24 Oct PORTFOLIO WRAPPER SELECTION
Tony Wickenden, Technical Connections
Ensuring that your investment portfolio and the asset allocation underlying it is aligned with your financial goals and takes account of your attitude to risk is one of the most important things to get right in your financial planning. And part of that process is the regular monitoring of the portfolio against your current goals and attitudes to ensure that if, and as they change, so does your portfolio – if it needs to.
But making and monitoring portfolio choice is by no means all that contributes to the likelihood that your financial goals will be achieved. How you decide to invest and through which investment products (which we will call “wrappers”) can also make a huge difference to outcomes. Along with portfolio selection, construction and monitoring, choosing the right wrapper or wrappers for your portfolio will also be critically important. And tax plays a big part in making wrapper decisions.
Once you have taken care of the tax “no-brainers” of investing into registered pension schemes and NISAs (both of which deliver a tax-free investment environment), what you do about taxation can make a big difference to the “bottom line” – the net return for investors. In this article we will look at investment beyond these tax-advantaged products and will focus on “lump sum” investment into collectives and insurance-based investments via an investment management platform.
So what are the key factors determining which wrapper would be right for your investments?
Well, as for so many aspects of our tax system, the rules seem to be a little more complicated than they need to be – another reason why getting advice is so important.
Broadly speaking, any income that is produced from your investments (e.g.dividends from shares, investment companies or unit trusts and interest from deposits and government bonds) is taxed on you whether you receive it as income or it’s automatically reinvested for you. Of course, if you are a basic rate taxpayer the tax on this income is usually taken care of “at source” so you have nothing to pay. If you are a higher or additional rate taxpayer then you will have a bit more tax to pay.
If you realise any capital gains, say by selling your investment in shares or unit trusts, then, generally speaking, if your total gains (i.e. the difference between what you acquired the investment for and its sale price) in a tax year exceed £11,000 then you will pay capital gains tax on the excess at 18% if you are a basic rate taxpayer and 28% if you are a higher or additional rate taxpayer. Remember, you only pay CGT when you actually realise the gain, say by selling the investment.
Gains on insurance bonds:
And if you invest through an “insurance bond” then you pay no tax until you “cash in” and realise a gain. There are some complex rules (again your adviser can help you) but, broadly, you pay tax on the gain at your income tax rate when the gain is realised. The reason that you have no personal tax exposure until you realise a gain from an insurance wrapper is that the income received and capital gains made by the insurance company on the investments made on your behalf are subject to tax at the insurance company’s rate.
Broadly speaking, this is the basic rate for UK insurance companies and nil (on gains and income) for offshore insurance companies.
When the investor in a UK bond realises the gain from the bond they will only pay tax if they are higher rate or additional rate taxpayers. If the investor invests in an offshore bond then, generally, the whole gain is also subject to basic rate tax when realised.
Reliable, tried and tested ways to minimise tax on investments:
For investments through collectives (investment companies and unit trusts) and insurance bonds there are “tried and tested” non-aggressive tax planning strategies that can be adopted to minimise tax. Again, advice is essential to ensure that you keep as much as possible.
The key phrase in “wrapper selection” is “depending on the circumstances”. The more you put into the planning the more your solution is likely to deliver the optimum answer. Ultimately, though, whether the wrapper choices that are made now turn out to be the right ones will depend substantially on whether the assumptions about future tax rates, investment income and growth are borne out by what happens in reality.
The more they are (and we repeat the importance in this regard of thinking really carefully in the planning stage about what the future might look like for you) the more likely that the wrapper choices made will turn out to be the right ones.
It has to be accepted that however much time and effort is put into the planning, the future is inherently uncertain. Accepting this, in the right circumstances, it might pay to “hedge your bets” and use more than one wrapper – a process becoming known as “wrapper allocation”. Your adviser can help you with this and all aspects of the wrapper selection process through and aligned to the investment administration platforms to best serve your investment management needs.