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  • FIRST POST
    • neildt
    • By neildt 13th May 18, 12:09 PM
    • 19Posts
    • 1Thanks
    neildt
    Charges deducted from Capital or Income
    • #1
    • 13th May 18, 12:09 PM
    Charges deducted from Capital or Income 13th May 18 at 12:09 PM
    I'm looking to invest in a Stocks and Shares ISA with Hargreaves and Lansdown for the long term. I will be investing in funds that offer accumulation.

    I noticed the charges are deducted from either captial or income. Can somebody explain in basis terms the differences ?
Page 1
    • bowlhead99
    • By bowlhead99 13th May 18, 12:56 PM
    • 8,234 Posts
    • 15,017 Thanks
    bowlhead99
    • #2
    • 13th May 18, 12:56 PM
    • #2
    • 13th May 18, 12:56 PM
    Irrelevent to you as you are using an ISA and don't pay tax on your gains.

    But basically, investment funds have to distribute all their income out to investors (one of the reasons they get away without paying UK tax themselves).

    If they have 100k of management fees and operating costs, and during the year they make 500k of income and 500k of capital gains, they will have set out in their operating documents how the expenses are allocated.

    Some funds will take the 100k off their income leaving 400k net income and 500k capital gains and they will distribute the 400k to their investors as a dividend.

    Some funds (for example, those which have a goal of delivering a high natural income to their investors) will instead take the charges off their capital reserves when determining their distributable net income. So they would say they had 500k income and 400k capital gains and pay a dividend of 500k to the investors.

    Some other funds would split it 50/50 or some other route.

    But basically the extent to which charges are taken from income rather than capital determines what will be left over to kick out to investors as dividends (taxable under income tax when paid) vs capital (changing the overall value of the fund when you sell and thus your capital gains bill at that point).

    Generally speaking, if you use an accumulation fund class instead of an income/distribution fund class, the 400k or 500k of net income will not be physically paid to you but is still taxable income for the year - you've had the benefit of the income despite the fact it's all internally reinvested and you never see it. So the treatment of expenses does still matter.

    However, all that is overridden by the fact you are using an ISA in which all income and gains are entirely tax free and nothing to worry about.
    • Asghar
    • By Asghar 13th May 18, 3:05 PM
    • 208 Posts
    • 123 Thanks
    Asghar
    • #3
    • 13th May 18, 3:05 PM
    • #3
    • 13th May 18, 3:05 PM
    I'm looking to invest in a Stocks and Shares ISA with Hargreaves and Lansdown for the long term. I will be investing in funds that offer accumulation.

    I noticed the charges are deducted from either captial or income. Can somebody explain in basis terms the differences ?
    Originally posted by neildt

    Most funds take their management charges/fees from income.
    So if a fund has an ongoing charge of 1% per annum, the manager will take that 1% from the income the fund receives from the shares/bonds it holds. The remaining 99% in invested back into the fund and reflected in the unit price. This is completely transparent to you.


    However when the charges/fees are deducted from capital, 100% of the income the fund receives is invested back into the fund and reflected in the unit price. The manager then takes the 1% charge from the number of units you hold, so if you had 100 units, then after the 1% charge you will end up with 99 units.
    That you will notice, though the value of your 99 units should be the same, as the fund price itself will be 1% higher.
    • ColdIron
    • By ColdIron 13th May 18, 4:42 PM
    • 4,546 Posts
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    ColdIron
    • #4
    • 13th May 18, 4:42 PM
    • #4
    • 13th May 18, 4:42 PM
    Most funds take their management charges/fees from income.
    Originally posted by Asghar
    I don't know about that, funds with a growth objective might but many funds that have an income focus will take fees from capital to maximise that income
    The manager then takes the 1% charge from the number of units you hold, so if you had 100 units, then after the 1% charge you will end up with 99 units.
    That's not how it works. If you bought 100 units 10 years ago you will have 100 units in ten years time if you don't buy or sell any more. You don't receive a contract note informing you that the number of units has been reduced, how would you calculate your capital gain on sale if you don't know how many you have? The number of units is unvarying, the value of those units will reflect charges. A Corporate Action such as a stock split might change the number of units you have but this is an infrequent event and any changes will be reflected in a newly issued contract note
    • bowlhead99
    • By bowlhead99 13th May 18, 5:29 PM
    • 8,234 Posts
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    bowlhead99
    • #5
    • 13th May 18, 5:29 PM
    • #5
    • 13th May 18, 5:29 PM
    However when the charges/fees are deducted from capital, 100% of the income the fund receives is invested back into the fund and reflected in the unit price. The manager then takes the 1% charge from the number of units you hold, so if you had 100 units, then after the 1% charge you will end up with 99 units.
    That you will notice, though the value of your 99 units should be the same, as the fund price itself will be 1% higher.
    Originally posted by Asghar
    As Coldiron says, that's not how it works with the sort of funds the OP is looking at. The manager does not simply confiscate your units to pay for the running costs of the fund. So you keep your 100 units.

    The value of the units declines as the fund pays out costs and expenses and also when it pays out dividends to its owners. If it's taken its fees off its annual income stream (rather than its capital performance) to determine the remaining net income which it's going to pay out to investors as dividends, it will pay out fewer pounds of dividends and retain more pounds in the fund and so the net asset value of the fund will remain higher than if it had charged its fees to capital (everything else being equal).

    Some old insurance-based or pension funds might have a more archaic charging method where you pay for the fund fees with units or you receive extra units by way of a management fee rebate; there can be some complexities embedded within your statements. But with the transparent way that retail OEICs / ICVCs / UTs operate, you are not going to find that happening with the funds or (investment trusts) you buy through HL.
    • TheShape
    • By TheShape 13th May 18, 5:51 PM
    • 1,399 Posts
    • 1,270 Thanks
    TheShape
    • #6
    • 13th May 18, 5:51 PM
    • #6
    • 13th May 18, 5:51 PM
    OP mentioned 'the charges'. Do we know whether the OP is talking about fund charges or platform charges?

    Platform charges may be paid either from cash (either paid in or perhaps generated from income) in the account or by HL selling some of the units to cover the charge.
    • bowlhead99
    • By bowlhead99 13th May 18, 6:34 PM
    • 8,234 Posts
    • 15,017 Thanks
    bowlhead99
    • #7
    • 13th May 18, 6:34 PM
    • #7
    • 13th May 18, 6:34 PM
    OP mentioned 'the charges'. Do we know whether the OP is talking about fund charges or platform charges?

    Platform charges may be paid either from cash (either paid in or perhaps generated from income) in the account or by HL selling some of the units to cover the charge.
    Originally posted by TheShape
    You're right, we don't. All of us above had assumed it was in relation to the fund charges from the fund manager.

    On HL's 'at a glance' page for each fund, the 'other information' data box has an item "charges deducted from:" which is whether the fund manager takes their costs out of the income or capital flows into the fund. As the pop-up box next to that item suggests, "Some funds take charges from their capital and distribute all their income, which can reduce the capital growth potential. Other funds take their charges from the fund's income". It was that bit, that we assumed the OP meant.

    It's possible of course that he means the charges that HL levy for providing the platform / admin service. They run multiple virtual/theoretical cash accounts for you within the ISA - which is something that helps some customers stay on top of what's going on with their affairs but just confuses others .

    When you contribute to the ISA or put money into a fund or sell out of a fund, it puts the money in or takes the money out of your virtual 'capital' cash account. When you get income distributed back to your HL ISA account from your investments as (e.g.) interest or dividend or property income distributions, it puts it that money into your virtual 'income' cash account; and when you want to withdraw the ongoing income back to your own bank account you could take it out of that income cash account.

    But in reality if you try to buy an investment for 1000 with your total cash and there isn't enough in your 'capital' account, it will just grab the relevant shortfall from your 'income' account. Or if you want to withdraw 100 from your 'income' account representing last quarter's dividend income, but actually there's only 90 in there because of fees or some other investment you did, it will take the difference from your 'capital' account to make up your 100 withdrawal requirement. So really it is all just one big cash account to do with as you like, especially if you are using a tax wrapper anyway so that income or capital events have no tax consequences for you anyway. Some HL customers get annoyed that if you want to find out everything that's gone on in your account history you have to look at / download the income stuff and the capital stuff separately - because to their mind, really it is all one big account.

    However, some people want or need this preservation of capital and income events being separately listed and maybe they are planning to set it up to automatically distribute the contents of the income account to themselves each month or quarter or year. They might then be interested in how HL propose to grab their fees for running the ISA, and HL offer a variety of options in that regard.

    E.g., they can take the money you owe them each quarter from your income cash account in priority to your capital cash account, and then your non-ISA account ; your capital cash account in priority to your income cash account, and then your non-ISA account ; your capital account only (not your income cash account) and then your non-ISA account; or, your non-ISA fund-and-share account and then your income cash-account in priority to your capital cash account. (http://www.hl.co.uk/my-accounts/fee-collection-options)

    Each of those gives you a different result in terms of what would be left in your respective 'income' or 'capital' cash accounts (or other non-ISA account with HL). It doesn't make much difference whether you go income or capital as it only affects recordkeeping and not your tax bills, but if you had a plan to distribute some spending money to yourself periodically out of the ISA's "income" cash account each month, the amount you could take before that virtual account was empty, would depend on whether the HL fees had been first taken out of there or mostly/ entirely from the "capital" account.

    Paying your HL ISA platform fees out of some other account entirely (e.g. a HL non-ISA fund and share account) is quite attractive as it means you are not using up your precious 20k ISA allowance by paying for fees out of the ISA. But if you're not using up your 20k allowance each year anyway, many people will not care and just stick to the default option.
    Last edited by bowlhead99; 13-05-2018 at 6:37 PM.
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