Providing a valuable cash injection to your business

Many businesses recognise the need to insure their company property, equipment and fixed assets.

However, they continually overlook their most important assets – the people who drive the business.

Many fail to realise the impact on the financial security of a business that could result from the death or diagnosis of a critical illness of a key employee, director or shareholder.

Keyman insurance is designed to compensate a business for the financial loss brought about by the death or critical illness of a key employee, such as a company director. It can provide a valuable cash injection to the business to aid a potential loss of turnover and to provide funds to replace the key person.
Share or partnership protection provides an agreement between shareholding directors or partners in a business, supported by life assurance. It is designed to ensure that the control of the business is retained by the remaining partners or directors, but the value of the deceased’s interest in the business is passed to their chosen beneficiaries in the most tax-efficient manner possible.

The above are essential areas for partnerships or directors of private limited companies to explore. We can help you to determine the level of cover you may need, any necessary trust arrangements that could be required and provide agreements for you to use.

If a shareholding director or partner were to die, the implications for your business could be very serious indeed. Not only would you lose their experience and expertise, but consider too what might happen to their shares.

The shares might pass to someone who has no knowledge or interest in your business. Or you may discover that you can’t afford to buy the shareholding. It’s even possible that the person to whom the shares are passed then becomes a majority shareholder and so is in a position to sell the company.

A written legal agreement should be in place which would give the other directors or partners the right to buy the shares and gives the person to whom the shares have been passed the right to sell those shares to the remaining directors or partners.

To protect against these eventualities, each director or partner should take out a life insurance policy to cover a specified amount.

Making the right decision to protect your financial situation

With so many different protection options available, making the right decision to protect your personal and financial situation can seem overwhelming. There is a plethora of protection solutions which could help ensure that a lump sum, or a replacement income, becomes available to you in the event that it is needed. We can make sure that you are able to take the right decisions to deliver peace of mind for you and your family in the event of death, if you are too ill to work or if you are diagnosed with a critical illness.

You can choose protection-only insurance, which is called ‘term insurance’. In its simplest form, it pays out a specified amount if you die within a selected period of years. If you survive, it pays out nothing. It is one of the cheapest ways overall of buying the cover you may need.
Alternatively, a whole-of-life policy provides cover for as long as you live.

Life Assurance Options
Whole-of-life assurance plans can be used to ensure that a guaranteed lump sum is paid to your estate in the event of your premature death. To avoid Inheritance Tax and probate delays, policies should be set up under an appropriate trust.

Level term plans provide a lump sum for your beneficiaries in the event of your death over a specified term.

Family income benefit plans give a replacement income for beneficiaries on your premature death.

Decreasing term protection plans pay out a lump sum in the event of your death to cover a reducing liability for a fixed period, such as a repayment mortgage.

Simply having life assurance may not be sufficient. For instance, if you contracted a near-fatal disease or illness, how would you cope financially? You may not be able to work and so lose your income, but you are still alive so your life assurance does not pay out. And to compound the problem, you may also require additional expensive nursing care, have to adapt your home or even move to another more suitable property.

Income Protection Insurance (IPI) formerly known as permanent health insurance would make up a percentage of your lost income caused by an illness, accident or disability. Rates vary according to the dangers associated with your occupation, age, state of health and gender but IPI is particularly important if you are self employed or if you do not have an employer that would continue to pay your salary if you were unable to work.

If you are diagnosed with suffering from one of a number of specified ‘critical’ illnesses, a critical illness insurance policy would pay out a tax-free lump sum if the event occurred during the term of your policy. Many life insurance companies offer policies that cover you for both death and critical illness and will pay out the guaranteed benefit on the first event to occur.

Accident Sickness and Unemployment (ASU) can be taken out for any purpose to protect your income and to give you peace of mind. The benefits only pay for 12 to 24 months on a valid claim if you have an accident, become ill or unemployed. Most of these protection policies operate a ‘deferred period’, which is the period from when a claimable event happens to when the policy starts paying out.

Private medical insurance covers you for private medical treatment and you can choose to add on extra cover, such as dental cover. You may select the hospitals where you would want to be treated close to home. As always, the more benefits and the more comprehensive the policy you select, the more it will cost.

Beyond taking the obvious step of ensuring that you have adequate insurance cover, you should also ensure that you have made a will. A living will makes clear your wishes in the event that, for example, you are pronounced clinically dead following an accident, and executes an enduring power of attorney, so that if you become incapable of managing your affairs as a result of an accident or illness, you can be reassured that responsibility will pass to someone you have chosen and trust.

Shopping around for the annuity that best suits your needs

In June 2010 the government announced a review of the requirement to take your income by age 75. This is subject to consultation and new rules are likely to take effect in April 2011. If you reach 75 before April 2011 there are interim measures in place.

An annuity is a regular income paid in exchange for a lump sum, usually the result of years of investing in an approved, tax-efficient pension scheme. Currently you can choose when to start taking an income from your pension at anytime between the ages of 55 and 75. When you do this, up to 25 per cent of your pension can normally be taken as a tax-free lump sum. The remainder of your pension fund can then be converted into an annuity.

There are 2 different options to choose from:

Single Life
The income will be paid throughout your life only. When you die the income will cease.

If you’re in a relationship where you’re financially dependent on each other, you should consider choosing a joint life annuity which continues to pay an income to your spouse or partner, in the event that you die first.

Joint Life
You can choose up to 100 per cent of the income to continue being paid to your surviving partner after your death. If you have protected rights (from contracting out of SERPS or the State Second Pension) and are married, separated or in a civil partnership, a 50 per cent spouse’s income for your protected rights must be chosen.

How do I receive an income?

The vast majority of annuities are conventional and pay a risk-free income that is guaranteed for life. The amount you receive will depend on your age, whether you are male or female, the size of your pension fund and, in some circumstances, the state of your health.
Your pension company may want you to choose its own annuity offering, but the law says you don’t have to.

Everyone has the right to use the ‘open market option’, to shop around and choose the annuity that best suits their needs. There can often be a significant difference between the highest and lowest annuity rates available.

Some insurance companies will pay a higher income if you have certain medical conditions. These specialist insurers use this to your advantage and will pay you a higher income because they calculate that, on average, your income should be paid out for a shorter period of time.

Some older pension policies have special guarantees that mean they may pay a much higher rate than is usual. Guaranteed Annuity Rates (GARs) could result in an income twice or even three times as high as policies without a GAR.

A conventional annuity is a contract whereby the insurance company agrees to pay you a guaranteed income either for a specific period or for the rest of your life in return for a capital sum. The capital is non-returnable and hence the income paid is relatively high.
Income paid is based on your age, i.e. the mortality factor and interest rates on long-term gilts and income is paid annually, half yearly, quarterly or monthly.

Payments from pension annuities are taxed as income. Purchased life annuities have a capital and interest element, the capital element is tax-free, the interest element is taxable.

What are the different types of annuity?

The different types of annuity include:

Immediate annuity
The purchase price is paid to the insurance company and the income starts immediately and is paid for the lifetime of the annuitant.

Guaranteed annuity
Income is paid for the annuitant’s life, but in the event of early death within a guaranteed period, say five or 10 years, the income is paid for the balance of the guaranteed period to the beneficiaries.

Compulsory purchase
Also known as open market option annuities, these are bought with the proceeds of pension funds. A fund from an occupational scheme or buy-out (S32) policy will buy a compulsory purchase annuity. A fund from a retirement annuity or personal pension will buy an open market option annuity, an opportunity to move the fund to a provider offering higher annuity rates.

Deferred annuities
A single payment or regular payments are made to an insurance company, but payment of the income does not start for some months or years.

Temporary annuity
A lump sum payment is made to the insurance company, and income starts immediately, but it is only for a limited period, say five years. Payments finish at the end of the fixed period or on earlier death.

Level annuity
The income is level at all times and does not keep pace with inflation.

Increasing or escalating annuity
The annuitant selects a rate of increase and the income will rise each year by the chosen percentage.
Some life offices now offer an annuity where the performance is linked to some extent to either a unit linked or with profits fund to give exposure to equities and hopefully increase returns.

A more flexible alternative to established unit trusts

Open-Ended Investment Companies (OEICs) are stock market-quoted collective investment schemes. Like investment trusts and unit trusts they invest in a variety of assets to generate a return for investors. They share certain similarities with both investment trusts and unit trusts but there are also key differences.

OEICs are a pooled collective investment vehicle in company form and were introduced as a more flexible alternative to established unit trusts. They may also have an umbrella fund structure allowing for many sub-funds with different investment objectives. This means you can invest for income and growth in the same umbrella fund moving your money from one sub fund to another as your investment priorities or circumstances change.

By being “open ended” OEICs can expand and contract in response to demand, just like unit trusts. The share price of an OEIC is the value of all the underlying investments divided by the number of shares in issue. As an open-ended fund the fund gets bigger and more shares are created as more people invest. The fund shrinks and shares are cancelled as people withdraw their money.

You may invest into an OEIC through a stocks and shares Individual Savings Account ISA. Each time you invest in an OEIC fund you will be allocated a number of shares. You can choose either income or accumulation shares, depending on whether you are looking for your investment to grow or to provide you with income, providing they are available for the fund you want to invest in.

Like unit trusts OEICs provide a mechanism of investing in a broad selection of shares thus aiming to reduce the risks of investing in individual shares. Therefore you have an opportunity to share in the growth potential of stock market investment. However do remember that your capital is not secured and your income is not guaranteed.

Each OEIC has its own investment objective and the fund manager has to invest to achieve this objective. The fund manager will invest the money on behalf of the shareholders.

The value of your investment will vary according to the total value of the fund which is determined by the investments the fund manager makes with the funds money. The price of the shares is based on the value of the investments the company has invested in.

Collective investment schemes run by fund management companies

Open-ended investment funds are often called collective investment schemes and are run by fund management companies. There are many different types of fund. These include:

– Unit trusts
– OEICs (Open-Ended Investment Companies, which are the same as ICVCs – Investment Companies with Variable Capital)
– SICAV (Société d’investissement à capital variable)
– FCPs (Fonds communs de placement)

This list includes certain European funds, which are permitted under European legislation to be sold in the UK.

There are many funds to choose from and some are valued at many millions of pounds. They are called open-ended funds as the number of units (shares) in issue increases as more people invest and decreases as people take their money out.

As an investor, you buy units/shares in the hope that the value rises over time as the prices of the underlying investments increase. The price of the units depends on how the underlying investments perform.

You might also get income from your units through dividends paid by the shares (or income from the bonds, property or cash) that the fund has invested in. You can either invest a lump sum or save regularly each month.

Open-ended investment funds generally invest in one or more of the four asset classes – shares, bonds, property and cash. Most invest primarily in shares but a wide range also invest in bonds. Few invest principally in property or cash deposits. Some funds will spread the investment and have, for example, some holdings in shares and some in bonds. This can be useful if you are only taking out one investment and remembering that asset allocation is the key to successful investment you want to spread your investment across different asset classes.

The level of risk will depend on the underlying investments and how well diversified the open-ended investment fund is. Some funds might also invest in derivatives, which may make a fund more risky. However, fund managers often buy derivatives to help offset the risk involved in owning assets or in holding assets valued in other currencies.

Any money in an open-ended investment fund is protected by a trustee or depository who ensures the management company is acting in the investors’ best interests at all times.

For income, there is a difference in the tax position between funds investing in shares and those investing in bonds, property and cash. Whichever type of open-ended investment fund you have, you can reinvest the income to provide additional capital growth, but the taxation implications are as if you had received the dividend income.

No capital gains tax (CGT) is paid on the gains made on investments held within the fund. But, when you sell, you may have to pay capital gains tax.

Investing in commercial property brings investors significant tax benefits

Lower prices and lower borrowing rates have led to an increased interest in putting commercial property into a Self-Invested Personal Pension (SIPP). The general fall in the price of commercial property has made it a more affordable investment and has made it possible for SIPPs to acquire property interests that may have previously been unobtainable.

It is possible for the trustees of a SIPP to borrow money from a commercial lender in order to assist with the purchase of suitable property. HM Revenue & Customs (HMRC) guidelines state that the Trustees can borrow up to 50 per cent of the net asset value of the SIPP, as calculated immediately before the borrowing takes place. This limit includes all existing borrowing.

Investing in property can be particularly beneficial when it is used to buy the business premises of the SIPP plan holder. You can invest in commercial property that you already own or plan to buy. The property becomes an asset of your pension fund, bringing you significant tax benefits:

– Any growth in the property value is tax-free – when you come to sell the property, there’s no capital gains tax to be paid on any profit
– Rental income is free of income tax – there’s no income tax payable on any rental income you receive. However, if VAT is included in the rental income this may be payable to HMRC

– In addition to these valuable tax benefits, investing your SIPP funds in commercial property has other advantages as well:

Protection against market volatility – the commercial property market is generally considered less risky than investing in company shares, but you should be aware that investing in a single property could increase the investment risk and property can take longer to sell

Tax relief for your business – if you use the premises for your own business, any rent you pay is an allowable business expense

Estate planning – if you should die, the property doesn’t usually form part of your estate, so potentially there’s no inheritance tax to pay on it

The pension and tax rules are subject to change by the government. If the investments perform poorly, the level of income may not be sustainable. The value of your SIPP when you draw benefits cannot be guaranteed as it will depend on investment performance. The value of fund units can go down as well as up and investment growth is not guaranteed. The tax benefits and governing rules of SIPPs may change in the future. The level of pension benefits payable cannot be guaranteed as they will depend on interest rates when you start taking your benefits. The value of your SIPP may be less than you expected if you stop or reduce contributions, or if you take your pension earlier than you had planned.

Your questions answered

Q: Exactly what are the new CGT rules?
A: The capital gains tax (CGT) rate for individuals with income and chargeable gains – after allowable losses, reliefs, personal allowances and annual exemptions – below the upper limit of the income tax basic-rate band of £37,400 remains at the Pre-Budget rate of 18 per cent. The new 28 per cent CGT rate applies to chargeable gains above this limit. The rate of CGT for capital gains which qualify for Entrepreneurs’ Relief is 10 per cent and the lifetime limit is £5m. All taxpayers benefit from the CGT annual exempt amount of £10,100 for 2010/11.

Q: How do I know if I am a ‘basic-rate’ taxpayer?
A: Taxpayers who have total taxable income and chargeable gains, after taking into account any allowable losses, reliefs, personal allowances and annual exemptions, of up to £37,400 are subject to CGT on their chargeable gains at the rate of 18 per cent.  The interaction of reliefs and losses may in some cases mean that it can be difficult to establish at the time of a chargeable disposal if gains will be subject to CGT at 18 per cent or 28 per cent.

Q: What is Entrepreneurs’ Relief?
A: Entrepreneurs’ Relief was introduced in April 2008 and enables qualifying gains to benefit from a reduced rate of CGT of 10 per cent.  Each taxpayer has a lifetime limit on gains that can qualify for Entrepreneurs’ Relief and, with effect from 23 June 2010, this limit was increased to £5m. In order to be a qualifying disposal for the purposes of Entrepreneurs’ Relief, assets must have been held for at least 12 months and involve the sale of all or part of a trading business or the sale of shares representing more than 5 per cent of the company’s market capitalisation.

Q: Should I time when I dispose of assets to reduce CGT on the gain?
A: Some people paying higher-rate tax may be able to fluctuate their income in one tax year to bring it and the gain they want to realise below the threshold for higher-rate tax. This could be a good solution if you’re drawing your pensions, or for self-employed people who have more control over their incomes.

Q: Can I give assets to my wife to take advantage of a lower tax threshold?
A: Assets can be transferred to a spouse or civil partner or held in joint names to minimise CGT liabilities. Holding an asset in joint names means the annual exempt amount (currently £10,100) of each individual is deducted from the gain before tax is due. Also, it may be appropriate to transfer full ownership to a spouse or civil partner where their income places them in the lower-rate tax band, thus leading to a lower CGT liability after allowances have been taken into account.

Q: How can I increase the value of the lower CGT band?
A: Because pension contributions are deducted from your income before tax is assessed, making additional contributions into pensions can extend the limits of the lower tax rate band. Then, any gains realised from other assets are taxed in accordance with this extended band after allowances have been taken into account.

Q: What about CGT-exempt assets?
A: Many assets can grow in value free of CGT. For example, any asset held in an Individual Savings Account (ISA) is CGT-free.

With the government’s announcement to align CGT rates for non-business assets with income tax rates for higher-rate taxpayers, you may have a number of concerns if you hold capital-appreciating assets. To discuss your individual requirements, please contact us for further information.

Thresholds, percentage rates and tax legislation may change in subsequent finance acts. Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor. The value of your investment can go down as well as up and you may not get back the full amount invested.

Using your pension top-ups to mitigate the effects of CGT

Following the emergency Budget, the Chancellor, George Osborne, has confirmed that the 28 per cent capital gains tax (CGT) rate introduced for higher-rate tax payers would remain in place for at least the length of this parliament.

From a financial planning perspective we now have some certainty about the rules, which enables us to make positive decisions for our clients about how best to reduce the impact of CGT until at least May 2015. This also gives you more stability and certainty when it comes to your tax and investment planning.

The threshold for gains before CGT becomes payable is £10,100 (2010/11) for all. Most basic-rate taxpayers could face 18 per cent tax on gains above this, while higher-rate taxpayers may be subject to a 28 per cent CGT rate.

A pension can be used as a highly effective tax shield, so the higher the rate of CGT, the more incentive there is to place funds under the protection of a pension. If you are now facing a 28 per cent CGT rate, we would like to have the opportunity to discuss the options available to you. Even as a basic-rate taxpayer you may for the first time find that your gains, when added to your income, push you into paying the higher-rate of CGT.

Selling an asset with gains over the CGT threshold would generate sale proceeds that could be used to fund a pension contribution that would attract tax relief of 20 per cent plus a further 20 per cent for higher-rate taxpayers to claim back through self-assessment. The tax relief could enable you to reduce the effect of any CGT that is paid and contribute to recovering any investment losses from falling markets.

It may be important that you maintain exactly the same portfolio of assets and the same investment strategy. This is possible through an in specie (the distribution of an asset in its present form, rather than selling it and distributing the cash) contribution of assets (or part of the asset, such as a property) which is viewed as a disposal for CGT purposes but also attracts tax relief.

Some Self-Invested Personal Pension (SIPP) providers may not allow in specie contributions in this way but those with experience can manage the process to ensure investors work within the overall contribution limits to maximise the benefits.

An alternative option if you’re a higher earner could be to sell your portfolio into the SIPP. In this instance, CGT would be payable on the sale and there is no tax relief as it is not a contribution. But it could be a useful way of releasing cash held by the SIPP back to you while sheltering the assets from any future CGT liability.

If you’re a high earner there may be other advantages to using pension arrangements. An example of this is if you find dividend income or rent from property push your earnings over £100,000 so that your tax-free personal allowance is reduced. In this instance, shifting the assets into a pension would protect against both an effective rate of income tax of up to 60 per cent and CGT going forward.

Protecting your lifestyle from the unexpected

Most home buyers purchase life assurance when they arrange a mortgage, but far fewer obtain another form of financial protection that they are considerably more likely to need before they reach retirement.

Critical illness cover is a long-term insurance policy designed to pay you a tax-free lump sum on the diagnosis of certain specified life-threatening or debilitating (but not necessarily fatal) conditions such as a some forms of heart attack, stroke, certain types/stages of cancer, multiple sclerosis and loss of limbs. The cover can provide cash to allow you to pursue a less stressful lifestyle while you recover from illness, or you can use it for any other purpose.

A more comprehensive policy will cover many more serious conditions including loss of sight, permanent loss of hearing and a total and permanent disability that stops you from working. Some policies also provide cover against the loss of limbs.

If you are single with no dependants, critical illness cover can be used to pay off your mortgage, which means that you would have fewer bills, or a lump sum to use if you became very unwell. And if you are part of a couple, it can provide much-needed financial support at a time of emotional stress.

The illnesses covered are specified in the policy along with any exclusions and limitations, which may differ between insurers. Critical illness policies usually only pay out once, so are not a replacement for income. Some policies offer combined life and critical illness cover. These pay out if you are diagnosed with a critical illness, or if you die, whichever happens first.

If you already have an existing critical illness policy, you might find that by replacing a policy you would lose some of the benefits if you have developed any illnesses since you took out the first policy. It is important to seek professional advice before considering replacing or switching your policy, as pre-existing conditions may not be covered under a new policy.

Some policies allow you to increase your cover, particularly after lifestyle changes such as marriage, moving home or having children. If you cannot increase the cover under your existing policy, you could consider taking out a new policy just to ‘top up’ your existing cover.

Very few policies will pay out as soon as you receive diagnosis of any of the conditions listed in the policy and most pay out only after a ‘survival period’, which is typically 28 days. This means that if you die within 28 days of meeting the definition of the critical illness given in the policy, the cover would not pay out.

Permanent total disability is usually included in the policy. Some insurers define permanent total disability as being unable to work as you normally would as a result of sickness while others see it as being unable to independently perform three or more ‘Activities of Daily Living’ as a result of sickness or accident.

Activities of daily living include:

– Bathing
– Dressing and undressing
– Eating
– Transferring from bed to chair, and back again

Keeping control of your investments

Income Drawdown (or Unsecured Pension) is the name given to the facility that enables you to continue to keep your retirement savings invested and take an income each year rather than buying an annuity. This facility can only be continued to age 75, with transitional rules in place from 22 April 2010 to 5 April 2011 increasing the age to 77, at which time an annuity has to be bought or the money transferred into an Alternatively Secured Pension (ASP). From 6 April 2011, the rules will change again. The government is currently running a consultation on the new rules to apply from this date.
Income drawdown is an alternative to an annuity. It allows you to draw an income directly from your pension while the fund remains invested. One of the most attractive features of income drawdown is that you keep control of your investments and choose the level of income you draw (within limits).

You continue to manage and control your pension fund and make all the investment decisions. Providing the fund is not depleted by excessive income withdrawals or poor investment performance, it may be possible to increase your income later in life.

The income that can be taken from a drawdown arrangement can be varied each year between a minimum and a maximum. The minimum is £0 and the maximum is 120 per cent of a pension, calculated according to tables produced by the Government Actuaries Department (GAD).

These tables are based on the amount your fund would buy as an annuity based on your life only and with no allowance for any future increase. The maximum amount needs to be recalculated every five years. After each review you will be advised of the new annual GAD limit, which could be lower or higher than the limit from the previous five years.

A review will also be triggered if you add more money into your drawdown account from your main pension fund or if you take money out to buy an annuity. Each year you may request that a review takes place on the plan anniversary. This will restart the five-year period. In some cases, funds may also have to be moved out as a result of a divorce court order and this will also trigger a review.

You decide how much of your pension you want to move into drawdown. You can normally take up to 25 per cent of this as a tax-free lump sum and draw a regular income from the rest. There is no minimum withdrawal amount, so you could choose zero income if you wish. Any income is subject to tax at source, on a Pay As You Earn (PAYE) basis. You decide where the remainder of the fund is invested and you should review and monitor the situation regularly.

The maximum income you can draw can be more than the income from a level, single life annuity bought using the same fund. The maximum is calculated at the start of your drawdown plan, using GAD tables that use your age and 15-year gilt yields to calculate the income available from your fund. The income limits calculated at this point are fixed until the next review, although you should review any income you take more frequently.
As long as you stay within the maximum limit, you can control how much income you take and when you take it.

You always need to be aware of the risk that your income withdrawal can deplete your capital. This reduces the capacity for income in the future.

If you smoke, or suffer from ill health, an annuity income could be higher than the GAD limit allowed under income drawdown, as the GAD calculation does not take health or lifestyle into account.

You can use your income drawdown fund to buy a lifetime annuity. If you want to continue drawing an income directly from the fund when you reach your 75th birthday it can continue into an ASP, although income is restricted and death benefits are severely limited. The fund is automatically moved to an ASP if you have not set up an annuity by age 75.

You also need to consider when using income drawdown that your capital is not only being eroded by income withdrawals but is also exposed to market movements. In the worst case scenario your pension fund could be eroded, meaning you have little or no private money to live on in retirement.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.