Technical News: Issue 25

London needs to wake up to new threats

Financial hubs in the Gulf are on the rise.

They rely purely on oil and gas. They don’t have much in the way of a domestic economy, nor do they have the depth of technical skills to compete in highly sophisticated service industries. Yet commerce hubs in the Gulf, such as in Bahrain, are emerging as genuine finance centres on their own terms. Most of the major European financial centres think they are competing purely with one another. But those in the Gulf could in time pose a real threat to Paris, Frankfurt and, of course, the City of London too.

In Bahrain, for instance, financial services are already the largest sector of the economy, overtaking oil and gas in 2020. One of the country’s advantages is that both monetary policy and regulation are combined in the central bank, allowing it to maintain flexibility and ensure stability while promoting growth. The Minister for Trade and Commerce, Abdulla bin Abel Fakhro recently said that “we have been working to make the country far more innovative, and to encourage startups, especially in financial services.” Likewise, the Development Board is pressing ahead with developing its finance industry, with its own fintech hub, and lots of emphasis on digital banking and cryptocurrencies.

Bahrain is tiny. The total population is only 1.5 million people, and only half of those are locals. It ranks 76th in the GFCI global ranking of finance centres. Even so, it has more than 400 financial institutions operating on the island, finance accounts for 16% of GDP, and, along with its better-known neighbour, Dubai, it’s not just a domestic finance centre, but one that is also doing business with the rest of the world.

Bahrain has four big trends on its side.

First, flexible regulations. The island is working hard to make sure its regulatory environment favours innovation and investment. Fintech and crypto are just as important as traditional banking, insurance and trade finance, and growing all the time. That is not just a coincidence.

Start-ups have been actively encouraged, and not just tolerated as they are in most European finance centres.

Second, huge investment in modern infrastructure. Bahrain has only recently opened a glittering new airport and, of course, the facilities in Dubai, Qatar and Abu Dhabi are just as good. The region’s airlines have modern fleets and quick connections to the rest of the world. It is an easy place to operate a business.

Third, low or zero taxes, especially on capital and wealth, combined with strong economic growth. Bahrain levies no income tax, or capital-gains tax, and although it will introduce a corporation tax, mostly to comply with the OECD’s new global minimum rate, that will only apply to domestically generated profits. The same is true of most of the Gulf states. Meanwhile, their economies continue to thrive. Even with a relatively low oil price, and little prospect of higher prices any time soon – there is too much shale oil in the world, and even if they do rely on subsidies, renewables are growing fast – Bahrain will expand by more than 3% this year, and the whole of the United Arab Emirates by 3.4%. As taxes rise across Europe, especially in both France and the UK, those zero rates are going to become more and more attractive over time.

Finally, an increasingly skilled workforce. Most of the Gulf states have high levels of education, and the more liberal ones have brought plenty of women into high-level positions. They have turned into a magnet for young talent from all around the world, not least because the tax regimes, alongside the quality of life, are more attractive than the countries from which the immigrants come.

However, plenty of challenges remain. The region is politically unstable and will remain so as long as Israel is at war with its neighbours. The huge number of expatriates and foreign workers may not always be available to keep the economy running. Oil and gas may not be as crucial to the Gulf economies as they once were, but they remain the foundation on which the region’s prosperity was built, and as the rest of the world switches to renewable energy its value will keep on falling. The next two decades may easily prove a lot tougher than the past two. Even so, the region is still racking up some of the fastest growth rates in the world, and with every year that passes more and more of that growth is coming from manufacturing, tourism and, perhaps most of all, finance.

We think of places such as Bahrain or Dubai as purely regional financial hubs. They have a niche handling all the wealth that the oil and gas industry generates, but not much else. We don’t think of them as having the experience or expertise to compete on their own terms. And yet that view is becoming very dated. Europe is suffocated by high taxes and cumbersome regulations. Unlike New York, or Singapore, or Shanghai, the Gulf is in virtually the same time zone, and it is only five or six hours by aeroplane from most European capitals. There are a growing number of highly skilled expatriates, fleeing endlessly rising taxes in their own countries.

It may not be long before start-ups decide to base themselves in the region, or companies choose to list their shares in one of the Gulf states. Add it all up and one point is clear. Emerging finance centres such as Bahrain are turning into a threat to complacent European finance hubs, and especially London – a threat that the City of London should be taking seriously.

Trump’s Wall Street Surge

The latest global fund manager survey from The Bank of America shows marked bullishness on US assets, and a dismissive attitude to the rest of the world. Yet investors could be repeating the mistakes they made in the president-elect’s first term, when many ‘Trump trades,’ from US small caps to a stronger dollar, enjoyed a short rally only to underperform over the full four-year term.

On Wall Street, investors are taking the Trump policies they like (tax cuts and deregulation) seriously, while dismissing those they dislike (immigration clampdowns and high tariffs) as just campaign rhetoric. Trump needs Congressional support for his pro-growth plans but can quickly impose tariffs and immigration rules himself via executive order. Trump’s first year in 2017 was marked by chaos and scrapped trade deals – it was only later that he finally gave Wall Street a tax cut.

High US inflation is now Trump’s problem. The incoming President’s basic instinct to cut government spending is good, but he won’t make the serious changes to welfare policies that would be needed to balance the books. As long as federal deficits stay in the $1.5trn range, the new administration will be dealing with inflationary issues. US core inflation, which excludes volatile food and energy prices rose to 3.3% in October.

Across a range of statistical measures, inflation remains above 3% and is no longer clearly declining.

Another headwind is that bond yields are rising. Credit is meaningfully tighter than many currently working in finance have ever known. The yield on the US ten-year Treasury Inflation-Protected Security (TIPS), a proxy for interest rates after inflation, is now above 2%. That doesn’t sound like much, but it’s higher than it was for 14 years prior to 2023.

Trump isn’t so mad as to pour fuel on the inflationary fire with massive tariff hikes. But that’s no reason for calm. The US is overdue a recession and a big market correction at some point over the next four years. From hidden leverage in private equity to crypto assets that have no lender of last resort, financial risks are mounting.

Inheritance Tax net tightens

In 2027, retirement savings in the UK will no longer be exempt from inheritance tax.

Privately, many financial advisers concede that excluding pension savings from the inheritance-tax (IHT) net has always felt like an anomaly. It therefore surprised very few people when the chancellor announced in the recent Budget that this anomaly will come to an end in April 2027. Thereafter, pension savings passed to your heirs will count towards the value of your estate, like most other assets you bequeath. And that means they could be subject to IHT.

Many people will find themselves caught. The government expects 8% of estates to be affected by the change. Some families will face sizeable bills. If you die with £250,000 left in your pension fund, say, and the rest of your estate has already used up your IHT allowance, the bill on the money will come to £100,000. It may be even worse. When families receive pension assets from someone who has died after they reach 75, there is usually income tax to pay on this money. The effective tax rate on some inherited pensions could thus be as high as 67%.

It’s not all bad news. Conventional IHT planning strategies could now prove useful to pension savers. It might make sense, for example, to convert your pension fund savings into as large an income as possible and then start giving it away; the IHT system allows you to make gifts out of surplus income with no IHT liability.

Alternatively, you could withdraw lump sums from your pension funds and gift this cash to your heirs. These will be ‘potentially exempt transfers’, with no IHT due if you survive for seven years after making them. A range of other options, including gifts to charity, can also reduce your liability. And remember that couples each get their own IHT allowance, which can help with planning.

Still, from April 2027, the IHT landscape will look very different for many people. Conventional wisdom among advisers is that other things being equal, people with different pots of savings when they reach retirement should only start withdrawing cash from pension plans when their other assets have run out. It makes more sense to run down individual savings account (ISA) savings, say, where IHT is payable by your heirs, than pensions cash, where it isn’t.

That thinking may now need to change. If the ultimate tax bill for your heirs is going to be higher on pension assets, it will be sensible to use these up first. In practice, there is no single right answer here, given that people’s circumstances are so varied. Moreover, many families are more interested in the financial arrangements that make most sense while someone is living than what happens after their death.

Nevertheless, many families may now need to reconsider their approach to savings and investment in retirement, and take independent financial advice on the best options for them under the new system.

Defined-benefit (DB) pension scheme members should definitely pause for thought. For most people, these schemes are a superior arrangement because they offer a guaranteed benefit in retirement that it is hard to match with a defined- contribution (DC) plan. However, DB schemes don’t allow you to pass on an unused pot of savings to your heir in the same way; hence a growing trend in recent years for people to transfer money from DB to DC schemes. That was always a potentially flawed strategy given the benefits of DB pensions, but looks even more so now there will be no IHT benefit available on bequeathed pension assets.

Inheritance Tax net tightens

Cuts to agricultural property relief (APR) and business property relief (BPR) in the Budget prompted fury from many business owners. While the farming sector has been the most vocal, other asset-intensive businesses could also be hit when they pass down to the next generation. If you may be affected by the changes, it makes sense to take professional advice as soon as possible.

Currently, APR and BPR ensure that, when the owner of a farm, a business, or interest in a business, or shares in an unlisted company, dies, their heirs can carry on the business with no liability for inheritance tax (IHT). However, this will change from 6 April 2026.

Thereafter only the first £1m of value will pass down tax-free. IHT will be due on anything above that threshold, albeit at 20% rather than the normal 40% rate. So, after April 2026, if you leave business assets worth £2m to your children, they may face an IHT bill of £200,000. It will probably be possible to pay this interest-free over ten years.

The situation for farms is particularly complex because wealthy individuals have often bought agricultural assets to take advantage of APR. This has driven up the price of farmland, which has increasingly been pricing out genuine farmers. The consequence is that with agricultural land now valued at over £10,000 per acre on average, even a 100- acre family farm – very small by the standards of working farms today – is likely to exceed the £1m threshold and may be hit by the IHT charge.

So, farmers in particular fear that they will have to sell land to pay the bill, which may reduce the farm to a size where it is not economically viable – and thereby accelerate the demise of family farms. However, family members inheriting other asset-intensive business may face similar difficulties paying and must take out loans or sell assets, jeopardising their future.

If your family business may be in this position, it will be vital to understand your own potential exposure to these changes. It’s crucial to have a clear picture of the true value of the assets. Many companies and farms have substantial loans secured against them, and this will reduce the net value for tax.

Note too that spouses and civil partners who jointly own a business each get a £1m allowance. So, a married couple leaving a business to their family may effectively receive full tax relief on the first £2m They also get their individual £375,000 IHT allowances. In the case of farmers, they may also be able to apply their main residence allowance (£175,000 each) to reduce the IHT tax liability from the value of the farmhouse.

It is also possible to make use of conventional IHT planning strategies. If you’re happy to pass on ownership of your assets during your lifetime – perhaps in tranches – this will reduce the value of your estate at death.

The value of these tranches is exempt from IHT if you live for at least seven years after making them, under the ‘Potentially Exempt Transfer’ rules. Life insurance can help manage the risk of dying before the transfer is complete, since the pay-out from the policy can meet some or all of the IHT bill.

However, if you continue to benefit from these assets after passing them on, they will be deemed a ‘gift with reservation’ and still treated as part of your estate at death.

Clearly, some people are going to end up paying more. The Treasury’s figures suggest the APR change alone will raise £500m in 2027. Not all of that is going to come from wealthy landowners using taxplanning strategies. Careful and prompt planning will be needed to make sure that families can hold on to businesses they’ve built together.

Draw or defer?

Even High net worth clients with an entitlement to a UK state pension often ask for advice on when they should start to draw it.

More than one in nine Britons now works beyond their 65th birthday, according to data from the Office for National Statistics (ONS), roughly twice as many as 20 years ago. Some are doing so out of choice; others by necessity given their financial situation. But either way, if you’ve still got income coming in at the point when you can start claiming your state pension, it may make sense to wait.

Under the current rules, men and women alike are entitled to start receiving their state pension once they turn 66, though this will go up to 67 between 2026 and 2028. However, you don’t have to take the money straight away. And if you choose to defer drawing your state pension, you’ll be entitled to more money once you do claim it.

The bad news is that these arrangements have become markedly less generous in recent years. For a long time, those deferring their state pension claim received 10.4% extra income for each year of delay. Today, however, you get only 5.8% extra for each year of delay once you start claiming.

In cash terms, someone opting not to take their £11,500 state pension this year would be entitled to £667 of extra income if they started claiming in a year’s time. But crucially, they would have missed out on £11,500 of income by that point – and it would take just under 18 years to earn that back through the extra income they will be entitled to in the future.

In other words, the decision about whether to defer a state pension claim is a gamble on life expectancy. The longer you live, the better off you’ll be overall by deferring; but there is also a risk that you’ll die before you reach the break-even point.

The decision is finely balanced. The ONS says the average 65-year-old man can expect to live for another 19 years, rising to 21 years for the average woman. But those are just statistics – if you’re currently in good health, you may live much longer; equally, you could die sooner, particularly if you’re in poor health.

There are also some complicating factors to consider. For example, if you’re still working, it’s possible that you’re currently paying income tax at a higher rate than you will be once you’re fully retired. In which case, you’ll pay less tax on your state pension if you defer claiming it, reducing the number of years it will take to be better off overall.

On the other hand, if you’re on a very low income – and particularly if you’re receiving state benefits – any extra pension you get through deferring may be wiped out by reductions in your entitlement to these supports. In which case, deferring your claim will leave you worse off.

There isn’t a right or wrong answer here. Everyone’s circumstances will vary and whether to defer is a personal decision – ultimately, most people won’t be sure they have made the right decision for many years.

Importantly, you don’t have to defer for a full year. You’ll get extra pension if you put off your claim for as little as nine weeks. Also, if you’ve already started taking your state pension but now think deferring makes sense, you’re entitled to suspend your income for a period; you’ll then qualify for extra money on the same terms as someone who deferred their claim before they started taking their pension.