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Investment income planning using new CGT rates and structured products

Capital Gains Tax reductions announced in the Budget 2016 have made it far more attractive to use growth-generating structured products to fund regular income from capital, says Ian Lowes, founder of

When George Osborne announced he was reducing the rates for Capital Gains Tax (CGT) for basic and higher rate taxpayers, I would hazard a bet he wasn’t thinking that one of the unintended consequence would be to make structured products more attractive for people seeking retirement income – but that is exactly what he has done.

In the 2016 Budget Osborne announced that the higher rate of Capital Gains Tax would be cut from 28% to 20% and the basic rate from 18% to 10%, for relevant gains accruing on or after 6 April 2016. The CGT exemption amount remains at £11,100 for the 2016/2017 tax year.

This creates a potential tax advantage for clients with capital growth investments wanting income, and who have already made full use of their annual tax allowances and exemptions.

For retirees in that situation, who have growth investments outside a tax wrapper, using them as a form of income has now become much more attractive. Rather than pay 20% (or more) income tax on any income received outside of an ISA, by building up portfolios that can provide regularly spaced capital gains to be drawn as income, tax can be reduced on those payments to 10% (20% for higher rate taxpayers) or nothing if within the annual capital gains tax allowance.

Where structured products fit in

One of the advantages of structured products is that within a properly constructed financial plan they can be used to help provide those regularly spaced returns.

Structured products in effect are contracts between an investor and a counterparty to pay a stated amount on a specific date in the future, based on certain criteria being met – usually the underlying measurement, such as an index, being above a set level at the time the product matures.

Hence, for a structured product providing growth, the investor will know how much they will receive under what circumstances.

Within financial planning for retirement income, knowledge of potential outcomes is a major boon as it can allow the financial planner and paraplanner to construct a portfolio using structured products, which has the potential to create a regular ‘income’ stream that will benefit from the CGT exemption rate and sub higher and basic income tax rates.

It can make for quite accurate income and tax planning – accepting that there are no market set backs and the growth is achieved as planned.

And because there are always structured products in the market – with some providers offering rolling tranches of popular products – it is possible to take the growth as income and put the capital back into the next tranche of the product, hence creating the potential for a continual stream of income for the client.

Data on structured product maturities over 5 years (1/11/2011-31/12/2015) which compiled, show that for FTSE 100-linked products, the average total return across the different product types (and average term in years) was as follows:

Capital-at-risk                       28.39% (3.12 years)

Capital ‘Protected’                21.73% (5.06 years)

Deposit based                       19.51% (4.8 years)

Hopefully, this shows the opportunities provided by using structured products in a client’s portfolio, alongside the use of bonds, equity income and other income generating investments.

Of course, as with any investment there are risks attached – the underlying index might not perform as expected and so returning only capital not the required growth; and for capital-at-risk products, there could be capital losses involved. Although unlikely, there is also the risk that the counterparty could go bust and as such be unable to fulfil its contractual obligations. (See the product examples below.)

Hence, we would always recommend that structured products be used as part of a well diversified and balanced portfolio of investments, where they can successfully complement the potential returns and risks of more traditional investment vehicles.

Examples of current products

There are two types of structured products offering growth – straightforward growth products that offer a gross percentage return at product maturity, and auto-calls, which offer a set annual return over a number of years, where the product can mature at any time from a particular year onwards – typically years 2 or 3.

An example of the former currently available is the Investec FTSE 100 Defensive Growth Plan 2. This offers a potential gain of 36% after six years where the FTSE 100 index is above 50% of its closing level on 25th April 2016. The risks are counterparty risk and that at maturity the index is below 50% of this level, in which case a loss in line with the fall in the index will result.

Auto-calls are the most prolific of structured products available at the moment. These offer a set percentage return per annum with the potential to mature on specific anniversaries. So, for example, The Mariana Capital 10:10 Plan April 2016 (Option 2) (Collateralised) auto call product* offers 30% return at year three (10% per annum) if the FTSE 100 is at or above the initial index level. If the index is below that level, the investment continues to run with the potential to mature every year, adding 10% a year to the total return, until the end of the product’s 10-year 2 week maximum term.

The risks are that the index is never above the initial level on any of the anniversaries from years 3 to 10, in which case capital is returned in full at year 10. This is as long as the index is not more than 30% below the initial level at the end of the 10 year investment term, otherwise capital will be lost in line with the fall in the index over the term. Counterparty risk is reduced through a collateralisation mechanism that transfers the credit risk to four major financial institutions.

Of course, there is the risk that the stock market does not perform appropriately to the extent that an auto-call does not mature when needed and a growth product does not produce positive returns. Therefore, whilst using growth orientated products may be favourable from a tax perspective, such solutions should be used alongside natural income bearing investments which provide the minimum level of income required.

* This is a product offered by Mariana Capital and conceived in conjunction with Lowes Financial Management, which has a commercial interest in the Plan.

Article first published in Professional Paraplanner 

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