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Retirement planning Demo

10. Other investments for retirement planning

In this chapter we discuss alternative investment choices that can be used by investors to plan for retirement.

Individual Savings Accounts (ISAs)

Individual Savings Accounts are not investments themselves but flexible, tax-efficient savings wrappers within which a wide range of savings and investment products can be held virtually tax-free. They were introduced in April 1999 as a replacement for Personal Equity Plans, and significant changes were brought in to simplify the rules in April 2008.

There are many ISA providers offering tax-efficient savings through a wide range of investments products. ISAs may have one or 2 separate components:

Stocks and Shares – which includes equities, unit trusts, OEICs, investment trusts, life assurance, gilts and corporate bonds

Cash &ndash...

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...bined maximum - £11,520.

The Government announced in the June 2010 Budget that ISA subscription limits would increase in line with inflation with reference to the Retail Prices Index.

In the 2011 Budget, the Government announced that the rate of increase for ISA subscription limits would be changed from RPI to CPI (Consumer Prices Index). The CPI for the preceding year in September will be used and the increased limit will be rounded to £120 to allow for regular monthly subscriptions. If the CPI is negative the limit will remain unchanged. Following indexation of the subscription limit, the cash ISA limit will continue to be 50% of the overall subscription limit.


ISA investments are free of UK income and capital gains taxes, apart from the non-reclaimable tax credit on UK dividends and non-reclaimable withholding tax on some foreign dividends.

Tax treatment of the investor

Interest, dividends and property income distributions from ISA investments are exempt from any additional income tax

All interest earned within a cash ISA is credited gross

Withdrawals can be made at any time without loss of tax relief

Any capital gains on encashment are tax free, howev...

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...will be given details of any income or gains from the investments, which must be reported to their tax office if they are due to pay tax;

Where an ISA holds life assurance, the policy must end if the subscription is invalid. The policy may give rise to a taxable gain if the proceeds are greater than the premiums paid;

The ISA manager will repay any tax due to HMRC at the basic rate, but the investor must report the gain to their tax office and may have to pay more tax if they are a higher rate taxpayer.

There are strict rules in relation to the types of investments that can be held within an ISA. The following investments are eligible for inclusion in a stocks and shares ISA:

All UCITS are qualifying investments for ISAs;

Not all UCITS can be held within a stocks and shares ISA. Some funds which have guarantees or cash like assets can only be held in a cash ISA. In order to be eligible for a stocks and shares ISA, a UCITS must pass the 5% test (see below);

Shares that are officially listed on a recognised stock exchange anywhere in the world;

Corporate bonds that are officially listed on a recognised stock exchange, with at...

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...vestments held by the UCITS scheme does not significantly limit the risk to the investor’s capital to a 5% loss or less at any time in the following 5 years.

The 5% test also applies where there is no guarantee, but where the investments held by the UCITS scheme are such as to significantly reduce the risk of capital loss to 5% or less i.e. a money market scheme.

Investments that guarantee a return of at least 95% of the investor’s original capital are eligible for a cash ISA. Those investments guaranteeing lower returns of the original capital (or offer no guarantee) are eligible for a stocks and shares ISA.


These are benchmarks set by the Government to provide assistance to investors when choosing an ISA. They cover Charges, Access and Terms. Stakeholder ISAs replaced CAT-standard ISAs from 6 April 2005 onwards. However, if an investor took out a CAT-standard ISA before that date, it will continue to meet the CAT standards. Neither the stakeholder conditions nor the CAT standards guarantee the performance. They do however provide a useful benchm...

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...s paid into a ‘smoothing account’ to be used to top up the return in bad years

If the smoothing account needs extra capital, policyholders can be charged extra;

Managers must make available information about their policies on smoothing and charging

The whole of the with-profits fund and the whole of the smoothing account, apart from specific deductions allowed by law, are for the benefit of the policyholders.


It is possible to transfer some or all of an investor’s funds saved in a previous tax year into another ISA without affecting ISA subscription limits for the tax year. In fact the regulations stipulate that an ISA manager must grant a transfer on request, but they are not obliged to accept one.

If an investor wishes to transfer the current year’s ISA subscription, all of the current year’s subscription must be transferred in its entirety

Where an investor has made subscriptions in previous years, all or part of the previous ...

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...ing extra benefits such as a guarantee, may offer you less flexibility.


There are no tax charges on the termination of an ISA, however as the ISA is exempt from CGT any capital losses are not allowable against other gains. If there are any charges on termination these are likely to be the same as those chargeable on transfer.

When an ISA holder dies, the ISA is automatically terminated and the value of the underlying assets reverts to being taxable and will form a part of the investors’ estate for IHT purposes.


There is a choice between many individual ISA managers. Some managers only offer cash ISAs or only Stocks and Shares ISAs. Others offer both components.

The main types of ISA now available are:

Unit trust and OEIC ISAs - these are the most popular ISAs. They provide a broad spread of holdings for relatively small investments. ISAs may be linked to one or more funds and many managers offer an extensive choice of funds. Corporate bond ISAs based on unit trusts and OEICs, have also proved to be very popular. In particular high yield bond funds, investing in sub-investment grade bonds, have attracted many income seekers. The ISA’s tax structure favours the holding of bonds, as the account manager can receive the interest without any tax being deducted. ISAs may also be invested in any UCITS scheme recognised by the FCA;


Investment trust ISAs - investment trust ISAs are similar to their unit trust and OEIC counterparts, but usually carry explicit additional charges to those le...

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... to 5 years of any investment. This may be expressed as a percentage of the original investment or the current value. Some ISA managers also apply a termination fee when the plan is cashed in or transferred;


Commission – the purchase and sale of investment trusts and shares will usually involve stockbroking commission. This may be a flat rate charge, at the full rate or may be at a specially discounted bulk rate or 0.2% to 0.5%;


Dividend collection fee – self select ISA managers may charge a fee for each dividend collected rather than an annual charge. This is VAT free and usually between £4 and £7.50 which favours larger shareholdings;


Report fees – self select ISAs will often levy a substantial fee, e.g. £50 plus VAT, for investors who wish to receive annual reports to attend shareholder meetings. The size of the fee is designed to be a deterrent as in practice annual reports are easily available from other sources.

Cash deposits

Main features and types of potential returns

Cash deposits are not investments as such but deposits of funds into recognised institutions such as banks and building societies who in turn, use those funds to lend money to other institutions and individuals at a higher rate of interest than they pay the depositor.

Providing the investment is into a recognised financial institution such as a UK bank or building society or via National Savings and Investments, any capital invested via deposit accounts is exposed to minimal risk but equally, there is no potential for capital growth. Therefore the real value of the original capital can be eroded by the affects of inflation over time

Returns will be in the form of interest on the capital invested at the rate offered by the account. Both the nominal annual rate and the Annual Equivalent Rate are usually quoted. The nominal rate will just be expressing the annual rate of interest that the account pays. However, because interest can be paid at different times and frequencies, the compounding effect of for example, a monthly payment of interest rather than annual, will give rise to a different (higher) “effective” rate of interest overall

The rate can either be fixed or variable (most common). Higher rates can be offered either where larger sums are invested, or where the investor is prepared to give a period of notice before withdrawing funds

Penalties can be in the following forms: loss of interest for the period of notice required, loss if the difference between say a standard rate and the higher rate of interest provided for larger/longer-term deposits. With National Savings and Investments, no interest may be paid on certain accounts if the deposit is surrendered in the first year

Returns therefore can be greatly reduced if the investor withdraws funds at short notice or brings funds down to a level where a lower rate of interest is offered.

Key factors affecting price

In the case of cash deposits, the amount invested constitutes the “price” because it is from this sum that the interest payments will be defined

Where an individual makes regular savings into a deposit, it is worth checking at what levels will they need to reach before higher rates of interest are available

With variable rate accounts, investors should be aware of the wider economic conditions prevailing, so that they can maximise returns to counteract potential falls or accommodate anticipated rises in rates

Fixed rate account holders also need to take into account economic variables and be ready to release funds should rates rise so long as they are not penalised as a result.


The capital value of the sums invested into deposits do not as a rule, suffer any volatility in that the original amount will always remain level and growth can only be achieved by the compounding effect of accumulated interest in the account

Capital volatility is only likely to occur where the deposit taking institution has solvency problems. This is a rare event in the UK but can on occasion, happen

National Savings and Investments accounts are considered the most secure due to their government backing, but the larger banks follow closely behind. No building society has as yet defaulted on accounts although many of the smaller societies in the last few years have been taken over or merged

If default by the deposit taking institution does happen, then the Financial Services Compensation Scheme provides some protection against insolvency

Protection under this scheme will be limited to £85,000. This maximum applies per account holder and not per account.


Access to capital funds is usually instant but as already mentioned, this might be at the risk of interest penalties or loss of interest altogether.


Income tax is payable on interest from deposit accounts in the tax year in which it arises. It does not have to be physically paid to the investor to be taxable. The rate of tax paid will depend upon the marginal rate that the depositor’s taxable income comes within. Where an individual’s income does not exceed his personal allowances, then no tax is payable. Where income falls within the starting rate, basic rate,higher rate and additional rate bands, tax will be payable at the rates of 10%*, 20% 40%, 45% respectively

In most cases (although see later specific accounts), interest will be paid net of basic rate tax at 20%. Therefore non-taxpayers will be able to reclaim 20% back. If they expect their income to fall below the personal allowance, then non taxpayers can register to have interest paid gross by completing a form R85

Starting rate taxpayers reclaim 10%* income tax and higher rate taxpayers have a further 20% to pay (usually via self assessment).

* Where applicable

Fixed interest securities

Main Features & types of potential return...

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...up until the property can be rented out again. Further as there is over supply of these properties, many owners decide to sell at a rate above demand with the consequence that prices start to fall again.

The effects of this movement in price can be drastic if the owner is looking to make short term gains, but like other assets backed investments, if the longer-term view is being taken, then economic recovery could bring in new good quality tenants and increased property values as demand rises. This would smooth out eventual returns. Note however, that historically returns have not been much above the rate of inflation on average over long periods.


As already mentioned, property bought and sold directly is illiquid. Therefore the buying and selling process could drag on for long periods and investors could find that yields suffer as a result.

Investors could counteract this problem by not investing directly and instead use collective schemes such shares in listed property companies, property unit trusts, investment trusts, real estate investment trusts or insurance company property funds. They would need to be aware however, of how these schemes are structured as their behaviour may in terms of returns, risk, taxation and access could be very different to the underlying asset in which they invest in.


When considering direct investment into property as an individual, then the tax consequences for residential buy to let property are as follows:

Rental income is taxed as investment income and basic rate taxpayers will pay 20% tax, higher rate taxpayers 40% and additional rate taxpayers 45%

Certain expenses such as letting agents fees, insurance, repairs and redecoration can be deducted from rental income

Interest on loans to buy to let property can be claimed as an allowable deduction against rental income of the property

On disposal, any gain is subject to CGT using the selling price (less costs) minus the acquisition costs plus improvement expenditure not already relieved against income.

If the property is furnished, then a relief for wear and tear may be claimed on a renewals basis or, by a 10% annual wear and tear allowance based on 10% of the rent received.

Commercial property purchased by an individual will still follow the same fundamental rules in terms of the types of taxation that will apply to rent and gains received. However, certain allowances and exemptions exist, the detail of which is beyond the scope of these notes.

If an individual lets part of their principle private residence, then subject to certain conditions, up to £4,250 per year can be received tax free and the residence will continue to enjoy its tax exempt status for CGT purposes.

Note that purchasers of land and property in the UK will be subject to Stamp Duty Land Tax, the rate of which as a percentage of the total value of the consideration increases the higher the value.


We have touched on the variations in property investment already. We shall now finish off this section discussing the merits and pitfalls of two main types namely commercial and residential buy to let property.

Buy to let

We have already discussed some key issues but it is worth re-iterating that an individual wishing to buy this type of property needs to consider liquidity, management of the property, potential tenants and void periods before purchase and be aware of the risks involved

Attention should also be given to location, age, condition and adequate diversification of property and other properties/assets within the investor’s portfolio

When considering the yield that could derive from these investments, one needs to account for gross rent received, expenses, market purchase price and costs of buying. This can be put into the following formula:

Net operating yield = Gross rent minus expenses/Market price + costs of buying


Investment will be in the form of retail buildings, offices and industrial properties all with their special features and benefits

Again the quality of tenant is important as many of these properties only suit a smaller segment of the market

Lease terms can often be long (up to approximately 25 years)

Rent reviews are usually upward. Often they would be carried out every three or five years

Sale and purchase of property is slow at the best of times. With commercial properties this problem could be exacerbated due the availability of tenants in a specialist market.

The market is difficult to analyse with relatively few transactions being carried out with restricted information available on terms and conditions of the transactions.

Note that there are other ways to invest indirectly into property such as:

Shares in listed property companies

Property unit trusts and investment trusts

Insurance company property funds

Offshore property companies

Real Estate Investment Trusts.

Nature of collective investment

Collective investments (otherwise known as pooled investments), are schemes that cost effectively allow individuals to contribute relatively small sums either through regular savings or lump sum investment. The amounts saved by the individual are pooled together with other individuals’ savings to create a much larger fund. The managers of the collective investment fund can then buy and sell a wide range of stocks and shares and in some cases, other asset classes.

Such schemes allow individuals to benefit from the services of a skilled investment manager rather than try to pick stocks and shares on their own account. By having access to a large fund, investment managers are able to negotiate reduced costs associated with buying and selling stocks and shares. In addition, pooling resources with others enables investors to benefit from a diversified portfolio of several stocks and shares; something that would probably take much larger financial resources if they were investing directly on their own account.

We shall now go on to consider some of the more popular types of collective scheme.

Unit trusts

Structure and characteristics

Unit trusts are collective investment schemes set up under trust deeds. They are run by both trustees who have the responsibility of holding investments and overseeing the operation of the trusts, and managers who are responsible for the day to day management of investment assets within the trust. We will explain later on, the detailed roles of the trustee and manager.

As pooled investments, they allow investors to participate in a mix of stocks and shares with other investors, thus benefiting from diversification even though they may only have relatively small amounts to invest.

Unit trusts create “units” each of which is an identical proportion of the total assets of the trust. Most often, the assets of the trust will comprise mainly share or bond holdings. Where further funds are placed into unit trusts, ...

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... will look at these and the sectors invested in more detail later on

One big advantage of investment trusts is that because of their structure, they are able to borrow (or gear) to invest. This could have the effect of “leveraging” gains for the arrangement even though care should be taken that the trust can afford to repay its borrowings especially accounting for adverse market conditions.


Taxation of fund

Where these trusts are approved by HMRC, they will not be subject to tax on any capital gains made from the sale of shares or other portfolio holdings

Investment trusts are not subject to tax on any franked income (dividends received from UK companies)

They will be subject to corporation tax at 28% on unfranked income e.g. gilts, foreign shares, deposits etc. They can offset their own expenses against this income and so could end up paying comparatively little tax.

Taxation of investor

UK dividends will be received by investors with a 10% tax credit. This will be sufficient to cover any tax liability for investors paying up to basic rate tax. Non taxpayers will not be able to reclaim the tax credit

Higher rate taxpayers will suffer a further 22.5% income tax based on the grossed up dividend received. Their total liability is therefore 32.5% of the gross dividend. Additional rate taxpayers will pay a further 27.5%, making their total liability 37.5% on the grossed up dividend received

Any appreciation in capital value on disposal will result in a capital gain subject potentially to capital gains tax. However, you should note that the individual can still offset these gains by use of various allowances such as the annual exemption allowance where gains up to a certain amount each year are free of capital gains tax, and other allowances that may be available depending upon the circumstances of share ownership

These investments can be held within an ISA wrapper in which case, all income and capital gains made by the investor will be tax free.


These schemes are provided by several employers and take a number of different forms. It is important to have a basic knowledge of the main scheme types in order to identify their availability to the employee and the advantages of joining the schemes. Also you need to consider the effect that they have on the rest of...

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... acquired under a SAYE scheme can be transferred into an ISA or a Stakeholder Pension on a tax-free basis within 90 days of exercising the option;

The costs an employer incurs in setting up an approved SAYE Scheme are allowable as a deduction in computing the employer's profits for corporation tax purposes.

Selling a business

Individuals who own all or part of a business may decide when they retire to sell their share. <...

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...business as a means of investment/retirement planning is a high risk strategy not least for its lack in diversification.

Insurance bonds are a type of collective investment scheme that are categorised as single premium, non qualifying life assurance policies. The term is not really indicative of their use however, as they are primarily an investment vehicle

The varieties of bonds that are available on the market nowadays are wide; each attempting to serve a slightly different purpose in terms of capital and income needs whilst accommodating the investor’s views on risk, tax status and desire to access funds

If the bond has no specific term, it should usually be viewed as a medium to longer term investment of at least 5 years before the planholder gains full access to funds. This is so that the bond has a chance to recover from initial set up costs before accumulating investment returns. In addition, the longer the bond is held, the more chance it will have to “smooth” out the effects of any stockmarket volatility

We will now look at the common features of these investments before moving on to features relating to specific product types.

Common features and returns

These investments are structured as life policies. They are therefore subject to life assurance policy “qualifying” rules in terms of taxation. As only single premiums are invested, these rules will be broken and the policies will be treated as “non-qualifying”. There is therefore a possibility that on partial or full encashment...

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...umulative annual tax deferred allowance (although full encashment of segments can take place using the first formula).

If this does occur, it can cause an income tax liability of 20% of the gain to a higher rate taxpayer or 30% for an additional rate taxpayer. Where the gain when added to the income of a basic rate taxpayer pushes income into the higher rate tax band then “top slicing” will apply (see below). The reason that a higher or additional rate taxpayer will not pay a full 40% or 45% is there is effectively a credit for basic rate tax paid within the fund.

Top slicing relief

The basic calculation for a chargeable event gain is unfair in that it does not take account of how long the investment has been owned. Top slicing relief will be calculated to spread the chargeable gain across the full number of years that the policy has been held.

The effect of this is to produce a “slice” of gain that can then be added to other income in the year. If under the higher rate tax band 0% tax will be payable. For any portion over the higher rate tax band, 20% tax will be payable, and for any that falls into the additional rate band a further 25% tax is due. This tax charge is then multiplied by the number of complete years of investment to produce the final liability.

The full formula for calculating a gain is:

(encashment value + previous withdrawals) – (original investment + previous chargeable gains)

Main features and types of potential returns

These policies are defined as regular premium life assurance policies effected for a fixed term. They pay out on either maturity of the term or on previous death whichever is sooner.

Amongst other requirements, an endowment assurance must provide a minimum level of life cover of 75% of the premiums payable over the term (which can be reduced proportionately for over 55 year olds) and must be for a minimum term of 10 years in order to be classed as “qualifying” under life assurance policy rules.

If the policy satisfies qualifying criteria then no chargeable event gain will arise on any policy proceeds on death or maturity. This will effectively mean that there will ...

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...e fund. It is not uncommon for early surrender values to be more or less nil.


We have already discussed how life assurance policy funds are taxed internally (see investment bonds). The same criteria will apply to endowment policies.

The investor will only suffer tax on policy proceeds if the life policy is already or has become non-qualifying as a result of encashment or partially/fully non-qualifying as the £300 per person maximum monthly qualifying premium limit for new policies that commence from 6 April 2013 has been exceeded. Even in these circumstances, tax will only be payable if as a result of the chargeable gain being added to other income, the policy holder is a higher or additional rate tax payer.

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