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July 2019

Collective Investments

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Pooling money in one or more types of asset class

Collective investment schemes – also known as ‘pooled investment funds’ – are a way of combining sums of money from many people into a large fund spread across many investments and managed by a professional fund manager. There are a diverse range of funds that invest in different things, with different strategies – high income, capital growth, income and growth, and so on.

Different types of collective investment schemes

Unit Trusts and Open-Ended Investment Companies

Unit trusts and Open-Ended Investment Companies (OEICs) are professionally managed collective investment funds. Managers pool money from many investors and buy shares, bonds, property or cash assets, and other investments.

Underlying assets

You buy shares (in an OEIC) or units (in a unit trust). The fund manager combines your money together with money from other investors and uses it to invest in the fund’s underlying assets. Every fund invests in a different mix of investments. Some only buy shares in British companies, while others invest in bonds or in shares of foreign companies, or other types of investments.

Buy or sell

You own a share of the overall unit trust or OEIC – if the value of the underlying assets in the fund rises, the value of your units or shares will rise. Similarly, if the value of the underlying assets of the fund falls, the value of your units or shares falls. The overall fund size will grow and shrink as investors buy or sell. Some funds give you the choice between ‘income units’ or ‘income shares’ that make regular payouts of any dividends or interest the fund earns, or ‘accumulation units’ or ‘accumulation shares’ which are automatically reinvested in the fund.

Higher returns

The value of your investments can go down as well as up, and you might get back less than you invested. Some assets are riskier than others, but higher risk also gives you the potential to earn higher returns. Before investing, make sure you understand what kind of assets the fund invests in and whether that’s a good fit for your investment goals, financial situation and attitude to risk.

Spreading risk

Unit trusts and OEICs help you to spread your risk across lots of investments without having to spend a lot of money. Most unit trusts and OEICs allow you to sell your shares or units at any time – although some funds will only deal on a monthly, quarterly or twice-yearly basis. This might be the case if they invest in assets such as property, which can take a longer time to sell.

Investment length

Bear in mind that the length of time you should invest for depends on your financial goals and what your fund invests in. If it invests in shares, bonds or property, you should plan to invest for five years or more. Money market funds can be suitable for shorter time frames. If you own shares, you might get income in the form of dividends. Dividends are a portion of the profits made by the company that issued the shares you’ve invested in.

Taxed dividends

If you have an investment fund that is invested in shares, then you might get distributions that are taxed in the same way as dividends. The tax-free Dividend Allowance is currently £2,000 a year (2018/19).

Dividends above this level are currently taxed at:

  • 5% (for basic rate taxpayers)
  • 5% (for higher rate taxpayers)
  • 1% (for additional rate taxpayers)

Any dividends received within a pension or Individual Savings Account (ISA) will remain effectively tax-efficient. Basic-rate payers who receive dividends of more than £2,000 need to complete a self-assessment return.

Lifetime Allowance

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Breach may impact on more than a million workers

An estimated 1.25 million people are set to breach the current lifetime allowance (LTA) limit of £1.055 million for pension tax relief over the course of their working life, according to new research published.

The LTA is a limit on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – and can be paid without triggering an extra tax charge. It has been cut three times since 2010, and this research estimates that around 290,000 workers already have pension rights above the limit, and well over a million more people are at risk of breaching it by the time they retire.

Facing a tax charge of up to 55% on pension savings

Those who exceed the LTA could face a tax charge of up to 55% of their pension savings above this level at the time of testing. Around 290,000 non retired people have already built up pension rights in excess of the LTA. Fewer than half of these are thought to have applied for ‘protection’ against past reductions in the LTA and so could face significant tax bills when they draw their pension. Worryingly, many may be unaware of this. Almost half of these people who are already over the LTA are continuing to add to their pension wealth, thereby storing up an even bigger tax charge with every passing year. And amongst non-retired people who are not currently over the LTA, an estimated 1.25 million can expect to breach the LTA by the time they retire.

Groups likely to breach the lifetime allowance

The two main groups likely to breach the LTA are relatively senior public sector workers with long service, whose Defined Benefit pension rights will exceed the LTA, especially as they now have to work to 65 or beyond rather than 60 as in the past, and relatively well-paid workers in a Defined Contribution pension arrangement where their employer makes a generous contribution into their pension pot.

Highest earners may be less affected by the lifetime cap

Typical salary levels of those affected are in the range £60,000–£90,000 per year. But ironically, the very highest earners may be less affected by the Lifetime Cap because they are now heavily limited by the amount they can put into a pension each year. The data suggests that only a couple of thousand people exceeded the LTA in the latest year for which figures are available (2016/17). The number likely to face a tax charge could therefore increase more than a hundredfold, purely based on those who have yet to retire but who have already exceeded the LTA.

Workers who would not regard themselves as ‘rich’

The research finds that one of the reasons why so many people will exceed the LTA is that current policy is simply to increase it each year in line with price inflation (as measured by the CPI). By contrast, wages will tend to grow faster than inflation, and the money invested in pension pots should grow faster than inflation over the long term. This means that the LTA will ‘bite’ progressively more severely over time and will affect hundreds of thousands of workers who would not regard themselves as ‘rich.’ t

Source data: [1] Research conducted for Royal London is based on detailed analysis of data on more than 7,700 workers from Wave 1 and Wave 5 of the ‘Wealth and Assets Survey’ March 2019.