Advisers should see the potential in securing a healthy Return on Planning for their clients in IHT mitigation.

The WAY Group Newsletter for Financial Advisers | August 2011

Save IHT and boost the "Return on Planning"

Mark Benson TEP, Technical Manager, WAY Investment Services Limited

A key objective for clients' long-term investments will be to grow their wealth at a greater rate than it is eroded by inflation. An important piece of advice towards achieving this end is to seek the superior long-term returns offered by equity investment, since over longer timescales bank or building society deposits will struggle to maintain their purchasing power. It is highly illuminating to compare the benefit that advice would have brought the UK investor in the two decades either side of the millennium (see chart below).

The problem for the investor is all too apparent: In the 1990s equities delivered fabulous inflation-busting returns. A client investing £10,000 on 1st January 1990 in the FTSE 100 would have almost £42,000 on 31st December 1999, well in excess of the £14,083 needed to beat inflation or the £17,923 in the building society. It could be argued that the extra £24,000 that the FTSE has delivered is the "Return on Planning" - that is to say a direct benefit of the advice to invest in equities.

Since the turn of the millennium equities have failed even to beat the building society. Our 1990 investor would have £58,750 after 20 years - still ahead of 20 year inflation thanks only to the 1990s returns. A millennium investor of £10,000 would have just over £14,000 on 31st December 2009 just barely ahead of the £13,000 needed to keep up with inflation. The bigger problem for the adviser is that whilst these gross returns beat inflation, after tax and charges are taken into account they probably will not. It might therefore be argued that the Return on Planning has been negative.

These disappointing returns have, rightly or wrongly, led to the current pressure to reduce charges and commissions, and with many commentators predicting a future of continued lower returns questions are being asked about the value of advice, and especially about the value of active management. The outcome can be seen in the growth of passive or semi-passive investment products that can offer equity investment with a lower Total Expense Ratio (TER) than on more traditional active managed funds. Add in the increasing use of wrap platforms, who also need their share of the available remuneration, and the squeeze on each link in the provider chain is acute.

The value proposition

The challenge for advisers and for product providers is to put forward a proposition based upon the holistic value of the planning, not just the investment product recommendation. One way that value can be clearly demonstrated is by ensuring that the client's investments are made within the most tax-efficient environment, and nowhere is there greater potential for such added value than in IHT mitigation.

Let's consider our investors once more. All things being equal the initial advice was equally valid in 1990 as in 2000, yet the year 2000 client may not accept this point of view. If the proposition is that the charges and commissions levied are simply for investment advice, they may argue that the outcome is worse than if they had left the money in the bank. However if they are paying for a comprehensive financial plan, which encompasses powerful tax mitigation, the fees will seem much better value.
Most clients will be aware of the benefits of ISA investment in saving tax. If our 1990 client was advised to invest via a PEP (using his £6,000 allowances from 1990 and then 1991) the gain of £48,750 as December 2009 would be exempt from Capital Gains Tax (CGT) saving him at least £6,950 on disposal. Although using his PEP allowances was clearly good advice, it might be argued that he could do equally as well these days by picking up the ISA FTSE Tracker application at the supermarket checkout?

Now, suppose that our client is in his late 60s in 2009 and has an estate large enough to attract an IHT liability. Whilst the PEP/ISA tax saving has been very valuable that wrapper does nothing to protect his assets from IHT. In fact his ISA's value of £58,750 could generate an IHT liability of £23,500 which is well over 3 times the CGT saving that has built up over 20 years. Our client is therefore at a time of life where making the investment within a reversionary interest trust, whereby the wealth is sheltered from IHT, may well be a much better strategy then continuing to use an ISA wrapper. Critically, this is not something that the client is likely to be aware of and is certainly not something that can be discovered at the supermarket checkout!

When looking at the value proposition we can see that the IHT saving is beneficial regardless of the performance of the underlying investments. If the investments grow the trust will keep that growth outside of the client's estate, but even if we endure another extended period of low returns the use of the trust will secure a healthy Return on Planning for the client. Furthermore the planning exercise may well encompass a wide range of associated elements such as the drafting of wills, creation of pilot trusts for pension death benefits, provision for long-term care and business succession.

Perhaps most importantly of all will be the simple matter of putting IHT planning on the agenda when the client is in their late 50s or early 60s at a time when they will not feel old. IHT planning is most effective when started early, not least because the most powerful tool to use and reuse is the 7 year inter-vivos cumulation period. The longer the client waits the less chance they have of surviving 7 years and the available options will be fewer and more compromised.

The good news is that as adviser remuneration becomes detached from the investment product sold there is an opportunity to demonstrate the true value of the advice by relating the fees to the overall benefit brought by the planning exercise. The Return on Planning from IHT mitigation can be quantified at the outset and the advice can therefore be shown to be good value in relation to the fees levied. In comparison the benefit of sound investment advice cannot be quantified with such certainty. As we have seen, that may bias the client to seek the cheapest solution. A good financial plan will have many elements, only one of which is investment selection, and advisers should be confident in demonstrating how they have secured a positive Return on Planning.

References:
Data & Statistics - WAY Fund Managers Limited

– Ends –

Associated links:

Download the PDF of this article: "Save IHT and boost the 'Return on Planning'..."

Download the PDF of an accompanying article in this series: "It's time to act on IHT..."

Download the PDF of an accompanying article in this series: "WAY? Oh yes,the IHT specialists..."

(Please Note: The above feature articles first appeared in Investment Adviser on 25th July 2011. Reproduced with kind permission.)

How to contact us

If you wish to discuss any matters arising from this article or, indeed, want to talk to us about any of WAY's products, then you are most welcome to call either Tony Lyons, IFA Support Manager, or Mark Benson TEP, Technical Manager , on head office telephone number: 01202 890895. Or, if you prefer, you can use the website: Contact Form to get in touch. We look forward to hearing from you.

The WAY Group Newsletter for Financial Advisers | August 2011

Please Note:
This document has been prepared for Financial Intermediary Clients and Professional Associates of WAY Investment Services Ltd and is not intended for and must not be distributed to Private Investors. This document does not constitute investment advice. Services referred to in this document may not be suitable for every investor and if in doubt independent financial advice should be sought. No representation or warranty is given (express or implied) as to the accuracy, completeness or correctness of the information nor the opinions, interpretations and conclusions contained in this document. No liability is accepted whatsoever for any loss howsoever arising from any information in this document subject to the rules of the Financial Services Authority or the Financial Services and Markets Act 2000. Past performance is not necessarily a guide to future returns and changes in rates of exchange between currencies may cause the value of investments to rise or fall. Share prices, values and income can go down as well as up and investors may get back less than their initial investment. WAY Investment Services Ltd is an Appointed Representative of WAY Fund Managers Ltd which is authorised and regulated by the Financial Services Authority.