Is it a fair cop?

On the face of it the recent statement that ISAs are here to stay is good news for investors.  It means that savers can continue to put aside £7,000 each year into investments which are permanently exempt from Capital Gains Tax (CGT) and from higher rate Income Tax.  But how beneficial are these concessions?  Anecdotal evidence from some of WAY’s supporting IFAs indicate that a high proportion of PEP and ISA holders could easily hold and manage their investments perfectly well and effectively tax-free by utilising their existing annual CGT allowances.  Most are not higher rate Income Tax payers and so will not suffer any further tax on dividends/distributions.  So are they needlessly investing in PEPs and ISAs?

The only real beneficiaries of these tax-exempt investments are either (a) those taxpayers who invest in cash or fixed interest investments (not equities or mixed funds) and who benefit from exemption from standard rate Income Tax on those specific investments, or (b) higher rate taxpayers who are already utilising their annual CGT allowances.  For these two minority groups the continuing concessions are very good news.  WAY has many regular contribution ISA investors who are young, dynamic, higher-rate taxpayers saving into high growth funds for school fees and other medium term commitments, and doing so with the added benefit of pound cost averaging.

So far, so good.  What is rarely questioned, however, is whether these ISA savers should be taking any other considerations into account.  Is the ISA news all good or is there a potential downside?

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.  In my view investors from their mid-sixties onwards who believe they will have an IHT liability should no longer be 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 some £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 accumulated savings?  The answer 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.

WAY offers a comprehensive range of IHT mitigation arrangements, uniquely offering both unit trust based and offshore bond based plans.  These are further subdivided between flexible and discounted schemes whereby trustees have a great deal of flexibility in making financial provision for both donors and beneficiaries.

A simple recent example illustrates the benefit of this approach.  The lady in question was a fit and healthy 73 year old widow.  She and her late husband had bought their ex-Council house under the ‘right-to-buy’ scheme and the rump of the mortgage was paid off from her husband’s PEPs and ISAs.  The table shows her circumstances both before and after swapping her PEPs and ISAs for a combination of flexible and discounted schemes from the WAY stable.  She has a life expectation of some 13 years but only needs to survive 7 to remove the gift into trust from her estate.  Assuming she does live those 7 years then she will have virtually removed IHT from her estate.  Even were she to live less than 7 years then her net IHT liability would be substantially reduced as a result of moving her funds.  Moreover her income is maintained and, via her trustees, she retains tremendous flexibility over the future return of funds from the flexible trust.

Before vs After Planning

Paul Wilxox,
Chairman & Technical Director, WAY Group.

Tags: Capital Gains Tax, Higher Rate Income Tax, IHT, ISA, ISA Savers, Life Expectation, PEPs | Posted in ISAs |
Comments: One Comment

One Comment to “Is it a fair cop?”

• Eric Hundin

  19.06.09

  I found your blog on MSN Search. Nice writing. I will check back to read more.

  Eric Hundin

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