Contractors looking for good mortgage deals or for alternative investments to buy-to-let properties should take action now, or face bottlenecks in early 2016 as the tax yearend approaches.
“Lenders with fresh annual lending targets want to incentivise borrowing during February after the traditionally slow holiday period,” explains CMME's Taj Kang. “That means there are great deals available for contractors that are time limited.”
Contractor Wealth’s Angela James urges contractors to review their finances and take full advantage of tax allowances before yearend: “With the dividend tax changes taking effect from April 2016, contractors should be considering other tax efficient methods of taking cash out of their business. Pensions remains one of the best options.”
Both advisers agree that the lead times for mortgages, pensions and investments are such that contractors seeking good mortgage deals and to finalise investments before the end of the tax year must act quickly.
Mortgage deals come but once a year
According to Kang, like many businesses, lenders are slaves to their annual targets. This works well for contractors, as he explains: “What drives the mortgages market is the sequence of events. Lenders tend to work to the calendar year for lending targets.
“When January comes, activity is low and lenders are looking at this big target with not much money going out the door. As a result, they entice contractors to borrow by cutting rates, particularly for remortgages.”
This means there are particularly good deals to be had during January and this has been the pattern for at least the last three years. “The lower rates usually last until late February when the housing market properly wakes up,” adds Kang.
Contractors seeking a mortgage or remortgages should engage with a broker now because of the lenders’ lead times: “In my experience, December and January tend to be busy months for remortgages and we typically enjoy a 20% increase in enquiries.”
Buy-to-let mortgages are becoming increasingly unviable
Less positive is the state of the buy-to-let mortgages market since Chancellor George Osborne announced the phased withdrawal of mortgage tax relief on buy-to-let properties in the Summer Budget 2015 and the hike in stamp duty.
“There is likely to be a significant drop in buy-to-let activity during 2016. Professional investors putting down large deposits can still make the buy-to-let model work.
“However, contractors with a highly leveraged buy-to-let portfolio, with a high debt to value ratio, will find that as the mortgage interest tax relief is withdrawn over the coming years, they will have to start actually subsidising their property with contracting income due to rising tax bills.”
Kang believes the Government’s actions will drive contractors towards investments and pensions as the costs of owning investment property escalates.
Pensions could become the new buy-to-let option for contractors
James agrees, and is already seeing early impact of the measures as contractors are asking her for alternatives for property investments: “As a higher rate taxpayer, buy-to-let is no longer so attractive due to the higher tax and stamp duty.
“The most significant tax planning opportunity is still pensions, and they will be even more so from April 2016 following the dividend tax changes.”
Take pension action quickly before allowances change
Although there have been no formal announcements, James believes that the annual and lifetime allowances for tax-free pension contributions will change: “’Enjoy the allowances while they are there’ is the message I would get out there.
“The lifetime allowance is likely to reduce to £1m, and people think that’s a lot of money but it will only buy you a £50,000 a year income.
“Again, you might think that £50,000 a year is a good income, but most contractors are earning well over that sum each year. My experience is that most people spend more when they retire, not less.”
Based on the Government’s track record, higher and top rate earners are the ones most likely to see a reduction in allowances, so the pressure is on: “We have another Budget in March 2016.
“The Chancellor made no changes to allowances in the Summer Budget 2015 or in the Autumn Statement. So, we could see announcements to cut allowances for higher earners sooner than we think.”
Alternatives to pensions and property
For many younger contractors, pension freedom at age 55 and retirement is a very long way off, so they could be looking for investments that are more accessible. According to James, the next most tax efficient investment after a pension is an ISA.
“Contractors can invest in an ISA and access their cash whenever they want. But you have to save more into an ISA to get the same result as a pension because there is no relief on contributions, like there is with pensions.”
James notes that alternative investments, such as antiques, art and cars, are unregulated and do not benefit from tax relief, so they are relatively costlier and riskier when compared with pensions and ISAs.
Consider diversifying and collective funds
Another alternative to property and pensions, and also an effective diversification strategy to spread risk, are collective funds: “Collective funds are essentially when investors pool their money with other investors through a mutual fund that means they can access investments they would not be able to as individuals.
“The collective funds can invest in all types of investments, including equities, bonds, commodities, exchange traded funds and retail and commercial property. The perception is that collective funds are expensive as you have to pay for a fund manager, but this is not always the case.
There is now so much choice that there is something for everyone, depending on their investment strategy, required returns and appetite for risk. Furthermore, when invested via a financial adviser, contractors can access funds that are not on the general market and benefit from lower administration fees, as these are all negotiated by their adviser.
A ‘little and often investment’ strategy
Market conditions are volatile at the moment, so contractors considering collective investments, or any other that is traded on a financial market, would benefit from a ‘little and often’ investment strategy. In fact, when a market is going down that can be the best time to invest.
James explains: “A contractor buying on a monthly basis can benefit from pound cost averaging. The way this works is, take contractor investor A who invests £10,000 in January for a period of five years. Then contractor investor B invests £160 per month for five years.
“All other things being equal, investor B enjoys the larger portfolio. That’s because investor B would have bought more ‘units’ of the investment when the markets were down, whereas investor A bought all their units on the first day of the investment.”
Take action now, before it is too late
As Kang highlights with mortgages, James also highlights that contractors seeking pensions and investments are up against the clock: “The first quarter of any calendar year is always busy as the end of the tax year approaches. This effect will be multiplied in the first quarter of 2016 as the dividend tax changes approach.
“Contractors with cash to invest, or who are unsure of their position, should make speaking to an adviser a priority. Once the end of the tax year passes on 5 April, a contractor who took no action has potentially lost a whole year of allowances.”