Andy Haldane, the Chief Economist at the Bank of England, complained recently that he did not understand pensions and then, as if to prove the point, went on to suggest that property might provide a better return than pension investment.
Property or pension?
Those who do understand pensions know that property represents a single asset class, whereas there is a very broad range of investments which can be accessed via a pension scheme, and performance differs widely depending on which investments are chosen.
There are other good reasons for rejecting Mr Haldane’s comment, as the Chief Executive of the Financial Conduct Authority, Andrew Bailey, has pointed out. First, one of the basic rules of investment is never to put all your eggs in the same basket. Investments should be diversified.
Secondly, the family home is for most people their main financial asset, and it makes little sense to become even more dependent on the property market.
Thirdly, property is an illiquid asset. It may take a long time to sell, particularly during the periodic fluctuations in property values. In addition, unlike a pension fund, a property seldom lends itself to partial disposals.
So pensions remain a must-have financial asset, and benefit from the crowning tax advantage that private pensions in drawdown can be passed from one generation to the next without incurring any charge to inheritance tax.
Subject only to the £325,000 ‘nil rate band’ for IHT and the new ‘family home allowance’, which will be phased in from 2017 and then rise gradually to £175,000 by 2020/21, the value of the family home will continue to be fully taxable and is the main factor in causing estates to be subject to inheritance tax.
In addition, a number of new taxes are reducing the advantages of property investment.
New property taxes
First off, with effect from 1 April 2016, a 3% stamp duty land tax surcharge has been imposed on the purchase of UK residential property if the buyer already has an interest in other residential property either in the UK or abroad.
People moving house who buy their new home before selling their current home will be subject to the surcharge but will be able to reclaim the tax if the existing home is sold within three years (18 months in Scotland).
Secondly, as from April 2017, tax relief on buy-to-let mortgages of residential property will be reduced progressively over 4 years to the basic rate of 20%.
As a further discouragement to buy-to-let owners, the rate of capital gains tax on the sale of residential property which is not the owner’s principal private residence will remain at 18% for basic rate taxpayers and 28% for higher-rate taxpayers, even though the rates have been reduced to 10% and 20% on the disposal of other assets.
Up-dated pension protection
Successive reductions in the lifetime allowance for pensions – i.e. the maximum amount that can be held in a defined contribution scheme such as a personal pension without incurring a tax charge – have led to successive dispensations for people who have contributed on the assumption that the higher limits would continue, and would have been penalised by a lack of notice of the new reduced limit.
The limit was reduced with effect from 6 April 2016 from £1.25 million to £1m, having previously stood at £1.5m and before that £1.8m.
As with previous reductions, two forms of ‘protection’ are available – Individual Protection and Fixed Protection.
Individual Protection 2016 (‘IP2016’) is designed for people whose pension savings were worth more than £1m on 5
April 2016 and will continue to be available if further contributions are made, though any excess over the lifetime limit will be subject to tax.
Fixed Protection 2016 (‘FP2016’), which can be taken out either alone or in conjunction with IP2016, is the only form of protection available to those whose pension savings were worth less than £1m on 5 April 2016. It allows them to accrue up to £1.25m without any tax on the excess over £1m. The condition, however, is that no further contributions must be made after 5 April 2016.
Investors’ relief on gains
The Finance Bill 2016 included a proposed new tax relief for investors in trading companies with which they are not connected and which are not listed on the Stock Exchange. To qualify, the investments must have been held for at least three years.
This ‘investors’ relief’ provides the same reduced 10% charge to capital gains tax as entrepreneurs’ relief, which is available to business owners who sell their businesses. In both cases there are of course conditions to ensure that the relief is not abused. One of the conditions attaching to investors’ relief is that the gains in respect of which the relief can be claimed are subject to a lifetime limit of £10 million.
In addition to capital gains tax relief, all investments which qualify for investors’ relief should also qualify for 100% relief from inheritance tax, subject to their having been held for two years.
The pound in your pocket
The post-Brexit decline in the value of sterling, relative to the US dollar in particular, reminds one of the comment by Denis Healey, the 1970s Chancellor who presided over successive devaluations and was asked on one occasion what his feelings were. He said “I have mixed feelings. It’s rather like watching your mother-in-law driving your new car over a cliff”