Note: This is a rant this week. Feel free to skip down to the money and investing links if it’s not your bag. I will delete abusive comments.

–––

“I thought then, for the first time, about the arrival of General Winter. If he had been here ten days ago, he would not have been much help to the Args, dug in on the heights with no chance of their High Command getting their air forces into the skies. But I think he would’ve finished us.”
– Sandy Woodward, Admiral in the Falklands War

And so nationwide riots on the utterly predictable absence of Brexit on 31 October turned out to be another fantasy dreamed up by the nation’s Barry Blimps.

For which we should be grateful. But not surprised.

I think it’s becoming clear that many of those who voted Leave in 2016 don’t actually care much for Brexit. The polls show the country still fairly evenly split, true, but it defies credibility to imagine a million Leave supporters marching through London.

The EU was the sworn enemy of a minority of politicians, businessmen, and trade union leaders. For most of the rest of its British detractors it was a fantasy bogeyman – used by the tabloids to scare the credulous, but evaporating when exposed to the light.

With the exception of migration (which for the trillionth time we could have at least tightened using existing EU rules, without Brexit) few Leavers can point to any concrete downside caused by our membership.

It’s all about theoretical losses of sovereignty, or fears of a future super state.

You say tomato, I say turnip

How do we reconcile this practical disinterest with the anger that’s split the nation?

It’s clearly because even though many Leave voters don’t really care much about the EU, they understandably do care that their vote is apparently being denied.

Not enough to riot, thankfully, but enough to make their grown-up kids dread Christmas.

To help them get this angry, they’ve been aided and abetted by three years of pie-in-the-sky promises from Government, which gilt-edged the stretched version of reality peddled by the Leave campaign – and by a bucket load of dangerous posturing about ‘the enemies of the people’.

True, if you’ve spent more than five minutes following the saga you’ll know the real reason we’ve not Brexit-ed is because MPs have been trying to square Leave’s Pandora’s box of bogus promises with the realities of globalization, the Union, and the economy.

You’ll also know that as a result, both Remainer and Brexiteer MPs alike have voted down the various Withdrawal Bills.

But never the mind facts, eh? This is Brexit we’re talking about.

As for Remainers, we’re not just angry because we’re leaving this flawed but ultimately positive project.

We’re angry because Brexiteers’ means don’t justify the end – and because even now, nobody has been able to articulate why the end is worth it, anyway.

We’ve all taken our sides, and we’re more dug in and furious than before the Referendum ever happened.

Populism goes mass-market

I have a golden rule in life and as an investor: never presume things can’t get worse.

It’s very possible this General Election will double down on the division. You may be relieved to learn then that I don’t intend to follow the next six weeks of futility here on Monevator.1

I do get a few nice comments and emails saying our Brexit debate is better than elsewhere. A few Leavers have even generously said I’m more balanced than most of the opposition, which perhaps shows how bad things are.

But even if this was the right venue for relentless politics, my heart is not in it. Because this election seems doomed to achieve nothing except to make the environment more bitter.

Having alienated most of its thoughtful or at least moderate minds – some of whom resigned as MPs this week – the Conservative party under its professional blusterer-in-chief will stomp further to the right. A more right-wing Tory party will be a feature, not a bug.

Labour meanwhile is headed by one of the few people in Parliament who could make Boris Johnson look like a preferable Prime Minister.

Lastly, edging out towards the fringes as the main parties abandon the center, the Lib Dems, the SNP, and the Brexit fan club party are taking more extreme positions.

We saw the Rebel Alliance defeat a no-deal Brexit. Now we have the political equivalent of a Tatooine cantina vying for our votes – would-be MPs whose positions on Brexit are ever more alienating to the other side.

Division! Clear the lobbies!

While I think Johnson will probably get a small majority – leaving aside for now the Farage factor – I doubt he’ll get an obedient army of Brexit ultras under his command.

But even if he does, this season’s upcoming plot twist is premised on the idea that ‘sorting out Brexit’ will be the end of this farce.

In reality, the trade negotiations with the EU – technically termed ‘the hard part’ – will begin the day we leave. And even if we eventually bork out with a no-deal, once the lorry motorway car parks have been set-up and the Swiss have flown in emergency medical supplies we’ll soon be back to Brussels to start negotiating again anyway. Getting a deal with the EU is, well, non-negotiable.

Contrary to the Referendum marketing, our trade with Europe is of supreme importance. Some see BRINO2 as the endgame, given the desire of most MPs to avoid an economic hit.

Indeed as the years tick by, Brexit could seem an ever more Quixotic project with no upside and dwindling supporters as the older Leavers die and the younger ones start deleting their embarrassing pre-2020 social media accounts.

We might even end up back in the EU in a decade, only with all our special arrangements gone.

Remember, there is no upside to Brexit except maximizing technical sovereignty, which nobody will notice anyway, and, if you it appeals to you, potentially curbing migration, which the Government will probably try to offset with work visas and more ex-EU migration, for economic reasons.

Moderates won’t find emptied council houses for their kids. And racists won’t be relieved.

Meanwhile any sleight of hand Johnson and Javid do try to gee us up with by ending austerity could have done without Brexit – and with £100bn extra in the economy if growth hadn’t been flattened by years of Brexit buffoonery.

Lies, dammed lies, and Leaving

Much is said about how the millions of disenfranchised who voted Leave will feel betrayed if we don’t Brexit.

But what about if we Brexit and it achieves diddly-squat for them?

The harsh reality is most of these people were lost to politics before they were weaponized by Dominic Cummings’ data-targeting. You think the past three years has won them back?

They came in pissed off and that’s how they’ll stay, whatever happens from here.

Leave-supporters can bluster all the want, but Remainers have been right about nearly everything so far – except that immediate post-vote recession. We’ve had a slowdown, sure, but no recession.

But otherwise?

Leaving the EU turns out to be very hard, not very easy.

Far from superior trade deals on day one, we’re 1,226 days on from the EU Referendum and only about 8% of UK trade has even been ‘rolled over’ under existing EU trade terms.

There isn’t a grand emerging consensus that Brexit is an opportunity. There’s at best a grudging concession that we have to go through with it, a bit like a colonoscopy.

And the EU hasn’t fractured and bickered – it’s more united than ever.

We haven’t taken a new position on the global stage, except perhaps as the clown act.

The special Brexit Day fifty pence coins are being melted down but the ‘Get Ready For Brexit’ posters are still up, reminding us of £100m that we taxpayers will never see again – and that is only the thinnest end of the national waste of money, time, and effort.

Déjà vu (that’s French for Brexit)

Then again, we haven’t left yet, right?

That’s a fair retort, in that it’s at least true.

For those who don’t read the comments, this is what happens after every Brexit article here so far.

A fairly polite conversation takes place, in which initial claims of political infringement by the EU or an economic advantage from Brexit are efficiently taken apart. A stat will be thrown out stating that most Leave voters were motivated by sovereignty concerns, so why are we discussing the economy? Yet nobody will give good answers when probed about the actual impact of this perceived lack of sovereignty, or why Britain is especially affected. Eventually, Brexit supporters will say we don’t understand, it’s about migration, or ‘culture’ or ‘Englishness’. (It used to be I’d also get a few emails about Muslims, but at least that seems to have died down.)

Equally, I’m sure this rant feels like Groundhog Day to Leavers, too.

Perhaps it’s the one that will make you unsubscribe? A few always email me to say they’ve had enough, they’re off.

I don’t blame them – but I feel I can’t ignore the White Elephant in the room.

Around and around we go.

None of the above

Remember 2012, and the Olympics, and Britain on top of the world?

Remember 2015, and fancy skyscrapers popping up across London? Remember start-ups founded by clever migrants who came to the UK for our global outlook? Remember how we got through the financial crisis without huge job losses and remember talk of building a Northern Powerhouse before every plan was washed away by Brexit? Remember the Polish builder who fixed your boiler? Remember when you couldn’t get a coffee south of Watford without a sneer and then for ten years it was all smiles from young Spaniards and Greeks? Remember how you could daydream about living in Rome or Barcelona or Berlin because it was your right, not a gamble? Remember when the UK was the fastest-growing economy in the G7? Remember when Cameron was a nice-ish Conservative leader, modernizing the UK’s natural party of government?

Remember when we increasingly believed we were more alike than different?

And Leavers ask us to worry about the betrayal of voters who came out once to protest.

Many of us already feel betrayed.

See you on the other side.

[continue reading…]

1. I mean with these intros. I’ll still include some political links in their Brexit quarantine box. [↩]
2. Brexit In Name Only. [↩]

This post is one of a series looking at returns in the decade after the financial crisis.

The ‘inevitable’ bond crash has been a recurring theme of the last ten years. Hysterical commentators periodically warn of Bondmageddon. Many investors were scared out of high quality bonds altogether – because interest rates had to rise.

Even Monevator wrote about the risks several times…

• In 2008
• In 2012
• In 2013
• In 2015

…but not nearly as often as some of you commenting on this website told us we were irresponsible for still recommending diversified portfolios that including ‘sure losers’ like bonds…

After all, the expected returns for bonds hovered around zero a decade ago, whereas the average historical real return has been about 1.5%.

What did that tell you?

Absolutely nothing as it turned out. As usual, Trustnet provides the chart that tells our story:1

N.B. Vanguard’s UK Investment Grade Bond tracker contains about 70% corporate bonds.

The annualised returns for the last 10 years proved to be:

• Index-linked Gilts2: 8.2% (5.3% real) – purple line B
• Investment grade bonds: 6.5% (3.5% real) – magenta line D
• Intermediate Gilts: 5.6% (2.6% real) – lime line C

Trustnet doesn’t have 10-year data yet for a pure corporate bonds tracker, a long gilts tracker, or a hedged global bonds tracker. However Vanguard’s long gilts fund is outperforming its intermediate equivalent by 9.6% vs 5.9% over five years.

So while bonds have underperformed a World equity fund’s 12.1% return over the period – just as you’d expect – they’ve exceeded their historical average tally, whilst performing their allotted role as a portfolio stabiliser and diversifier.

Anyone who dumped bonds for equities didn’t lose out, sure. But they did take on a ton of risk that wasn’t guaranteed to pay off like it has.

Things could have gone differently, and historically it often has. Luck trumps judgement until it doesn’t.

The beauty of simplicity

Indeed the last ten years have been an adventure in humility. For all my tilts towards factors and emerging markets, I’d have been better off sticking with a single total world portfolio as recommended by Lars Kroijer.

Only a foolhardy UK investor would have banked everything on the US market with its rich valuations, but its returns over the decade are surely why there are so many perky American FIRE bloggers around. There may be fewer following in their footsteps if the market mean reverts.

I was close to going into commodities but ultimately heeded the warnings – especially from Bernstein and Ferri – that the case was built on a recent period of outperformance, and that the available investment vehicles were questionable.

“Don’t invest in what you don’t fully understand” saved the day there.

The results for sector investing and megatrends proved to be a total crapshoot and I’m glad I stayed out of it. Stories are catnip for humans. If you see a product that looks like it sprang from a marketing department or a media agency (AI, robotics, big data, cannabis and blockchain ETFs all come to mind) then watch out.

The last decade of bond returns are the most instructive of all. Nothing seemed so certain as losses for that asset class and yet it just hasn’t happened.

That doesn’t mean I’m rushing into long bonds but I am upping my exposure to gilts in line with my changing risk profile.

Yes, they’re expensive but no other asset class can do the same job.

Take it steady,

The Accumulator

This is the last of our 10-year retrospectives, but you can still read the others to see how other passive-friendly strategies fared over the decade. Let’s meet here again in 2029!

1. Trustnet provides annualised and cumulative return data for periods of up to 10 years. The results below are quoted in nominal £ returns, with dividends reinvested from 14th September 2009 to 13th September 2019. [↩]
2. Gilts are another name for UK Government bonds. [↩]

Ever heard the slogan: Tax doesn’t have to be taxing? I’m guessing whoever came up with it never had to deal with the annual allowance for pensions savings.

Oh, and don’t get me started (yet…) on its ghastlier sister, the tapered annual allowance.

These finickity pension rules are enough to make even hardened tax accountants sigh into their calculators.

But let’s be brave and together try to get through this guide to the annual allowance.

What is the annual allowance and why does it exist?

The annual allowance for pensions savings for 2019/20 is £40,000. This means that if your total contributions into your pensions during the current financial year are greater than £40,000 then you must pay a tax charge.

This tax charge is an individual’s top marginal income tax rate (for example 40% for a higher-rate tax payer) on the amount that’s contributed to a pension that’s above the annual allowance.

When you put money into a pension, the Government provides you with tax relief. The underlying principle behind this pension tax relief system is that you defer taxes. You get back the tax you paid today in your pension, but you will later pay tax when you take the money out as income.1

With the annual allowance, the Government is basically capping the amount of tax relief it will give you in a year. In effect, it is saying: “You’ve got enough from us this year, you’re on your own now”.

This may strike you as quite reasonable in principle. Why should the Government subsidize the pension savings of the ‘metropolitan elite’?

And in general I agree. But there are some issues.

Firstly, people don’t earn a consistent salary over their career. They are likely to earn more in later years – and at that point they’ll want to contribute much more to their pensions.

Secondly, lots of government tinkering has resulted in some unintended consequences. These unintended consequences appear to undermine the spirit of what the introduction of the annual allowance was meant to achieve. More on that later.

Tax relief

Let’s quickly touch on the tax relief rules and how they work.

Currently, tax relief on gross individual pension contributions is limited to £3,600, or 100% of relevant UK earnings per tax year. The annual allowance sets the upper limit on the amount of pension contributions on which you receive tax relief.

There are two types of pensions tax relief:

• There is ‘net pay’ tax relief, where salary is paid after deducting pension contributions. Therefore you automatically get full tax relief.

• There is also ‘relief at source’, where HMRC ‘tops-up’ each contribution by 20%. Higher- and additional-rate tax payers have to complete a self-assessment tax return to receive extra relief.

Importantly, there is no carry forward of unused tax relief.

Annual allowance

The annual allowance is based on ‘pension input amounts’ – that is, the total of all your pension contributions.

The annual allowance can be carried forward.

The annual allowance varies depending on how much you earn and whether or not you have taken some pension benefits.

Mayday A-Day

The annual allowance came into existence on 6 April 2006. This date is known to those in the pensions industry as ‘A-Day’.

A-Day is the pension expert’s equivalent to the birth of Christ. Everything in pension land is now dated as pre-A Day or post-A Day.

Prior to A-Day there were a bunch of rules and limits as to how much could be contributed to an individual’s pension. It was all very convoluted and messy.

A-Day cleaned the place up – sort of.

The annual allowance was initially set at £215,000. In 2010/11 it was lifted up to £255,000. Then in 2011/12 it was dramatically slashed down to £50,000. Finally, a further cut in 2014/15 gave us today’s £40,000.

A highly boring technical addendum: You’ll notice some asterisks by some of the figures in the chart above. Due to the dramatic change in the annual allowance in 2011/12, a one-off pension ‘straddling’ adjustment was available. We won’t delve into the detail, but if 2011/12 is relevant for your annual allowance, remember that there were some special rules that applied. In 2015/16 the Government aligned pension input periods to tax years. Before then, pension input periods and tax years were not necessarily aligned. The Government adjusted the annual allowances so that for the period 6 April 2015 to 8 July 2015 the annual allowance was £80,000, while for the period 8 July 2015 to 5 April 2016 the annual allowance was zero. But you could carry forward the lower of £40,000 and £80,000 less what you input between pre-8 July; minus what you input post 8 July. In effect, you could get up to £80,000 in annual allowance. We’re pretty sure they do this kind of thing just to win bets with co-workers.

With the introduction of pension freedoms in 2015, a money purchase annual allowance was introduced to further limit the amount of tax-relief available for those who have accessed some of their pensions.

In 2015/16 and 2016/17 the money purchase annual allowance was £10,000. In 2017/18 it was reduced to £4,000.

Finally in 2016/17 the Government introduced the tapered annual allowance, potentially reducing an individual’s allowance to a minimum of just £10,000. (Again, more on that later).

How the annual allowance works

The annual allowance is assessed each tax year (unlike the lifetime allowance, which is assessed at certain points of time when you interact with your pension).

Inputs

The first step is to calculate your total pension contributions in the relevant pension input period.

For defined contribution pensions this is straightforward:

For defined benefit pensions it’s a little bit more complicated:2

To calculate the ‘value’ of a defined benefit pension you take the total amount of annual pension built up at the start and end of the year and multiply by a factor of 16.3

It’s easier to see with an example:

Tina is a member of a final salary scheme giving her a pension of 1/60th pensionable pay for each year of service.

At the start of the pension input period Tina’s pensionable pay is £80,000 and she has 31 years pensionable service.

At the end of the pension input period Tina’s pensionable pay has risen by 5 per cent to £84,000 with 32 years pensionable service. Tina does not have any other pension arrangement.

Step 1: Calculate opening value

Annual Pension: 31/60 x £80,000 = £41,333.33
Multiply by factor of 16: £41,333.33 x 16 = £661,333.28
Increase by CPI (say 3%): £661,333.28 x 1.03 = £681,173.27

Step 2: Calculate closing value

Annual pension: 32/60 x £84,000 = £44,800
Multiply by factor of 16: £44,800 x 16 = £716,800

Step 3: Calculate pension input amount

Closing value – opening value = £716,800 – £681,173.27 = £35,626.73.

Tina is within the annual allowance and there is no charge.

Carry forward

Unused annual allowance from pension input periods that ended in the previous three tax years can be carried forward and added to the annual allowance for the current pension input period.4

You don’t need to make a claim to HMRC to use carry forward, but keep a note if you do – just in case.

The annual allowance charge

As we warned earlier, a charge is levied on the excess of pension contributions above the annual allowance.

For example, if an individual has a total of £50,000 contributed to their pension in a year and they have no carry forward, the excess of £10,0005 will be liable to a charge.

The charge is applied at the individual’s marginal rate. In effect, it sits on top of an individual’s taxable income.

For example, for a higher-rate taxpayer the tax charge on an excess pension contribution of £10,000 is £4,000 (£10,000 x 40%).

If you’ve exceeded the annual allowance you’ll need to record this in a self-assessment tax return. When doing your tax return there’s a specific box to fill in if you’ve contributed in excess of the annual allowance.

It’s possible to get your pension scheme to pay the charge for you, under the ‘scheme pays’ system. This is available if:

The total annual allowance charge is over £2,000, and

The inputs are in excess of the standard annual allowance in the scheme.

Pension schemes must provide the information you need for calculating your pension inputs automatically each year. But don’t rely on your various schemes, it’s up to you. If necessary, contact your pension provider to get the information you need.

The tapered annual allowance

No doubt the bit you’ve been (eagerly) waiting for. In 2016/17 the Government introduced the tapered annual allowance. Aimed at high earners, this tapering sees the annual allowance reduced for people who have ‘adjusted income’ over £150,000 and ‘threshold income’ over £110,000 a year.

The tapered annual allowance reduces by £1 for every £2 over £150,000 down to a minimum of £10,000.

Both adjusted income and threshold income need to be above the limits for the tapering to come into effect. If you are over only one of the limits, the taper doesn’t apply.

Calculating adjusted and threshold income

Both adjusted and threshold income include all taxable income. The difference between the two can be summarised as:

• Adjusted income includes all pension contributions (including employer and salary sacrifice)
• Threshold income excludes pension contributions.

Unintended consequences

Unfortunately, there have been many unintended consequences with the tapered annual allowance.

Most prominently it has snared doctors in a pensions tax trap, with many doctors landed with five-figure tax bills.

But more importantly, it’s just plain stupid policy. The tapered annual allowance is fiendishly complicated to apply because it relies upon predicting future total income and pension contributions before they become known.

In some cases, people who contribute in excess of £40,000 can face a marginal tax rate of over 100% – that is, they are actually worse off if their salary increased!

For instance, an individual may earn above the adjusted income but below the threshold income meaning the taper doesn’t apply. But then a small pay rise – even if non-pensionable – can put somebody over both and result in a big tax charge.

Most in the private sector have avoided the issue by paying benefits in kind. However, public sector workers lack the flexibility to avoid getting stung with big charges due to being in defined benefit schemes. Usually the only way to avoid a big tax charge is to opt out of their pension – which can mean losing other valuable benefits such as death in service payments for dependents.

I’m sure some readers may not feel much sympathy for public workers and their defined benefit pensions. But it is not in society’s benefit for experienced doctors, firefighters, judges, and so on to do less work on account of arbitrary and complex tax rules.

The good news is that the Chancellor is reviewing the taper. The bad news is that we’re unlikely to see any changes soon.

There appears to be a lack of appetite to scrap the taper. The much-promised pensions bill finally popped up in the queen’s speech – but there was no mention of the taper in sight (and besides, who knows what the Government will soon look like anyway!)

Money purchase annual allowance

In 2015 the Government brought in the fabled pension freedoms. These changes necessitated the need to introduce a new allowance in order to prevent individuals crystallising a pension and then ploughing the money – plus a dollop of lovely tax-free cash – back into a pension.

Thus the money purchase annual allowance (MPAA) was born.

From 6 April 2015, an individual taking income from flexi-access drawdown or taking an uncrystallised funds pension lump sum triggers the MPAA.

Initially, the MPAA was at £10,000 before being dramatically slashed to £4,000 on 6 April 2017. The MPAA triggers if an individual:

• Takes a pension commencement lump sum and income (from flexi-access drawdown)
• Takes an uncrystallised funds pension lump sum
• Exceeds the GAD rate in a capped drawdown (i.e. turns a capped drawdown into a flexi-access drawdown).
• Takes a flexible annuity (depending on specifics)

It does not trigger when an individual:

• Takes a pension commencement lump sum only
• Remains in capped drawdown
• Takes an annuity (non-flexible)
• Takes a small pot (via commutation)

The money purchase annual allowance applies to defined contribution pensions only, not to defined benefit accrual. However, defined benefit pension contributions are still tested against the annual allowance.

There is no carry forward of the money purchase annual allowance.

It’s worth noting too that the money purchase annual allowance doesn’t replace the current annual allowance. If applicable, the money purchase annual allowance and annual allowance will be calculated alongside each other.

Just like with the tapered annual allowance, the complex rules have lead to people falling into traps. The Office for Tax Simplification has called for it to be reviewed.

Annual allowance planning

It’s possible to avoid getting stung by the annual allowance with some careful planning.

The first thing to do is to keep track of unused allowances that can be carried forward.

Secondly, forecasting future salary changes and bonuses can help determine when the annual allowance may kick in and give you time to prepare.

Thirdly, most private sector employers are already alert to the annual allowance and in particular the tapered annual allowance, and so offer benefits in kind in lieu of pension contributions.

Also remember a golden rule of taxes:

Paying a tax charge isn’t necessarily a bad thing.

For example, an individual opting out of their pension to avoid a tax charge even when there is a net benefit is like them asking their employer to stop paying their salary because they’ll have to pay income tax.6

When assessing what you should do about the annual allowance, think about:

1. What do you get? Consider levels of contribution, future salary increases, and any interactions with tapered allowance
2. What does it cost you (net of tax relief) to get those benefits?
3. Is there a net benefit after tax charges? If you’re in a defined benefit scheme with ‘scheme pays’ what is the commutation factor?
4. What will you get if you stopped contributing today? (Consider the loss of other benefits such as death in service benefits)
5. How valuable is the alternative benefit? (Your employer paying a benefit in kind)
6. What will you do instead of contributing to the pension? Will you receive more salary? Invest in ISAs or other investment vehicles? Are there differences in access and risk factors compared to the pension?

To conclude where we began, this is a fiendishly complicated area so seek professional advice if you need it. And do let us know of anything we’ve missed in the comments below.

Phew – we made it!

1. It’s a bit more complicated than that – what with tax-free cash and the lifetime allowance – but we have to at least try to simplify things! [↩]
2. Note that if the difference in the following calculation is a negative amount then your pension input is nil – HMRC isn’t generous enough to give you extra allowance to carry forward for future years. [↩]
3. If you have any lump-sum benefits, these are added after applying the 16 times factor. [↩]
4. As we mentioned earlier, bear in mind that tax relief on pension contributions is capped at 100% of relevant UK earnings per tax year. [↩]
5. £50,000 – £40,000 [↩]
6. I’ve borrowed this excellent phrase from Pru Adviser. [↩]