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Quantitative easing in Europe
Insight
Key issues in personal financial planning
Winter 2015
Lamborghinis for all!
A
fter much speculation, the European Central Bank (ECB)
finally announced that it would begin quantitative easing with
immediate effect in January. The figures are eye-watering: the ECB
will buy back €1.1 trillion in assets, including government bonds
and EU institutions at a rate of around €60bn per month.
The quantitative easing package has been long awaited and was
greeted with enthusiasm by markets, which rose following the
announcement. Nevertheless, there remains some reservations over
the impact of quantitative easing on an economy. Some economists
believe that it is largely ineffectual, while others believe that it may
lead to long-term inflation.
The theory behind quantitative easing is that central banks buy
assets, such as government bonds, or high quality corporate using
money that it has ‘printed’ (created electronically). It uses this
money to buy the assets from investors such as banks or pension
funds. This is designed to increase the amount of cash in the
financial system, encouraging financial institutions to lend more to
businesses and individuals. This in turn should encourage them to
invest and spend more, thereby boosting economic growth.
Many look to the experience of the US and UK, where quantitative
easing appears to have been effective and seems to have
contributed to rising asset prices and confidence plus economic
recovery. A recent Bank of England report estimated that the
quantitative easing programme between March and November
2009 helped to boost the UK’s economy by between 1.5% and
2%. However, the largest quantitative easing programme remains
that of Japan, where the results are still unclear.
What is the likely impact for the Eurozone? The quantitative
easing programme has been put in place to relieve the deflationary
pressures in the Eurozone economy. It has already contributed to
a weakening in the Euro, which should ultimately have a positive
effect on the Eurozone economy as a whole. If it acts to boost
growth, this would be good news for the global economy – the
Eurozone is the world’s second largest.
But perhaps its most important function is to shore up confidence
– that policymakers are committed to promoting growth, that they
are committed to supporting the currency union whatever it takes
and that they will continue to do ‘whatever it takes’.
Equally, the ability to pass on pension wealth will not stop after
the original member’s death. A beneficiary can then nominate
their own successor to take over the drawdown fund following
their death. This is in notable contrast to the current rules, when
lump sum death benefits are the only option for non-dependents to
receive pension wealth.
There are other considerations, however. The Greek elections and
the election of the anti-austerity Syriza party have thrown the
political situation in the Eurozone into disarray. Anti-austerity
parties appear to be gaining traction in other places such as Spain.
This may ultimately undo some of the good work achieved by
quantitative easing.
These changes create real opportunities for multi-generational
wealth planning and may change the way that pension pots are
used. With pensions subject to onerous tax rules, it made sense
for those with a variety of options to deplete their pension pot as
quickly as possible. However, under the new rules, it may make
sense to hang onto the pension pot for as long as possible, knowing
it can be passed to future generations in a tax efficient way.
It effectively becomes a trust for future generations.
The impact on asset markets is not entirely predictable. However,
quantitative easing would usually push up the market price of
government bonds by increasing demand. This reduces the income
available on those bonds. When it has been introduced elsewhere,
it has usually proved positive for stock markets. European shares
were one of the worst performers in 2014, and investors will be
hoping for a better year in 2015.
Currency market volatility
One of the key side-effects of quantitative easing is greater
volatility in currency markets. The Euro has already dropped
significantly since quantitative easing seemed assured and many are
predicting further depreciation.
For some years now, currency markets have been relatively benign
as interest rate policy in the major developed markets of the
Eurozone, Japan, the US and UK all headed in the same direction.
Now, however, the US and UK look likely to tighten rates, while
Japan and the Eurozone continue to announce measures to
stimulate their flagging economies. Currency markets are at the
forefront of this. Equally, at a time of low global growth, currency
devaluation remains a key way for governments to boost economic
growth (because exports become more competitive) and there
is likely to be more ‘competitive devaluation’ from countries
struggling to generate growth.
A stronger sterling may be good for holidaymakers, but it has
implications for investors. Currency is likely to make a greater
impact on investment returns over the next few years. Last year,
much of the difference between the performance of the US and
European markets could be attributed to currency considerations
and this disparity is likely to continue. It means that those investing
in global markets need to be more alert to currency considerations.
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and income. Past performance is not a guide to the future and the value of investment can fall as well as rise. You might not get back the full amount invested particularly if an encashment is made in the early years. The descriptions of
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Churchill Investments plc
9 Woodborough Road, Winscombe, North Somerset BS25 1AB
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www.churchillinvestments.co.uk
Death benefits - Example 1
The Government has decided that those who have saved into
defined contribution pension schemes can be trusted with the
money they have saved, even if that means a few may use the funds
to buy a Lamborghini. Pensions minister Steve Webb was quoted
on the BBC: “If people do buy a Lamborghini but know that they’ll
end up just living on the state pension, that becomes their choice”
The new era of flexible pensions comes into effect at the start
of the new tax year. From April 2015, the retirement income
limits will be removed for defined contribution pension schemes.
This means retirees have a lot more options about how they take
their retirement income. Those who have not yet taken draw
down on their pension pots – within certain conditions – may
take single or a series of lumps sums without designating them
for drawdown first.
In the recent Autumn statement, there were also changes to the
way pensions are taxed on death, which – to our mind – promise
to be just as significant as the original pension reforms. Perhaps
most notably, the 55% tax charge previously imposed on residual
pension pots for those over 75 or those under 75 who were in
drawdown has been amended. The residual fund on a personal
pension scheme for an individual over 75 in drawdown is now
subject to a 45% tax rate, while for an individual who dies prior to
75, there is no tax payable.
Under the old rules, those who inherited the income from a pension
pot from someone who died under 75 – which was only available
to dependents – saw it taxed as income. Now it can be paid to
any beneficiary and is tax free if taken via the new flexible income
arrangements or an annuity. Those who die after 75 can also now
pass their income over to any beneficiary, but it will be taxed as
income in the hands of the beneficiary. However, they can decide
when that happens. In particular, they can wait until they may be
paying tax at a lower rate – such as after retirement – to take an
income. In the meantime, the pension pot remains invested and
preserved. This is a wide-reaching reform, potentially benefiting up
to 2 million retirees, according to government estimates.
Mr Abbott died on 1st December aged 65 with a SIPP valued
at £700,000 on which no income had been drawn. His wife
will receive a drawdown pension from this after 6 April 2015.
The fund grows tax-free, and Mrs Abbott can make tax free
withdrawals at any time. She dies six years later when the pot
is valued at £600,000 and she is under 75 on death. Her three
children can now inherit £200,000 tax-free, also making taxfree withdrawals at any time.
How your pension can be passed on, post-75?
Old tax rules
Lump Tax charge of 55% sum
New tax rules
Tax charge of 55% tax
for payments made
before 6 April 2015
Tax charge of 45% tax for
payments made between 6 April
2015 and 6 April 2016
Taxed as income at your
marginal rate for payments
made from 6 April 2016
IncomeTaxed as income at marginal rate via an annuity or income drawdown.
Taxed as income at marginal
rate via an annuity or
income drawdown
Only available to dependents
Available to any beneficiary
continued on page 2…
In this issue
The new pension rules
Good news on Isas
QE in Europe
page 2
page 3
page 4
The new pension rules – other considerations
More good news on Isas
I
sas are becoming an increasing potent weapon in an investor’s
armoury. Over the past five years, the government has
significantly increased the amount that can be saved into an Isa,
which now stands at £15,000. It has also broadened the scope of
allowable investments, incorporating retail bonds, peer to peer
lending and Aim shares.
The Autumn statement saw Isas become even more attractive.
Partners can now inherit a deceased spouse’s Isa pot. The Treasury
said in its statement: “150,000 married Isa savers pass away
each year, and their Isa tax advantages die with them, even if
they were saving as a couple. Autumn Statement announces that
from 3 December 2014, if an Isa saver in a marriage or civil
partnership dies, their spouse or civil partner will inherit their Isa
tax advantages.
“From 6 April 2015, surviving spouses will be able to invest
as much into their own Isa as their spouse used to have, on
top of their usual allowance, and so will be better able to
secure their financial future and enjoy the tax advantages they
previously shared.”
The dilemma for final salary schemes.
Members of final salary pension schemes will not necessarily see
the full benefits of the new pensions system. The new income
flexibility is not available for defined benefit schemes and the
death benefit position is also different. This means retirees
would have to transfer into a defined contribution pension to
secure the same options.
This creates a dilemma. For some time, defined benefit schemes
have been the gold standard for pensions and the standard advice
was that anyone who had one should take advantage. The rule
changes make the decision-making a little trickier. Retirees have
to decide whether to transfer progressively into an alternative
arrangement to take advantage of the new flexibility, or retain the
advantages of a defined benefit scheme.
The choice will be individual, though the value of a guaranteed
and inflation-protected income for life and ongoing benefits for a
surviving spouse should not be disregarded lightly. Flexibility is
undoubtedly useful, but it can bring uncertainty and for many
the right choice will be to remain with the existing scheme.
However, it is something that all holders of a defined benefit
scheme need to consider.
The choice will also depend on the health of the individual. In
general, staying with the original scheme will tend to be better
for those likely to live longer in retirement. While these things are
not always possible to predict, if an individual and their spouse
enjoys relatively good health, they should factor this into their
deliberations. Equally, the best option may be a blend of the two.
Nominating beneficiaries
The new pension rules allow individuals to nominate beneficiaries
beyond their dependents. This is relatively easily done: All pension
providers allow you to nominate beneficiaries, either at the point
at which a pension is started or at any other time. It should also
be possible to amend your choice any time if your circumstances
change. Usually, it will simply involve completing and returning an
‘expression of wishes’ form. When deciding on a beneficiary, you
should bear in mind your existing Will.
Minimum pension age
The Government has announced that the minimum pension age
will increase from 55 to 57 from 2028. This potentially affects
anyone under 40 who is planning for their retirement. The
government has said that the minimum pension age will continue
to be 10 years below state pension age, which is currently due to
rise in line with increasing life expectancy.
Pension contributions
Those who access the new pension flexibility from 6 April 2015
can continue making pension contributions, but the Government
had to react to the possibility of over 55s using the new flexibility
for immediate risk-free gain. As a result, it has put in some interim
measures to prevent abuse of the new rules. After April 2015, if
individuals make withdrawals from a defined contribution pension
in addition to the tax-free cash, contributions to money purchase
pensions will be restricted to £10,000 (though their overall
annual allowance will remain £40,000). This is to prevent people
‘churning’ – taking money out of a pension scheme and then
immediately reinvesting it to get further tax relief. It also won’t be
possible to carry forward any unused allowance.
As part of the same anti-abuse measures, the new rules state
that individuals taking pension benefits flexibly must inform
their pension provider within 91 days of any contributions made
to other providers, or face a fine of £300. This affects anyone
taking income from a defined contribution scheme after April
2015. However, there are exceptions: for example, if a pension
pot is deemed ‘small’ - £10,000 or less – or if you go into capped
drawdown before April 2015, the rules will be different.
The Government estimates that these restrictions will only affect
around 2% of pension savers over 55.
…continued from page 1
Death benefits - Example 2
Simon, a widower, dies age 82 and nominated his son John to
receive his drawdown fund (established under the new rules).
As Simon died after age 75, John is taxable at his marginal
rate on any income withdrawals. John sadly dies age 70 and
leaves the remaining fund to his daughter Jenny. Jenny can
take withdrawals from the drawdown account tax free as
John died before 75.
Previously, Isas lost all their tax benefits on death of the holder
and became part of the estate for inheritance tax purposes. From
the 3 December last year, the surviving spouse will be given an
additional ISA allowance, equal to the amount the deceased spouse
had in their ISA, which can be used from 6 April 2015. The key
point is that the spouse can continue to receive the same tax-free
income stream. With Isas increasingly used alongside pensions to
supplement retirement income, this is a valuable change.
The way the new benefit is structured is complicated: technically,
the Isa wrapper and its tax benefits still disappear on death and
the investments still become part of the estate for inheritance tax
purposes. As a result, if the Isa is transferred to anyone but the
spouse, it will still be subject to tax. It is only because there is no
inheritance tax payable between husband and wife that the transfer
escapes under the new rules.
The ISA limit will also increase to £15,240 from 6 April 2015.
From here, the Isa allowance will rise in line with inflation.
The new rules increase the utility of Isa wrappers as a wealth
management and financial planning tool.
Although the government estimates that 150,000 people
will benefit from the change, the amount of the benefit will
depend on how much is held in the Isa, how much income it
generates and the tax rate of the surviving spouse. Accountants
PricewaterhouseCoopers put together the following table, using
a 2% income from investments to calculate the annual benefit of
inheriting the Isa tax breaks to the surviving spouse:
Isa pot at
death
Annual income
at 2%
Annual saving
for surviving
spouse (20%
tax rate)
Annual saving
for surviving
spouse (40%
tax rate) £5,000
£100
£20
£40
£10,000
£200
£40
£80
£20,000
£400
£80
£160
£50,000
£1,000
£200
£400
Pensioner Bonds
The Autumn statement also saw announcement of details on the
‘pensioner bonds’. These have been designed as an alternative to a
savings account for the over-65s. They have higher rates of interest
than conventional savings accounts and were launched through
National Savings & Investments.
The pensioner bonds came to market in mid-January and proved
hugely popular. Around £1bn of bonds was sold out in two
days, crashing the NS&I website in the process. The bonds came
to market with interest rates of 2.8% for one year and 4% for
three years. Around £10bn of the bonds will be made available.
Pensioners will be allowed to save a maximum of £10,000 in each
version of the bond, a total of £20,000.
Although the interest rates look attractive compared to other
savings accounts, there are some disadvantages. The money is tied
up for one or three years, which means that they are not useful for
‘rainy day’ cash that might be needed in an emergency. Equally,
interest on the bonds is taxable at an individual’s personal tax
rate and it is not possible to register to receive interest gross, as is
normally possible with saving accounts. Non-taxpayers or those
who have had too much tax deducted will have to reclaim it via a
self-assessment tax return, which can be an administrative chore
for those who don’t normally need to submit a return.