Andrew Storey, Group Innovation Director at EV, reminds advisers and paraplanners why it is so important to make robust and up to date assumptions within the financial planning process – even if you don’t have a crystal ball!
While the recent Budget had little in the way of income tax changes, if you cast your mind back to the (second) Autumn Statement, in an effort to bring down debt, reduce borrowing and cut inflation, Jeremy Hunt announced several changes that mean we will be living in an environment of higher income tax from April onwards.
Death by stealth
It seems a long time ago now, but last November, while the Chancellor gave with one hand, reversing the rise in National Insurance rates that had been announced in the Spring 2021 Budget, he took away much more with the other, extending the freeze on tax thresholds and allowances until 2028. While these ‘stealth’ taxes are likely to be more palatable for consumers than increasing the tax rates themselves, the Office for Budget Responsibility (OBR) estimates that gradually dragging more people into higher tax brackets will create 3.2 million new taxpayers and 2.6 million higher-rate taxpayers within five years1.
Coupled with freezing the tax bands, Jeremy Hunt also reduced the additional rate of tax threshold (in England, Wales and Northern Ireland) from £150,000 to £125,140 in April2. These changes could have quite an impact on clients, especially when you factor in the impact of inflation.
The ravages of inflation
While inflation isn’t rising quite as quickly as it was, it’s still far higher than the 2% target rate. The OBR predicts inflation will fall sharply later this year and will be around 2.9% at the end of 20233. However, there are still much political and economic uncertainty in the UK and globally and our own asset model average CPI inflation forecast expects an average of just under 4% a year for the next three years, with a 1 in 20 chance that it could be as high as 7%.
Factoring in the right level of inflation is vital when it comes to financial planning, especially given the length of the income tax threshold freeze. Crucially, high inflation will lead to rising wages, tipping more people into paying more tax. Continuing to assume inflation will continue at 2.5% a
year, as has been common practice for many advisers for the past decade, could leave your client’s ability to keep up with expenses falling short of expectations, and your firm falling foul of the Consumer Duty principle of avoiding foreseeable harm to investors.
A double whammy
The impact of increased taxation alongside the effect of inflation is that most people will see a reduction in the spending power of their income. Clients, particularly those near or at retirement who are less able to save more or increase their earnings, will likely be concerned about their future income.
Unfortunately, none of us has a crystal ball to know exactly how inflation will play out over the next five years. However, getting the calculation wrong can have a huge impact on a client’s cash flow. For example, a person earning £150,000 would pay £10,000 more in income tax if inflation were 7%, rather than 2.5%. Even on a salary of £50,000, the difference would be just under £3,000.
Source EV
In today’s era of investment volatility and rising prices, it’s crucial to create realistic estimates and factor in the likelihood of clients covering their expenses based on various inflation and market performance levels. This probability of meeting future income goals can only be achieved through stochastic cashflow modelling, as it checks numerous “what-if” market scenario calculations to fully
stress-test the client’s plan. This process can give clients peace of mind that their plan is on track or facilitate discussions on adjustments to spending or saving to achieve their targets.
No one expects advisers to be fortune tellers. However, setting the right parameters at the start and stress-testing the financial plan against a range of possible future scenarios will help you set the correct expectations and make sure that your recommendations will deliver the best outcome for the client.
About Andrew Storey
Andrew Storey is Group Innovation Director of EV. He provides a unique combination of actuarial, technical and user experience skills to design and deliver innovative planning and suitability solutions for financial guidance, digital advice and face-to-face advice. Andrew has experience in delivery from design, specification, testing and client management.
Having started his career as an actuarial consultant at PriceWaterhouseCoopers, Andrew has over 25 years’ experience in pensions, investments and IT solutions and an extensive knowledge of retirement income planning. Previously, he was responsible for designing and delivering system efficiency and data quality at a large outsourcing firm. Whilst a Stakeholder Manager at pensions actuarial consultancy Barnes & Sherwood, he passed the Financial Planning Certificate and has an in-depth understanding of the advice process.
Andrew holds a BSc degree in Actuarial Science from City University London and a Diploma in Management from Reading University
