Treasury delighted – it’s the ISA season again

The annual ISA momentum is building.  Our doormats are dancing to the impact of ISA circulars from any and every financial institution we have ever dealt with and many others with which we haven’t.  The effort of selling ISAs to clients each year and the danger of selecting what turns out to be inappropriate funds, all for very little reward, means that many advisers leave the annual ISA scrum to the direct sellers.  However, there is every good reason for advisers to revisit this whole scenario and do themselves, their clients and companies like WAY an enormous favour. 

Who benefits from ISAs?
By stealth tactics the Treasury is misleading investors into thinking there are substantial tax benefits in retaining PEP and ISA portfolios into one’s dotage, while simply ensuring that it can continue to collect large amounts of IHT from the unwitting and unprepared elderly investor.  I believe investors from their mid-sixties onwards who believe they will have an IHT liability should no longer be investing in or holding PEPs and ISAs.  What so many of them do not realise is that they will suffer a punitive IHT sting at death, whereby they and their families potentially lose a colossal 40% of their hard-earned savings.  This loss completely dwarfs the often marginal annual tax benefits resulting from the ISA wrapper. 

Based on Office of National Statistics figures for holders of ISAs and PEPs, combined with our own research, WAY Group estimates that at least 165,000 elderly investors (aged 70 or older) are holding ‘tax-sheltered’ portfolios in excess of £100,000.  Based on published mortality rates this would mean that at least £0.5bn, or one sixth of the annual total IHT tax take of £3bn, arises from IHT on PEPs and ISAs from this group!  This cannot be right. 

I believe that there are substantially more then 300,000 investors across the country who currently hold substantial equities-based tax-free investments within their portfolios with no provision whatsoever for these funds to be transferred into alternative investment schemes which can mitigate the IHT. Over half of these investors – some 165,000 – of those with large tax-sheltered investments are aged 70 plus. This is the age group at the greatest risk of losing out on the tax-free benefits of their savings strategy. 

So what can these investors do to avoid IHT on their ‘tax free’ savings?  There are two parts to the answer, the first relating to accumulated savings already within PEPs and ISAs and the second dealing with future surplus annual income which might otherwise have been directed to ISAs. 

Accumulated PEP and ISA Savings
The obvious solution for redirecting accumulated savings is simple, even after Gordon Brown’s Budget measures from last year.  They should encash up to £285,000 of their ‘tax-free’ savings and gift them to their chosen beneficiaries via a flexible trust.  Although gifts into such trusts now constitute an IHT taxable transfer there will be no tax so long as the gift is within the current Nil Rate Band for IHT – £285,000 per person.  Such gifts fall out of account after 7 years and so there is an opportunity for each taxpayer to make gifts up to this level every 7 years. 

At age 65 the average investor still has a life expectation of some 16 years (males) to 19 years (females).  Even at age 75 these numbers are 9+ and 11+ years.  This means that any average investor has time to gift their former PEPs and ISAs completely IHT tax-free so long as they start shortly after their mid 60′s.  The real benefit of the tax exemptions associated with PEP/ISA portfolios is that when this IHT mitigation exercise becomes appropriate the targeted funds can be surrendered entirely tax-free at that point, making investment in an IHT mitigation plan that much more effective.

 There are a number of schemes available whereby trustees have a great deal of flexibility in making financial provision for both donors and beneficiaries. This means that investors can switch into IHT-protected investments knowing that their savings are beyond the tax man’s reach but not beyond their own reach, courtesy of their chosen trustees. Any investor with £250,000 in PEPs and ISAs is likely to save £100,000 of IHT by moving across to an IHT mitigation arrangement.  We are talking substantial potential savings here – the kind of savings which investors cannot ignore.  Not only does the client benefit but IFAs can earn worthwhile commissions or fees as compensation for the very complex work involved in establishing and monitoring the necessary trusts. 

Substitute for future ISA Savings
Many investors habitually save the maximum ISA allowance each year to obtain scraps of tax benefits which fall from the Chancellor’s table.  These sums simply compound the 40% wealth tax which Gordon Brown (or his successor) will collect on the taxpayer’s death.  So is there a more efficient use for these amounts of, generally, surplus income which will deprive Brown of his unjust desserts and yet benefit the investor? 

 Taxpayers have been using the ‘normal expenditure’ from income exemption introduced by Section 21 of the IHTA 1984 for many years.  This is normally exercised by straight unconditional gifts or by the establishment of simple trusts.  The fact that such gifts are immediately exempt from IHT is an exceptional benefit.  However donors making such gifts have hitherto been deprived of any future benefit.  Anybody unsure about putting funds beyond reach has therefore not taken advantage of this facility.  Since last summer WAY has offered it’s unique ‘Gifts from Income’ Inheritor Plan which allows donors to make instantly exempt gifts into a specially drawn trust but retain influence over those monies, including the right to have them reverted at some time in the future.

 What this means in simple terms is that investors who qualify for making ‘normal expenditure’ gifts can make regular savings not into ISAs, which will incur the 40% IHT charge on death, but into a Gifts from Income IHT arrangement, which offers instant IHT exemption (no waiting for the expiration of the 7 year inter vivos period).  Advisers only have to complete trust documentation with clients in the first year.  In subsequent years it is only necessary for funds to be paid across.

 The only caveat on this arrangement is that the regular gifts do genuinely qualify for the ‘normal expenditure’ exemption.  There are 3 rules for this: (i) the gifts (into trust) must be regular, (ii) they must be gifts from surplus net income and (iii) making the gifts must not adversely affect the donor’s standard of living.  So long as these conditions are met there is no limit to the size of regular gifts.  Some investors have substantial surplus income, sometimes tens or hundreds of thousands of pounds, which can be gifted in this way with immediate IHT exemption.

 So my message is clear – together we can help our clients and ourselves to obtain substantial financial benefits from switching from an ISA to an IHT mitigation approach where the only loser is the tax man.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd March, 2007 |
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