Long mooted, an increase in the National Insurance contribution for individuals and employers was approved by UK parliament, writes Mike Coop, chief investment officer Emea at Morningstar Investment Management Europe.
From 1 April 2022, workers will contribute an additional 1.25% on earnings. There is also an additional 1.25% tax on earnings from dividends, which will impact investors holding investments outside of a stocks and shares ISA, self-employed business owners who pay themselves dividends and transactions above the dividend tax allowance.
Although relatively small-seeming in isolation, the current action, combined with other changes in the past decade, means that taxes in England and Wales are now at their highest levels since the Second World War.
With six months to go until the new change comes into effect, advisers should be ready to have conversations about the impact of the tax rises, and ultimately what measures can be put in place to stem the impact of this forthcoming policy. The divided rise, in particular, is set to have several consequences in investing strategy and approach.
Seeking income from capital
One implication that has been under-discussed is the impact for investors seeking income from their capital.
The last two decades have seen income across several income sources decline, as bond yields, property yields and credit spreads have declined in Britain and throughout the developed world. This in turn has made investors more dependent on dividends to deliver needed income.
Dividend yields have already been under pressure due to the increased use of ‘share buybacks’ as a more tax efficient way of returning capital to investors.
As taxes on dividends rise – rates now top out at 39.25%, depending on income tax band – expect the shift towards buybacks and away from dividends to continue. This in turn will reduce ‘income’ available to investors as a percentage of their overall capital as fewer companies offer attractive dividends, and the tax taken on those dividends increase.
Capital withdrawal strategy
With less options available for dividend based strategies, it is increasingly likely that more advisers and investors will need to switch to a capital withdrawal strategy in retirement instead of relying on dividends for income.
In a capital withdrawal strategy, absolute return and portfolio risk are prioritised, over the relative return and risk approach that’s common in the market today. That means it becomes more important than ever to maximize the price at which shares are sold, as they represent the entirety, or nearly the entirety, of value derived from an investment.
A capital withdrawal strategy may need shifting investments and expanding into new asset classes and types of investments. It may also shift discussions around withdrawal rates, although advisers typically consider a ‘withdrawal rate’ to be inclusive of any dividend contributions.
Conversation with advisers
The upcoming changes can serve as a catalyst for conversations between advisers and clients, who may not realise how exposed they are to the shifting strategy. This also can be a good chance to re-evaluate the overall approach, including professional and personal changes that stemmed from the last two unusual years.
The need for this readjustment is particularly vital as there is no certainty that this will be the end of tax hikes. The government has spent heavily to try to counteract the worst impacts of the pandemic, and debt has been increasing at historic levels.
The treasury has given statements that it wants to shift to a more balanced approach, wherein fiscal discipline comes more to the fore. That very well may mean additional taxes, including those that impact investors.
Two strategies for dealing with the growing tax dilemma are:
- Broad-based sources of income, including infrastructure and Emerging Market debt; and
- Longer-term valuation driven investing, which results in more stable capital returns that lend themselves to “harvesting” extra income by drawing down capital.
This article was written for International Adviser by Mike Coop, chief investment officer Emea at Morningstar Investment Management Europe.
