less INCOME - more GAIN

sneekymum

Can anyone help?

We live on a low income boosted by tax credits (for three children). We have no mortgage or other debts and don't really need any more money. (sorry folks - I know how this sounds...)

My mother owns some commercial property - some of which is empty and she's trying to sell - and that with her own bungalow and savings puts her way over the IHT threshold. As most of her assets are in property, upon her death all of her cash would go on tax and there'd still be lots more tax to pay. Having considered all sorts of advice over the years we've finally settled on using Potentially Exempt Transfers (PETs) as a way of eventually paying less IHT. These are gifts of cash given without reservation which become IHT free after seven years. The fact that I have decided to keep them safe in case I want to give them back is entirely legal.

So

I need to find a place to invest lump sums that won't impact on the Tax Credits we receive. I've used up the ISA allowances and bought one index-linked National Savings certificates for £15K (these two things are specifically excluded when counting income for Tax Credits). I've put a lump in a Commercial Property Fund in the hope that it will grow mostly by capital gains and produce minimal income. (This was part of an overall strategy an accounts for no more than 10% of Mother's liquid assets)

Now what?

Any income produced is effectively taxed at 57% for those of us on Tax Credits. That's 20% at source plus a reduction of 37p in every pound that our income increases by on the tax credit form. (This applies to everyone who receives Tax Credits so if you''re saving outside an ISA -.... why?) Even if I did put it in accumulating funds I'm not really comfortable asking my mother for a 37% of the income-she-didn't-receive refund.

I know there are funds of long gilts - do these produce no income and some capital gain? Or should I go for more National Savings Certificates? Or has anyone got a better idea??

robnye

i believe you can open isa's in your childrens names..... but check the info at your local building society.

sneekymum

Thanks - but I think it better to keep things in my own name. - Ultimately there will be a distribution between my sister and her children (who live in South Africa) and my children (+me). I know this all seems unduly complex but its nothing compared to what a string of IFAs had in mind....

dunstonh

Investment Bonds would avoid any income as the whole product is treated as growth. The tax advantages (on a level playing field) are not as good as unit trusts/OEICS but in your case the reduction in tax credits makes unit/trust OEICs undesirable. Even if you pick low yield funds, there is always some distributions to take into account. That doesnt happen with an investment bond. Modern investment bonds operate very much like the fund supermarkets with free switching and big fund ranges. Most of the funds tend to be the same unit trust funds that you will no doubt be aware of. The charging structure on modern bonds can be quite good. Indeed, I did a quote the other day for someone that after 5 years had a negative reduction in yield (in other words, the allocation rate given at the start exceeded the charges over the 5 year period). If you are going to be a higher rate taxpayer on withdrawal, then the bond will be less desirable as they are liable for further tax. However, bonds can also be placed in trust which can be very useful in circumstances like yours.

The bonds can remain in your mothers name as well (if that is helpful) and placed in trust to beneficiaries. The 7 year rule applies on these as long as she makes no withdrawals for her own benefit. (the correct trust would prevent that)

You are a pretty experienced investor (from past posts that appears the case), so picking funds etc shouldnt be a problem for you. It just appears to be the tax wrapper that is of concern at this stage.

NSC are tax free but I dont know if that means that the income they do generate has to be declared to the tax credits people or not. I'm guessing not as they do not go on the tax return but it would be worth checking with them first. If not, the index linked version of NSC could be desirable for you.

Gilts produce income. In an ISA, its tax free, in a bond there would be no tax to pay but in an OEIC/UT, it would be included. If you buy them "standalone" you would also have to include them.

EdInvestor

Hi sneekymum

sneekymum wrote:

I've put a lump in a Commercial Property Fund in the hope that it will grow mostly by capital gains and produce minimal income.

IME commercial property funds are normally attractive because of their yield, not their capital gains (though in the past couple of years the asset class has done particularly well and the returns are about half and half in the 15% range )

But what is the position if you reinvest the income, ie choose the "accumulation" rather than the "income" version of a fund?

Is the dividend yield counted as income or not?

If not, many types of funds have the two versions.

sneekymum

Dunstonh - Investment Bonds do strike me as an option but the MVAs do scare us a bit - we've already got an MVA of over 20% on a £100K offshore bond which seem to be stuck there till 2012. Mother says she wants immediate access to her money (why? beats me..- you're an IFA, you know people place these brick walls in the way...). The big advantage in not putting stuff in her name is that any IHT due (should she die today) will be due on the residue of her estate - let the solicitor fight with the IR over how to extract the tax from a pile of semi derelict properties with tennants who won't pay rent yet seem to have absolute right to remain for some years to come. (Don't ask). Also, my sister has always tried to hide money from her husband (!), and she's finally starting to face up to her own IHT problem (no Nill Rate Band and a limit of £55K to the South African husband). So in all it seem best for me to hold all the strings.

NSCs don't count for Tax Credits. Even Index Linked ones - its looking likely that we'll go for another £20K this week (already got the £15K IndexLinked 5-yearer this issue).

But that's peanuts compared to the £200K I'm going to be looking for a home for due to the sale of one of the empties. (A sale on it fell through last week as the buyer was in doubts about a strip of land which appears to be a ransom strip - the very strip of land I wrote to our solicitor about months ago and he confirmed it was just part of the road and nothing to worry about....) So its back on the market...

At the end of the day we do wonder (as must you lot) what all this money is for. We haven't been abroard since 1990. I haven't even got a passport...

Note for anyone attempting to follow this - Mother's assets cannot be passed over without triggering massive Capital Gains Tax. Her liquid assets are no where near enough to pay Inheritance Tax. We've concluded that the best plan is to make her liquid assets evaporate and let the Inland Revenue fight it out in probate after she's gone - I'll be able to watch from a foreign beach somwhere...

EdInvestor - the Commercial Property Fund way Mother's way of easing some guilt in that she'd promised my father that she wouldn't sell his properties..

Also, Whether funds accumulate or pay dividends isn't going to wash with the Tax Credits people - after all we're supposed to be poor - which we are in fact.

EdInvestor

Also, Whether funds accumulate or pay dividends isn't going to wash with the Tax Credits people - after all we're supposed to be poor - which we are in fact.


The Revenue seems to only concerned with income you receive. They specificially mention income from "savings and investments, shares,trusts and settlements,foreign income,pensions and property".Not clear if investment bonds would be included, perhaps they are regarded as "insurance" :rolleyes:

Is it just a question of reporting?

Am I right in think they're quite happy for you to make capital gains, it's just income they are worried about?

sneekymum

EdInvestor wrote:

Am I right in think they're quite happy for you to make capital gains, it's just income they are worried about?

I think so - though it would be a good idea to check

IMHO I don't think they've really though the whole tax credit thing through properly.....

dunstonh

Dunstonh - Investment Bonds do strike me as an option but the MVAs do scare us a bit - we've already got an MVA of over 20% on a £100K offshore bond which seem to be stuck there till 2012

Only with profits funds have MVRs. Investment funds do not. They are unit linked (like your OEICS/UTs) and have no MVRs attaching to them.

The accessibility issue will eliminate many bonds as they have no initial charge but have a 5 year step down penatly. After 5 years, the penalty goes and they become available for withdrawal (which takes about 10 days). However, this could be offset with a high intial allocation which would break even the withdrawal charge very quickly. You would expect a very high initial allocation on your amount. 107% should be what you look for. With a first year penalty on surrender of 9% and 7% on year 2, it means it only has to be there 12 months to break even (assuming full surrender). There is no penalty on death. There are no exit penalty versions available yet these have initial charges instead. However, again, an increased allocation should wipe those out.

If you have the money in your mothers name still but in trust, the 7 year timer starts counting. If she passes away, the investment would be surrendered without penalty and paid to the beneficiaries named in the trust. If its in the first 7 years, then the IHT rules apply exactly the same as if it had been placed in your name. The main advantage would be if she passed away in the first 5 years. The investment would be surrendered on death without penalty. In your name, if you needed to surrender, there would be a penalty (assuming you chose a 5 year exist penalty version).

There is an extensive range of property funds available with bonds. Some have very high quality funds which are not available by other means (Zurich has the Eagle star property fund, Scottish Mutual has the very high regarded Morley property fund, NU has both of their property funds and the New star property fund (which is increasingly diversifying out of London now and has become rather more balanced around the UK). They are just examples and not advice for anyone else reading.

Also, the bond would allow you to pick some high yielding investments which you couldnt get on other means, if you desired.

sneekymum

Thanks Dunstonh - I have to admit knowing nothing at all about Investment Bonds - though I'm happy to devote many hours to finding out....my mind is already mulling the idea of starting a few bonds which can stagger the gains to make use of CGT allowances...

The main thing to tacke is whether they'll work for Tax Credits - I don't mind a huge gain in many years time - once my youngest is at school we'll lose £300 a month in tax credits anyway (no more nursery fees) - and I might even have time to work. Tax Credits may just go away anyhow - once they realise that people like us are not prepared to pay 57% income tax as soon as our total earnings exceed £22K.

dunstonh

Investment bonds have no personal liabilty for CGT so you wouldnt need to worry about that.

Investment bond taxation is within the investment and is the equivalent of basic rate tax (22%). This makes them less tax efficient than OEICS where 20% is the tax.

However, the investment bond is not liable for CGT so you dont have to worry about that. Also, there is no reduction in age allowance on any withdrawals made. This can be useful for over 65s earning above the £19,500 age allowance threshold. (maybe your mother?)

The only potential negative is if you withdraw more than 5% in a single year, this creates a event (known as a chargeable event) that can lead to a tax liability. For basic rate taxpayers there would be no liablity. For higher rate there would be. However, the issue for you would be the liability is on income tax. BUT, if you dont draw more than 5% out in a policy year and wait until tax credits are not applicable, you will not have any income/income tax to worry about.

Im not making any provider recommendations here but if you were to look at the Norwich Union step down portfolio bond, you will see the fund range looks like a mini fund supermarket and many of the fund names will be recognisable to those who have used the fund supermarkets. So consider it an example of what sort of thing is available. There are a lot of others with similar ranges so they would need to be investigated as well.