Topping Up Class 3 NICs

State pensions are a crucial aspect of financial planning because they are secure sources of income guaranteed by the State and paid until death. State pensions are funded on a ‘pay-as-you-go’ basis which means that there is no underlying fund from which to provide retirement benefits and the National Insurance Contributions (NICs) of the current working population are used to pay the State Pensions of those who have reached State Pension Age (SPA).

Entitlement to the new State Pension is accumulated through Class 1 NICs (for employees) or Class 2 NICs (for the self-employed). Class 4 NICs (paid by the self-employed) do not contribute towards an entitlement to the new State Pension. Entitlement is based on ‘qualifying years’ and 35 years of NICs are required to gain the full State Pension.

If an individual has gaps in their contribution record they can pay Class 3 NICs. They are voluntary and can be paid by individuals with an inadequate NIC record, allowing them to increase their entitlement to the new State Pension. Generally, if an individual wishes to pay Class 3 NICs, they should ensure they are paid within six years of the end of the tax year in which the contribution shortfall occurred.

The Class 3 NIC rate for 2022/23 is £15.85 per week, so it would cost £824.20 to purchase a full year of State Pension entitlement. If you make payment in respect of a gap in contributions that occurred in the previous two tax years, then you will pay the rate that applied for the tax year in which the gap occurred. If the payment is in respect of a tax year more than two years previously, the rate will be the one applicable in the tax year of payment.

Warning! The current arrangement of being able to pay class 3 NICs to fill gaps in your NIC record going back to the 6^th of April 2006 ends on the 5th of April 2023, after which you can only fill gaps going back six tax years. It is crucial to ensure that gaps prior to the 6th of April 2017 are filled in because topping up your State Pension is a very worthwhile exercise – each additional year of State Pension purchased provides an extra pension of £5.29 per week (£275.08 a year). Looking at this from another perspective, it effectively represents an annuity rate of 33.37%(!), meaning the payback period on your initial capital is only 3 years. This represents excellent value for every taxpayer to obtain secure income for life guaranteed by the State.

If you would like further information on anything covered in this article, please get in touch via the contact page.

Understanding investment charges

When looking to make investments, as well as considering the potential returns of the proposed holdings you should also make sure that you fully understand the costs involved.

Naturally there are a variety of different charges that can be applicable in the financial planning space and with the industry ‘jargon’ it can be difficult to understand what you are actually paying. We have therefore covered some of the main costs that you could incur with an advised investment portfolio.

• Adviser Charges
• Commission
• Platform Charges
• Investment Charges
• Entry and exit fees

Adviser Charges:

From 2013, adviser fees must be discussed up front and agreed with the client using a pre-determined payment structure based on the service provided rather than the product recommended. Advisers can charge both initial and ongoing adviser fees. Initial charges may be on an hourly basis or a fixed fee for a piece of work which will depend on the complexity of the work and the time it will take. Ongoing adviser charges are either expressed as a fixed percentage charge based on the asset value, or they can be a pre-agreed annual fee – it is only possible for an adviser to levy an ongoing charge if an ongoing service is provided to the client. If ongoing adviser charges are expressed as a fixed percentage, e.g. 0.5% of the total investment value per annum, the fee will increase or decrease in line with the value of your portfolio.

Many financial advisers will offer an initial meeting free of charge, and this gives a good opportunity for both parties to work out if they feel it to be a good fit. You should normally have the choice whether to pay both initial and ongoing adviser charges directly from your investment portfolio or separately from your cash balances.

Commission:

It has not been possible for financial advisers to receive commission on new investment products purchased after 31st December 2012. Trail commission was an annual fee paid to financial advisers over the lifetime of the investment product, therefore it can still be in place on investments set up prior to this date. Commission was a percentage fee and was included in the annual management charge of the investment, so it was not always clear how much was being paid. Other considerations which led to it no longer being used were that it was also paid to financial advisers each year without requiring them to review the investment or provide further advice to the client, and it was thought that commission payments provided an incentive for advisers to recommend investments which paid the highest fees, rather than because it was the best solution for clients. It is still possible to receive commission on non-investment products such as mortgages, insurance or protection products (e.g life insurance, critical illness cover, income protection)

Platform Charge:

Most investments these days are held on a platform – think of a platform like a supermarket, allowing you to buy all your different brands and products under one roof, rather than having to visit multiple establishments. Using a platform simplifies the management of your investments but it does come with a cost. Platform fees are most commonly charged as a percentage of the assets you have invested on the platform. Charges are often tiered, reducing the total percentage charged as the size of the investment portfolio increases, and are usually taken from a cash balance held within the plans. Sometimes platforms will charge a fixed annual administration fee charges in addition to or instead of the percentage charge. They may also charge further for ad hoc activities such as transferring in or out of your portfolio, withdrawing monies or for buying and selling certain investments.

Fund Charges:

If you are investing in funds (e.g. Unit Trusts or OEICs) then you will incur a fee known as the ongoing charge figure (OCF) – this is made up of the annual management charge levied by the fund house as well as various additional costs such as administration, accounting and regulation (not including transaction costs). The OCF has to be published by the fund managers on the fund Key Information Document (KID). This charge is expressed as a percentage of the asset value and is taken from within the investment as a price adjustment, rather than coming from a cash balance. Due to economies of scale, many platforms can access institutional classes of investment funds which have a lower annual charge, or OCF.

Entry and Exit Fees:

In addition to an OCF you may also have to pay entry and exit charges when you buy or sell an investment fund. This is very similar to a ‘bid offer spread’ which is the difference between the price at which you buy an investment and the price at which you sell it.

Some financial advisers will also charge exit fees, particularly if you wish to sell a plan or transfer away within the first few years. They are often on a sliding scale, reducing over the period the investments are held for. Exit fees are currently being reviewed by the FCA as they believe that unreasonable exit fees discourage consumers from leaving products or services which are not right for them. Firms are bound by the FCA rules and principles to treat their customers fairly and for this reason Five Wealth will never charge an exit fee.

This article does not cover all possible charges but is intended to be a guide to the most common. You may come across charges which have not been covered here, especially on older style investment or pension plans.

Whilst you will always pay fees for holding investments, it is important to understand what you are paying and to factor in the costs when making decisions. If you are paying more than you need to, compounding charges can make a big difference to the value of your investments over the longer term. Five Wealth take the overall cost of plans we recommend into consideration for all our clients, and aim to provide a service that is good value over the long term.

If you would like further information on anything covered in this article, please get in touch via the contact page.

Cutting through the jargon

Have you ever come across phrases such as ‘deep value’, ‘generating alpha’ or ‘currency hedging’ in an article about investments and felt slightly bemused as to what they mean?

Part of our role at Five Wealth is to ensure clients are comfortable with the investment strategy put in place for them. This can involve translating fund manager terminology into something more understandable for those who may not have had a great deal of experience with investments.

Investor documents, fund manager updates and the more technical newspaper articles can be packed full of jargon which often puts clients off reading them. The intention of this article is to pick out a few of the more topical phrases and try to explain them in an understandable manner.

Currency Hedging

Put simply, if an investment fund is undertaking currency ‘hedging’, it’s typically trying to remove some of the risk that fluctuations in currency can have on investment performance.

Let’s look at an example of how currency fluctuations can affect investment performance.

The share price of the US listed company, Apple, is down just over 20% year to date at the time of writing. A US investor would have felt the full extent of those falls and if they bought Apple shares on 1^st January 2022 and were forced to sell them now, they would have lost c.20% of their money.

A UK investor who bought Apple shares at the same time (using £s) and was also forced to sell them now, would have lost just 2.6% of their money! This is because what the UK investor is effectively doing is converting £s into $s when they buy the shares, and then back to £s when they sell them. You can now buy more £s for each $ than you could at the start of the year and so in this example, the UK investor has benefitted from currency fluctuations. Currency movements can just as easily move against investors.

Currency markets can move quickly and many fund managers take the view that they are less predictable than the market for company shares. Some fund managers will take the approach of ‘Que sera, sera’ when it comes to currency movements, whilst others will ‘hedge’ their currency risk by using a “currency forward” agreement to purchase an offsetting currency in the future at a fixed exchange rate.

Gilt Yields

A gilt is a type of investment issued by the UK government. By purchasing a gilt, you are effectively lending money to the government in exchange for a regular interest (or ‘coupon’) payment. The name gilt comes from them being ‘gilt-edged’ and they are viewed as being extremely secure – the British government hasn’t defaulted on its debt since the Bank of England was founded in 1694!

You might have picked up in the news that gilts, used heavily by large institutional pension funds and ‘low risk’ strategies, have had a torrid year. Year to date, the FTSE gilt index^*1 is down by almost 30%!

If they are so secure – how have they lost such a large chunk of their value?

Let’s say you bought a 15-year gilt at the start of the year for £10,000, which pays you 1.75% interest annually over a 15-year period, at the end of which you get your initial £10,000 back. If you held it for the full term, you wouldn’t ‘lose’ any money (except by way of inflation but that’s a topic for another blog!)

However, interest rates have increased over the year and perhaps more importantly, long term interest rate expectations have also increased. So, if you wanted to sell your gilt to someone else now, who would be prepared to pay you the full £10,000 for your gilt generating a fixed interest of 1.75%, when you can currently open 1-year savings accounts that pays 3% interest? You would be hard pressed to find a buyer. To sell the gilt, you would have to reduce the price, which effectively increases the yield on the gilt.

Factor Investing

You will often find that investments are categorised into one or multiple types of strategies, sometimes referred to as ‘factor investing’. Our investment approach is to maintain a diverse, long-term view which means using funds that span across multiple styles.

Growth strategy – Typically means investing in companies where the objective is long term growth. The companies may not be paying dividends to shareholders, instead choosing to reinvest their profits into growing the business. Some growth companies may not even be profitable, but fund managers invest in them because of what they think they will be worth in the future.

An example would be Snap Inc, the company that owns Snapchat, whose share price rose by 28% through 2021, despite it being largely unprofitable during that time.

Value strategy – Involves investing in companies that the investment manager feels is undervalued. This might be because it’s been caught up in a wider market sell-off, or because that type of company/sector is out of favour. The nature of value investing means that what is considered ‘value’ changes over time. As well as spotting opportunities, a value investor would typically try and avoid areas of the market that they consider to be expensive, such as asset bubbles. A prime example would be the 1999/2000 dot-com bubble, where investors poured money into anything associated with the burgeoning internet economy before the bubble burst and a lot of money was lost. In theory, a value investor would have looked at some of the company fundamentals such as how much cash they held, debt levels, revenue streams etc and steered clear when company valuations became detached from their balance sheets.

Quality strategy – Both growth and value strategies can incorporate ‘quality’ into their investment philosophy, and it simply means that you seek out companies which have features that enable them to perform well in all market conditions. What makes a company good quality is subjective, but typical attributes include strong revenue streams (e.g. subscriptions models), barriers to entry for other firms (e.g. protected intellectual property rights), sustainable levels of borrowing etc.

Changes in the economic landscape such as those we have seen this year with inflation and interest rate rises can quickly shift investor sentiment so that one ‘factor’ performs better than others. Our strategy at Five Wealth is to create a balanced investment approach with exposure to different factors.

If you come across any terminology within investor correspondence that you aren’t familiar with, we will be more than happy to explain it in a way which you will understand so please do get in touch with your adviser.

Please remember that your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

*1 – FTSE Actuaries UK Conventional Gilts All Stocks