Lower Forever?

When the bank of England cut base rate to 0.5% in March 2009, nobody was expecting that nearly seven and a half years later the Bank’s next move would be a further cut to 0.25%, but that is what happened in early August. At the same time the Old Lady announced several other monetary measures designed to keep down interest rates and encourage borrowing.

The impact

The aim of the Bank’s actions was to stimulate borrowing and help UK plc survive the downturn widely predicted as a consequence of the Brexit vote. Whether a quarter per cent reduction in interest makes that much difference to businesses’ investment decisions is a moot point: there was an element of being seen to do something as the government had made clear it would not act before the Autumn Statement in November/December.

The Bank’s moves had a number of effects. Predictably, the main banks and building societies began announcing cuts or reviews of their interest rates for both depositors and borrowers. This is becoming ever trickier, as base rate nears zero. One bank went as far as to tell some of its larger business customers that they would be charged for making deposits. At present this negative interest rate treatment is unlikely to hit personal savers, although once inflation is taken into account (the July RPI was 1.9%), in real terms if you leave money on deposit you are already seeing the value of your capital fall.

The Bank’s pledge to buy £60bn of government bonds over a period of six months (and 10bn of investment grade corporate bonds) drove down yields on fixed interest securities to record lows. As of late August, the prospective annual return on a ten-year government bond had fallen to just over 0.6%. This has prompted suggestions that far from offering risk-free returns, government bonds are now offering return-free risks. With yields so low, a small drop in the 10 year bond price can wipe out several years’ income at a stroke.

One corollary to falling long-term rates is still lower annuity rates. The best age 65 fixed annuity rate is currently about 4.6%, making last year’s very low rates look (with hindsight) a steal. That is a reminder of the danger in waiting for things to improve – they may get worse.

What can you do?

There are no simple answers, as what you do will depend upon your personal circumstances. If you are a mortgage borrower you may see no difference as over half of all mortgages are now fixed rate and so immune from base rate changes until the end of the fix period.

If you have money on deposit then, even with the benefit of the personal savings allowance introduced in April, inflation is probably beating your return. Once you have set aside enough cash to provide a rainy day reserve, you need to have a good reason to hold any more on deposit. If your requirement is income, then deposit-based investments are unattractive unless you require total security of capital (subject to the usual deposit protection scheme limits). The average yield on shares in the UK stock market is now around 3.5%, which puts even five year fixed rate deposits into the shade.

In terms of annuities, the starting point is to review whether annuity purchase is appropriate, given that the guaranteed income on offer now has a very high price tag. If you decide it is then make sure you get expert advice on the choice of annuity for your circumstances. There are many factors that determine annuity rates these days and they cannot be captured in brief weekend press league tables.

Action

Interest rates look set to stay even lower for even longer, despite inflation being likely to rise due to the weak pound. Whether you are looking for income from your capital or your pension plan, it is more important than ever to obtain advice on all your options. “Just leave the money on deposit for now” is unlikely to make financial sense.

ISAS: TOO MUCH CASH?

HMRC statistics never emerge that quickly, but at least when they do finally appear they should capture everything, which many more rapidly produced numbers do not. A good example is the April 2016 data for ISAs, which were published just as the country started its August Bank Holiday weekend.

Cash is King

HMRC’s number crunchers said that in the last tax year (2015/16) £58,785m was subscribed to the cash component of Adult ISAs, against £21,436m to the ISA stocks and shares component. For Junior ISAs, there was a similar story: £522m in cash and £399m in stocks and shares. In both cases the ratio of cash to stocks and shares fell, but in what was then the seventh year of a 0.5% base rate, that was to be expected. According to recent research covering 32 cash ISA providers undertaken for the Financial Conduct Authority, in April 2016 instant access ISA rates ranged from 1.5% to 0.05%, with accounts closed to new business and/or giving branch access generally paying lower rates than their open/internet access counterparts.

The balance of total investment in ISAs was much more even, reflecting the fact that historically less could be subscribed to the cash than stocks and shares via ISAs or their PEP/TESSA predecessors.

Enter the Personal Savings Allowance

In the March 2015 Budget George Osborne announced the personal savings allowance (PSA) which came into operation on 6 April 2016. At current interest rates, the PSA renders the cash ISA obsolete for most depositors:

• If you are a basic rate taxpayer, the PSA allows you to earn up to £1,000 of interest each tax year with no tax liability;
• If you are a higher rate taxpayer the PSA is £500, but that would still allow you to deposit £200,000 tax-free with interest at the current base rate.
• If you are an additional rate taxpayer, then your PSA is nil.

As a result of the PSA, deposit interest is now paid gross, ie no tax is deducted, mirroring the ISA treatment. The Chancellor recognised the impact of these changes on ISAs with a revision to the rules which now allow cash ISA funds to be temporarily withdrawn and then replaced within the same tax year, outside of the normal subscription limits.

Interestingly, this feature can also be used for stocks and shares ISAs, provided transfers between the two ISA components are made on encashment and subsequent reinvestment.

Action

The August cut in base rate is rippling through ISA cash rates. The reductions have not been instantaneous, so today’s rate might be due to fall next month, making current league tables of dubious value. If you have money invested in a cash ISA, you need to do review the rates payable.

Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FCA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at September 2016 and the contents of the Finance Bill 2016. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.