For investors that can't invest in a pension or have used up their Isa allowance, a collective investment account can be a useful way of minimising tax and boosting their income
The well-publicised savings gap has focused attention ' if it wasn't focused already ' on the importance of self-provision and there's plenty of choice of where to invest.
Wherever the investing consumer is faced with choice and the greater and harder these choices are the greater is the need for financial advice.
Most would agree that the essential first step in building an effective investment portfolio is to ensure that the portfolio fundamentals match the investor's aspirations, attitude to risk and investment timescales. Asset allocation and diversification are two obvious (and important) facets that need care and attention.
Clearly, financial advisers have a significant role to play here. Especially at a time when investor confidence is not generally high the appetite to take risk may be severely diminished. If, as a result, the portfolio parameters have narrowed (perhaps focused on more risk averse investments) the importance of securing an improved net return through minimising tax has increased. I will focus on how tax can be minimised through the choice of the legal structure (if any) surrounding the portfolio.
Approved pensions are, of course, extremely tax effective and Isas (given the capacity for tax-free gains and income) come pretty close. But what if an investor either can't or doesn't want to invest in a pension and either can't use or has already used their Isa allowance? Well, a relatively wide range of retail investment wrappers is available to choose from with no monetary limit on input. These include insurance-based and collective investments, both UK and offshore. However, a relatively new choice exists in the shape of the collective investment account. I would like to concentrate particularly on the tax benefits of such an account inside which clients can hold investment funds from many providers.
Before starting on this though it is essential to understand that the collective investment account is not a formal legal structure or 'outer shell' in the way that a unit trust or an Oeic is. The best way to describe it is as a portfolio management service with the account provider being appointed as the nominee through whom purchases of selected collectives are made. One example of such a structure is the new Sterling Investment Account. Of course, there are also others available in the market.
The key differentiator for the collective investment account is that it is possible for the investor to initially choose and then continue to manage the investments underlying the account. This is also feasible within an insurance structure (eg a multi-manager investment bond) but this has a wholly different tax outcome.
So what are the tax benefits that a collective investment account can bring to the investor?
Well, unsurprisingly, this depends on who the investor is. Let's have a look at some key categories. Of course, any particular investor may fall into more than one category.
If the investor is an individual then, while any income will be assessed on the investor regardless of whether the income is reinvested or not, capital gains will be eligible for taper relief.
The investor will also be able to use his or her unused annual capital gains tax (CGT) exemption, currently £7,700. The annual CGT exemption, used to the full by only a few investors in the UK, will be extremely useful in ensuring that a significant amount of investment management and portfolio rebalancing can take place each year tax-free. If the full CGT exemption is available each year, actively managing a portfolio of £100,000 (or more, depending on gains) should be entirely possible without triggering any taxable gains.
To the extent that collectives within the portfolio are held for three or more years, taper relief really starts working. Taper relief operates to reduce the amount of a chargeable gain. The amount of the reduction starts at 5% after three years and moves up to 40% after 10 years and it applies before the annual CGT exemption. This means that it has the effect of 'stretching' the annual CGT exemption. For example, if a gain of £12,833 was made and 40% taper relief was available, the chargeable gain would be reduced by 40% to £7,700 and this would be fully exempt within the annual CGT exemption at its current level.
For those whose pensionable income is above the earnings cap and for those who just do not wish to save any more inside a pensions, growth-oriented investments held through a collective investment account can provide a highly tax attractive means of providing additional funds in retirement.
And through a combination of taper relief and the annual CGT exemption a regular tax-free flow of capital could be provided to boost income in retirement. It is entirely possible to build a fund from which unconstrained and untaxed drawdown is possible within limits.
Tax effectively providing for the cost of further education for children and grandchildren is an issue that will have high priority for many parents and grandparents. As for any future expense, a combination of starting to save early and minimising tax will offer the greatest chance of success.
Holding the beneficial interest in collectives in a collective investment account, subject to a simple trust for the benefit of the child, can ensure that all gains are assessed on the child and not the investor.
This will then enable the child's annual CGT exemption to be used to minimise tax on gains accruing year on year through portfolio management and/or on final realisation. Taper relief will also be useful here for longer-term gains.
All income will be assessed on the child. If the income arising from the investments underlying the collective investment account exceeds £100 gross in respect of the unmarried minor child of that parent in a tax year, then the whole of the income will be assessed on the parent. This rule does not apply in respect of grandparents. So the Account for children will be most tax effective in respect of low yield growth-oriented investments. If an 'income' is required, then many collective investment accounts offer a regular withdrawal facility allowing capital and gains to be returned in a tax efficient manner.
There are significant funds held on trust in the UK. To the extent that capital growth is required or where there is a requirement for a mix of growth and income, this type of account offers a potentially attractive solution.
The recently introduced Trustee Act 2000 would not, for most trusts, have widened the range of permissible investments, but it should contribute to raising the awareness of the requirement that trustees should (in most cases) seek advice on investment selection and management. There is a real role here for investment-oriented financial advisers operating a collective investment account.
On the tax front, remember that trustees also qualify for taper relief, an annual CGT exemption of £3,850 (usually) and, subject to these, pay tax at a flat rate of 34%.
These are just a few of the categories of investor for whom a collective investment account offering a wide range of collectives can operate extremely tax effectively. Of course, the first requirement will be to construct and manage a portfolio that is appropriate to the investor's needs and most likely to deliver the desired outcome. However, with access to a wide range of collectives from a wide range of providers, the chances of achieving the right balance will usually be increased.
Tony Wickenden, Technical Connection
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