manager’s remuneration package, dressed up as an investment strategy. Whilst they might reduce tax, you can potentially lose more money on the investment itself. 

 The problem with putting your money into tax planning products like these is that you immediately find yourself invested in products that are not consistent with systematic investing. In other words, they’re not evidence based, informed by decades of empirical academic research and insight. Although higher-risk tax planning products might be suitable for some people, it is important to know that many of these products are poorly diversified, expensive and lack transparency. The success of these products is dependent on speculation and the active manager’s so-called skill. It is also worth noting that these products can be highly illiquid which means access to income or capital is limited and there is a greater possibility of capital loss. 

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Welcome to the Purposeful Wealth Podcast

Partial Transcript:

Benjamin Franklin once said, "But in this world nothing can be said to be certain except death and taxes." I'm sure you would agree...albeit there are other certainties I can think of! Not paying more tax than you need to is sensible in order to create and preserve wealth. Strategies will include utilising allowances, exemptions and tax planning products and solutions to legally minimise tax, in other words, Income Tax, Capital Gains Tax and Inheritance Tax. As much as reducing tax is about wealth creation and wealth preservation, it is also about proper stewardship. In other words, you want your money to work hard and smart for you so you can live the life that’s important to you, yet to ultimately transfer as much as possible to loved ones or causes and communities you care about. Tax will always play a part in the transfer of wealth, but if it’s done tax efficiently then the next generation will be able to enjoy more money. Furthermore, you will also enjoy more money during your life if you take a tax-efficient approach to wealth creation and preservation. I feel it’s important to explain, I don’t believe tax is a bad thing. We have to accept our responsibility for giving something back, paying our way in society and to ensure that goods and services are paid for. Paying tax is about integrity, and I believe, integrity is an important principle in living a fulfilled, and meaningful life. There’s also a Christian principle of paying tax. A story in the Bible, in Matthew’s Gospel, tells of an exchange between Jesus and the Pharisees, who were Jewish and the religious leaders of Jesus’s time. They were always trying to plot and catch Jesus out. One day they said to Jesus, “Tell us then, what you think? Is it lawful to pay taxes to Caesar, or not?” But Jesus, aware of their malice, said, “Why put me to the test, you hypocrites? Show me the coin for the tax.” And they brought him a denarius. And Jesus said, “Whose likeness and inscription is this?” They said, “Caesar’s.” Then Jesus said to them, “Therefore render to Caesar the things that are Caesar’s, and to God the things that are God’s.” Tax evasion vs tax avoidance Whenever you’re dealing with tax, it’s very important to understand the distinction between tax evasion and tax avoidance. Tax evasion is illegal; however, legally there are things that you can do to reduce your tax liabilities. You need to know that the strategy you are employing does not constitute tax evasion. In fact, tax evasion cases have reached a record high over the past few years, according to figures by HM Revenue & Customs (HMRC). Therefore, I would advise you to be very cautious in this respect as HMRC takes tax evasion extremely seriously. The government is always looking for ways to clamp down on anything that’s a little too aggressive when it comes to evading tax. As well as being cautious, much diligence is needed and you need to understand the risks of whatever you’re doing. Over the years, I’ve seen many people reduce their tax liabilities following advice they have received, from an accountant or financial adviser, but lose money in the process. There’s a balance to be struck here and new ways to avoid tax are emerging all the time. You have to be careful about what strategies you choose to implement and make sure you’re aware of the risks so you can determine whether these are risks worth taking. Simple ways to reduce tax There are som

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Welcome to the Purposeful Wealth Podcast.

Partial Transcript:

At the start of 2022 investors needed reminding that investing is not an easy game, despite having enjoyed around a decade of relatively strong – and fairly consistent - market returns, even in light of a global pandemic, recession, and political polarisation. The year 2022 laid bare the fact that investing can very much be a game of ‘three steps forward, one step back’. If there was no risk of market downside, it would be unreasonable to expect any return at all above cash. This podcast provides a brief look at the past 12 months, and highlights some of the lessons we can learn as investors. So let's look backwards For many investors, 2022 was a relatively tough year, with returns ranging from benign to poor, across most major asset classes...global developed, value companies being the exception. Rising prices made returns significantly worse on an after-inflation basis, with year-on-year inflation in the UK having reached levels not seen for decades. 2022 was particularly challenging for investors in bonds, as yields have risen (and thus prices have fallen) across much of the world. Bondholders with longer and lower quality debt suffered greater capital falls... ...whereas, shorter dated, high-quality bonds, as used in Wells Gibson portfolios, continue to be preferred. With few places to hide most investors will have finished the year in negative territory, which is to be expected from time to time. The magnitude of the falls, however, lie well within the tolerances of our client's financial plans. Investors with a reasonable amount of equity exposure should be able to withstand more material falls than those experienced last year - for instance, global equities fell by over 40% during the 2008 Financial Crisis. That said, those investors overweighting value companies and focusing on shorter-dated bonds will find themselves in better space than most, though this is little consolation when returns are still negative in an absolute sense. Investing is never a straight-line journey. Wells Gibson's sensible, systematic portfolios which comprise a diversified basket of equities – with tilts in favour of value and smaller companies - paired with short dated high-quality bonds - have provided better results than most other solutions in 2022. In fact, Wells Gibson's portfolios as whole, outperformed over 70% of professionally managed multi-asset funds over the 12 months due to these portfolio decisions. Investors, such as clients of Wells Gibson, with portfolios denominated in British Pounds, have benefited from the strong performance of the US dollar, which has meant overseas assets translate back to more in British Pound terms. In US Dollar terms (which is often reported by MSM), global equities fell around 18% in 2022, around 10% more than when viewed in British Pound terms. Some major US firms like Tesla and Meta may have hit the headlines with share price falls of over 70% and 60% respectively in the past year, however, they only represent a small allocation – and thus have a small impact - in Wells Gibson's well diversified portfolios.

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Find all our useful links on our LinkTree - https://linktr.ee/jonathangibson

And why not visit us at: https://www.wellsgibson.uk/

And get a copy of the book, Purposeful Wealth here: https://www.amazon.co.uk/Purposeful-Wealth-Contentment-Certainty-Financial/dp/B08T42FNGM

Find all our useful links on our LinkTree - https://linktr.ee/jonathangibson

And why not visit us at: https://www.wellsgibson.uk/

And get a copy of the book, Purposeful Wealth here: https://www.amazon.co.uk/Purposeful-Wealth-Contentment-Certainty-Financial/dp/B08T42FNGM

Find all our useful links on our LinkTree - https://linktr.ee/jonathangibson

And why not visit us at: https://www.wellsgibson.uk/

And get a copy of the book, Purposeful Wealth here: https://www.amazon.co.uk/Purposeful-Wealth-Contentment-Certainty-Financial/dp/B08T42FNGM

Find all our useful links on our LinkTree - https://linktr.ee/jonathangibson

And why not visit us at: https://www.wellsgibson.uk/

And get a copy of the book, Purposeful Wealth here: https://www.amazon.co.uk/Purposeful-Wealth-Contentment-Certainty-Financial/dp/B08T42FNGM