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New all time highs for FTSE 100

New all time highs for FTSE 100

 23rd February 2015

Last Friday the FTSE 100 closed above 6,900 for the first time in 15 years. Today it opened higher and pushed to 6,940 before falling back, but still held on to the hugely psychological level of 6,900. This is the first occasion that the all time high of 6,930 of 30th December 1999 has been breached.

Having struggled in the last year to hold 6,800, getting past and staying above that threshold has given impetus for the push onward to 6,900.

Today’s trading really needs to remain above 6,900 for confidence to push onward to remain. Falling below during the trading session won’t hurt too much, so long as it stays close and finishes above that key value at the close later today. Remaining above 6,900 may be the confidence stepping stone to move on to significant new highs.

In many ways this breakthrough was unlikely, with the uncertainty of Ukraine, Greece and China weighing against the generally upbeat UK data. And the inherent pessimism of winter in UK doesn’t help. But low interest rates, lower costs generally, and now rising wages add confidence.

The UK and US economies are without doubt the world’s strongest at the moment, and it seems that we’ll be consolidating new all time highs in major indices reflecting that success. But before the FTSE 100 soars higher it is most likely to spend some time coming to terms with these levels. A fall back to the strong support at 6,800, a 1.4 per cent fall, is to be expected before we see it moving very much higher.

But a positive and clean election outcome may see us looking at new all time highs of 7,000 rather than a retreat to 6,500.

Fingers crossed.

There is one dampener though. The last time the FTSE 100 index was at this level was on the eve of the millennium. So in real terms to match that figure we should allow for inflation. In order to better that momentous figure, the index — using the BoE inflation figures — would today have to reach 10726.

Professors Mike Staunton, Elroy Dimson and Paul Marsh of the London Business School, part of the team that designed the FTSE 100, have predicted that there is a 50 per cent chance that it will reach 10,000 by 2022.

Peter Marshall, February 2015

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Use your pension fund to avoid IHT

Use your pension fund to avoid IHT

In the last issue I pointed out that the new pension rules effectively make your pension fund the best tax shelter available in the UK. Not only does it avoid capital gains tax and income tax on rents and interest and higher rate income tax on dividends, it now also escapes inheritance tax. For many people, this creates the opportunity to revise investment strategies to minimise IHT.

The key issue is the 40% inheritance tax rate. Many people will have sufficient assets to be exposed to significant taxation at this rate. A couple, who can have combined assets of £650,000 before becoming liable to IHT, will still face a £40,000 tax bill on a £750,000 estate.

Under the old rules, where pensions had a 55% tax charge on death, it was better to keep the capital in ISAs. The new rules have changed the balance of advantage. While ISAs are exempt from income tax and capital gains tax – identical in treatment to pension funds – they do not benefit from tax relief on contributions, nor are they exempt from inheritance tax.

So, all other things being equal, most people will be better off by transferring capital from ISAs to pension funds if their estates will be liable to IHT, assuming they can get tax relief on the pension contributions.

Here is a simple example for a basic rate taxpayer.

£10,000 invested in an ISA yields 4% to produce an income of £400 net.

£10,000 invested in a pension fund attracts 20% tax relief and is boosted to £12,500. This sum yielding 4% generates an income of £500, which is subject to basic rate tax at 20% giving a net income of £400.

In income terms it is even stevens. But the capital in the pension fund is £2,500 higher, and the avoidance of IHT on £10,000 is worth £4,000.

And here is an example for a higher rate taxpayer who expects to pay basic rate tax when they withdraw income from their pension fund.

£10,000 invested in an ISA yields 4% to produce an income of £400 net.

£10,000 invested in a pension fund attracts 20% tax relief and is boosted to £12,500. This sum yielding 4% generates an income of £500, which is subject to basic rate tax at 20% giving a net income of £400.

The pension fund contribution attracts a further 20% tax relief (of the grossed up contribution, hence £12,500 at 20% = £2,500), which is received by the taxpayer.

So they now have capital in the fund of £12,500, at a net cost of £7,500; on top of which they have saved £4,000 in IHT.

In fact, the pension fund investor’s position is better than this since they are entitled to withdraw 25% of the fund tax-free at any point after age 55.

So for both basic rate and higher rate taxpayers, it can make sense to recycle some existing capital held in ISAs into pensions. For higher rate taxpayers, the optimal level of contributions is that which matches the higher rate tax liability for the year.

For some people, it will also make sense to draw down capital within an estate while preserving pension funds outside the estate.

For example, someone with £250,000 each in a pension fund and ISA could draw £15,000 a year (6%) from their pension fund as income. But if their estate will be liable to IHT they would be better off drawing that sum from their ISAs and leaving the pension fund intact. Effectively the £15,000 drawn from the ISA has a net cost of £9,000 assuming it would be liable to 40% IHT on death. People currently using flexible or capped drawdown schemes will be able to alter their future income withdrawals to whatever level they like.

Perpetual tax shelter

You can nominate as many beneficiaries as you like for your pension fund. The normal method is to specify the percentage share of the fund for each beneficiary. But note that you will need to check with your pension fund provider that they have the ability to administer benefits in this way – if not, you may need to switch your fund to another provider. If you want more flexibility, you can set up a spousal by-pass trust to receive your pension fund on your death, but it will cease to qualify for income and gains tax exemptions. So for most people, keeping the capital within the tax-exempt pension vehicle will probably be preferable.

Experts’ interpretations of the new rules – which will undoubtedly require more detailed guidance notes from HMRC in due course – suggest that someone nominated as a pension fund beneficiary can, on their death, leave their share to someone else, and so on in perpetuity.

Under these new rules, the pension fund can be used to provide a stream of tax-free income.

  • Dependant with taxable income below their personal allowance. Typically this will be a spouse with no pension rights and only a state pension. An amount equal to the difference between the state pension and the personal income tax allowance can be drawn each year tax-free.
  • Grandchildren. Each has their own income tax allowance, so if they are named as beneficiaries they (or their parents on their behalf) can withdraw up to that amount each year tax-free.
  • Non-resident. Anyone non-resident in the UK for tax purposes can draw benefits tax-free.

The new rules provide substantial opportunities for tax avoidance, but given the complexity of the interaction of taxes and reliefs, I recommend obtaining professional advice. I fear that given the obvious attractions of the new rules, there may eventually be legislative changes that erode these benefits. Make hay while the sun shines.

Chris Gilchrist, January 2015

 

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Dividend funds for the long-term

Dividend funds for the long-term

Since I last wrote about global equity income funds in May 2014 (issue 355), as my chart shows, performance has continued to be good. These funds are, in my view, ideal core holdings for most investors’ portfolios.

If you have large holdings in UK equity income funds, I think you need to beware of concentration in too few dividend-paying stocks. In the financial crisis, most UK equity income funds held lots of bank stock and took a big hit. Today, some hold lots of utilities and I can see these becoming a political football in the first half of 2015.

While I believe in dividend strategies over the long term – many studies have shown that buying higher-yielding shares beats growth stocks over 15 or 20 years – I have reduced my own UK holdings of equity income funds and increased holdings of global equity income funds. I am not yet drawing income from these investments, so I am not that concerned about the short-term fluctuations in dividends caused by exchange rate movements. Until the summer, the strength of sterling meant that the dividends paid by these funds had at best been static over the previous year. However, the usual “swings and roundabouts” can be expected – and the latest recent period of strength for the dollar will translate into higher sterling dividends in due course.The historic yields are pretty good. Some other funds (like M & G Global Dividend) have much lower yields because they aim for “growth and income”. I prefer equity income funds to yield over 3.5% but make an exception for the Invesco Perpetual fund because of its good record to date.

Newton Global Higher Income should be your selection if you are of a pessimistic or cautious frame of mind. Its holdings are mainly mega-cap blue chips. Its recent performance has been dull but I would expect it to do much better than its peers in bear conditions. For optimists, I would suggest Artemis Global Income where the manager prefers mid-cap stocks and is moving towards Asia. The Invesco Perpetual Global Equity Income fund has a somewhat stronger value bias and is probably in between the other two.

dividend funds for the long term

Fund performance since August 2010

You may also want to consider widening your net with regional funds. I now own the JPMorgan Emerging Markets Income investment trust, which also comes in the form of an OEIC. The OEIC yields 4.4% and has 50% of its assets in Asia/Pacific. There is a huge universe of high-yielding stocks in Asian markets, and JPM data tell me that high-yielding EM stocks are at the biggest discount to growth stocks for a decade or more. I’m pretty confident I am buying cheap assets.

This valuation anomaly has pointed me to another income holding: Schroder Asian Income, yielding 3.8%. Manager Richard Sennitt has steadily outperformed the sector average over recent years.

My other dividend buy is on the other side of the planet: Standard Life Investments European Equity Income OEIC. Launched in 2009, it has produced good returns and the manager has adroitly shifted from defensive blue-chips to more cyclical stocks. The £2bn fund yields 4.1%. With the ECB committed to providing banks with oceans of cheap money, the market seems to me to be pretty strongly underwritten, provided that the recent upturn in company earnings is maintained. In the short term, political worries may dominate, but there are certainly plenty of cheap stocks in Europe.

Chris Gilchrist, December 2014

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