Neil Jones, technical project manager at Canada Life, explains how drawing fees from bonds and collectives can affect a client's tax position
When the Financial Services Authority (FSA) announced the Retail Distribution Review (RDR) back in 2009, it took some time for the implications to be fully understood and the profession then began to appreciate the impact of adviser charges.
The rule to remember is that any money taken from a policy to provide a payment to an adviser must be the client’s money. It cannot be a product charge.
Let us consider bonds and collectives and consider how an adviser charge deduction can affect them for initial and ongoing deductions.
An initial adviser charge can be paid direct to the adviser by the client or deducted from the payment prior to the investment. If the latter then the net amount invested will be the relevant base figure for the 5% annual withdrawal allowance.
It is also possible for a provider to facilitate a charge after the money has been invested. The full payment would be invested and an immediate withdrawal processed, utilising part of the 5% allowance. However the allowance will be marginally higher as it is based on the gross amount invested.
As for an ongoing adviser charge, any deduction is provided by a cancellation of units, and under a bond this would generally be through a partial surrender. This would therefore count towards the 5% allowance.
For a client who is not taking an income this can be an effective way of paying the adviser charge as the tax is deferred. For those taking an income, the maximum available before a chargeable gain is triggered would be lower.
The impact of exceeding the 5% allowance is the same for a client taking a withdrawal; normal chargeable gain rules will apply.
Whichever product is chosen, advisers and customers need to fully understand the implications of taking adviser charges from an investment. The deduction may not give rise to a tax charge but could impact other areas such as income withdrawals.
Collectives include vehicles such as unit trusts and OEICs. When paying for any initial advice the required amount can be paid to the adviser direct, taken from the payment the customer makes prior to any investment or deducted after the money has been invested.
More care needs to be taken when considering an ongoing adviser charge deduction. Once an adviser and customer agree the cost of any ongoing services, there are two main ways a customer can pay the fees. Like the initial adviser charge they can pay them direct to the adviser firm, or have a regular deduction from their investments being paid to the adviser on their behalf. Choosing ongoing deductions will have implications:
Cash accounts: Under some platforms or wraps it is possible to have a cash account. This can be used to maintain a balance used to fund ongoing adviser deductions in the short-term without the need to sell any units. There are drawbacks:
• The adviser and client will need to decide how much should sit in the cash account. Although interest rates are currently low, when they increase the adviser will need to consider whether the client would do better by maintaining the cash deposit in an account outside of the wrap/platform.
• If the ongoing adviser charge is based on the value of the overall investment and includes the value of the cash account, would this create a product bias? This may not sit comfortably with an adviser firm’s TCF.
• Once the amount held has been exhausted, units would have to be sold to replenish the cash account and the process then begins again.
• When units are sold then there is the potential for a capital gains tax (CGT) liability and this would need to be considered with any other gains or losses.
Unit cancellations: The other method of facilitating an ongoing adviser charge deduction is through the cancellation of units each time a deduction is required. This can be an effective solution as it avoids the need to monitor a cash account, but there are drawbacks:
• This would be a disposal for capital gains tax purposes and while some might expect this to be within the customer’s annual exemption, tax could arise at either 18% or 28%.
• The charges may all be taken from one of the holdings, creating an imbalance in the portfolio weightings.
• As with any collective there is potential for CGT calculations to be required each tax year and there may be a charge involved that needs to be factored into the overall portfolio costs.
Remember that self-assessment is required if any CGT is payable, capital gains exceed four times the annual exemption or if the customer is claiming capital losses.
As we move into the world of adviser charging it is important to understand the implications of using adviser charges.
The client and adviser need to consider the effects of drawing fees from products and the impact on the client’s tax position and the potential drag on investment performance.
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