Are you still wealthy?

Over the last few years there have been strong hints that all may not be well in the world of wealth management. The Financial Services Authority is pushing through its Retail Distribution Review (RDR) aimed at creating more transparency, and hopefully more competition, for the benefit of investors. Wealth management has been a profitable business for advisers '“ but the wealthy are now starting to fight back.

While there have been economic downturns since the early 1970s, overall the good times have rolled. With rising asset values '“ particularly property and the stock market '“ the only decision to be made was to be in the market, i.e. to invest. On the back of that basic premise, wealth management houses and financial advisers have done well; there have been few complaints and until recently investors on the whole have been reasonably satisfied.

Growing pressures

The Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) published a report at the end of last year entitled Tomorrow's Investor (found at www.theRSA.org. uk). Here are three short quotations from that report:

'Ordinary savers want long-term, stable growth. They are interested in absolute returns, not relative ones. And they are not getting what they want.'

'Costs and charges have risen dramatically in recent years. In unit trusts, for example, they have more than doubled. Performance, however, has not followed suit. Investors are paying more but getting less.'

'A pension lasts 50 years. So an average £1 invested in the pension is there for 25 years. 1.5 per cent is paid in fees, on the balance of the fund every year. 25 times 1.5 per cent is 37.5 per cent, or approximately 40 per cent.'

For a long time, there has been recognition that costs, including commission incentives, and poor asset allocation are great destroyers of wealth creation and its preservation. To its credit, the FSA has recognised this factor and its RDR initiative is '“ for consumers '“ a welcome development. A concern is that these green shoots of progress will be lost in the volcanic eruption of the credit crisis.

Rising markets mask many things: falling markets brutally expose those shortcomings. For those with wealth currently there are two asset classes '“ cash (and one still has to make a call on appropriate currency and deposit protection) '“ and everything else. Nearly all real assets driven up by buying on cheap credit are now deflating in value in a wave of selling.

While investors cannot validly complain to the Financial Ombudsman Service as a result of market losses, they can complain with regard to related issues '“ for example inappropriate advice or assessment of their risk or personal circumstances. Here are some of the problems that have surfaced over the last few months:

• 'Cash funds' that were not actually of cash. The collapse of AIG and its subsequent rescue has revealed that a fund being promoted as a cash equivalent '“ but paying a little bit more than moneys on deposit '“ was nothing like cash: many short-term funds were steered into this AIG product which is now showing a shortfall of just under 20 per cent or the option to retain to 2012 in order to fully recover the initial deposit. A headline in Professional Adviser on 22 January 2009 reads: 'IFAs fear client reprisals as Standard Life cuts fund value' '“ a reference to Standard Life stripping 5 per cent off the value of its sterling pension fund, again regarded as a 'cash' fund. One IFA was quoted as saying that one of his clients had lost almost £60,000. Standard Life subsequently added back the 5 per cent by boosting the fund with a £100m payment '“ but toxic assets still remain in the fund.
• Inappropriate asset allocations. It is not unusual currently to hear from investors in their late 50s who have lost a third of their pension value over the last year. Were the advisers of those investors up to speed on the investors' retirement aspirations and strategies? There is often a need for cash on retirement for the purchase of annuities and spending of the tax-free lump sum '“ was that recognised in the adviser's investment strategy?
• In addition to too much equity exposure, many advisers exacerbated risk by putting investors into too many risky equities, e.g. too much in banks, commodities or direct equities.
• Too much leverage. Debt is good when asset prices are rising against even a modest inflationary background. Conversely, debt has a terrifyingly destructive force when inflation is very low '“ or possibly negative '“ and real asset prices are falling.
• Pension drawdown is when the pension fund remains invested after taking the tax-free lump sum and a return is taken from that fund. One bet with drawdown is that the fund will retain sufficient value to beat what would be available from an annuity. With an annuity purchase, the fund is usually lost to the investor '“ and of course the adviser! There are some interesting temporary annuity products on the market but costs need to be carefully considered. Over the last year or so, most people in drawdown would have been better off with an annuity '“ particularly if they had health problems.
• The receding tide has exposed amateur residential property landlords with one type of property (usually a flat) and too much borrowing secured on it. Indeed, even some of the big boys should have known better. There are REITs having to sell assets now to repay debt which would reduce any possibility of breaching their banking covenants.

Few sacred cows

In the Pre-Budget Report on 20 November 2008, the Chancellor announced some significant increases in personal taxation, mainly for those with higher levels of income. From 2010/11 the personal income tax allowance will reduce and effectively will be unavailable to those earning a taxable income of just under £150,000 p.a. or more.

Additionally, for 2011/12, a new higher income tax band of 55 per cent will apply to those with a taxable income above £150,000. There will be an increase in the rates of National Insurance from April 2011.

This is likely to be the starting point. As the shortfall between the government's expenditure and its reducing taxation income becomes starker, there will be few sacred cows.

What will be the consequences of this taxation shortfall? Here are some of my predictions:

• There will be more direct taxation possibly by the withdrawal of reliefs currently available.
• The withdrawal of tax relief on payments of interest on loans for the purchase of your home started with the relief being withdrawn for higher-rate tax payers. This could easily be applied with regard to the current tax relief on contributions to a pension fund.
• HMRC will become a much tougher negotiator. In July 2007 HMRC published its litigation and settlements strategy detailing its approach to negotiations with tax payers (type 'litigation and settlements strategy' in the search facility on HMRC's website). I predict a more robust application of this strategy.
• In spite of falling asset values, the take from inheritance tax is likely to increase. Estates marginally within the IHT charge will get less attention as resources switch to examination of the larger estates.
• As part of this strategy the CTO will be much tougher in grey areas, e.g. use of the income exemption and in technical areas where it can muster an argument in support of its view. We recently had claimed and agreed with the CTO a deduction against IHT for a Maltese tax levied on death in respect of a Maltese flat. That agreement has now been withdrawn on the basis the Maltese tax was not a tax payable as a result of death. We sought advice from a Maltese notary and the CTO's view is being challenged '“ £8,000 is at stake.
• The CTO is likely to issue more notices of determination in negotiations and will do so more quickly. How many tax payers want to take on the Revenue in litigation?
• In the 1960s and 1970s, this country had high taxation imposed on captive tax payers constrained by the exchange control rules. Mrs Thatcher abolished those rules in 1979. The only remaining obstacle to removing capital from the UK is the low exchange rate for sterling '“ that is unlikely to deter wealthy people from emigrating for taxation reasons.