An advice firm must pay compensation following a complaint from a client who said he was “wrongly” advised to encash some investment bonds without having regard to the likely tax implications.
According to a Financial Ombudsman Service decision, the firm, Prism Financial Advice, did not explain to the client that, as a higher rate taxpayer, he would face chargeable gains.
The client, Mr J, said Prism’s adviser did not look into partial encashment of the bonds or the option of using his existing bonds to give him the 5 per cent withdrawals he wanted. He said that would have met his annual Isa objective without needing to encash his bonds.
Mr J also took issue with the adviser’s recommendations about inheritance tax protection and said this was never discussed. He said this was irrelevant because he is single with no dependents. He also said the adviser did not discuss his early retirement plans.
Mr J said that as well as the extra tax liability he was charged a 3 per cent set-up fee and a 1 per cent ongoing charge. He wanted the tax liability and the new charges refunded.
Prism rejected the initial complaint. It said that MR J had confirmed in 2015 that he was a basic-rate taxpayer and that the adviser told him there would be no chargeable gains if his tax status did not change.
Prism said the adviser kept in touch with Mr J and that he reduced his income to keep within the basic tax rate. It said the adviser tried to get in touch with Mr J in early 2016 but he did not respond until making a complaint in March of that year.
Prism said it then helped Mr J achieve his objectives, including pre-funding a Sipp plan.
Prism said the recommendation to encash the bonds was to give his portfolio reduced exposure to risk. It reduced the set-up charge from 3 per cent to 1 per cent and agreed to pay Mr J £500 for communication failures.
A FOS adjudicator said the complaint should be upheld, however Prism did not agree.
The adjudicator said Mr J was always likely to remain a higher rate taxpayer, despite his attempts to reduce his income. He said the tax bill – which was £3,889 – was a result of Prism’s advice to encash the bonds.
Prism disagreed and said it was not clear Mr J would stay a higher rate taxpayer at the start of the year when it gave the advice to encash the bonds. It said if he had not increased his overtime during that year he would have stayed in the basic tax band.
It said in December 2015 the adviser recommended setting up a Sipp to maximise his pension payments and minimise his income but Mr J did not respond to offers of help with this. Prism said Mr J decided “at the last minute” to pay a lump sum into the Sipp that covers the encashment tax liability.
Prism said the tax bill from encashing the bonds is £1,479 and the rest of the bill was related to other dividends and earnings.
It maintained that the tax liability related to the bond encashment was because of Mr J’s actions and inactions following the surrender.
The complaint was referred to ombudsman Tony Moss who upheld the complaint.
The decision says: “The key issue, for me, is whether there were sufficient reasons to recommend surrendering Mr J’s existing bonds to reinvest in a new portfolio as this would inevitably involve a new setup charge irrespective of any potential chargeable gains. In my view there is not sufficient evidence to justify this recommendation.”
It says: “The adviser makes highly generalised references to the existing investments no longer offering the benefits they once did without offering any specific concerns about the bonds in question. Equally, he offers no detailed explanation as to why the proposed new investments would deliver better growth potential etc.”
It adds: “Crucially, the advisor does not explain why the existing portfolio could not be adjusted to potentially improve performance or provider greater flexibility etc. thereby avoiding encashment chargeable gains and new set-up charges. If Mr J had not been advised to go down this route he would not have incurred either a new set-up charge or a chargeable gain. He would have kept his original bonds and avoided both of these.”
The FOS said the adviser made a “significant error” by not spelling out the chargeable gain issue in the suitability report. It said that “undermined the overall advice at the heart of his report”.
The decision says: “I don’t dispute that it may have sought to help Mr J reduce his taxable income, including proactively assisting him to set up and fund a Sipp, but this does not mitigate its liability for the inappropriate encashment. This was simply appropriate advice for a client seeking to maximise pension contributions and minimise tax liability.”
The FOS said Prism should refund the 1 per cent set-up fee and the tax bill from the bonds being encashed. It said that amounts to £3,889. It said 8 per cent interest should be added to the two figures from the day the set-up fee was taken and the date Mr J paid the tax bill through to the day the complaint was settled.
It also said Prism should pay the £500 it already offered.