The Generosity of Government Tax Breaks and the Basic Principles of Magic
Have you ever seen first-hand a magician working close up magic? There, right in front of you, a trick that is absolutely awesome?
It’s pretty impressive and commonly mind boggling. How did they do it? The answer almost certainly lies in simple, straightforward deception. The magician is able to direct your eyes to seeing what they want you to see and avoids what they don’t want you to see. This doesn’t make it any less impressive, but it does explain how it is done.
This same principle is what has driven some of the recent tax policies of government. Let’s not forget that in this booming economy our government is still running the most eye-watering deficit. Long gone are the days of balancing the nations books, the new norm is perpetual deficits regardless of economic circumstances. If the government can’t get to a break even or surplus point in its own finances when times are good, when will they?
What this means is that the Treasury is on a constant quest to find new ways to raise funds. They need to find tax raising measures, but they have a problem. They cannot (or do not want to) make out and out tax rises. This results in constant effort to raise taxes using stealth. This is where the parallel to the magician’s deception comes in, because the trend today is to announce ever popular tax freedom measures all at the same time as trying to raise more tax!
So if you think of the big hullabaloo over the Pension Freedom announcements or increasing of the ISA allowance ask yourself this question – why are government doing this sort of freeing up of the tax burden at a time of national crisis in the nation’s finances? The answer is simple: because they create great headlines and the impression of a government helping savers. But the truth is somewhat different. The introduction of greater pension flexibility had a clear note in the Budget papers attached which showed that this would actually increase the amount of tax paid by pension savers in the medium term.
With the additional ISA allowances now available, the tax loss to the Treasury is minimal, negligible. Because the extra money people may put into ISAs in the future was not money that would produce much, if any tax, for HM Treasury in any event. And who tends to maximise their ISA allowances? The people who have savings, those who are older than the average. The value of the ISA tax saving is probably marginal in many cases, on an individual basis, but what is not marginal is the 40% Inheritance Tax (IHT) that could apply to this money in the longer term. ISAs ring fence sums from tax in the shorter term, but they are now also ‘ring fenced’ within the IHT ‘net’ in the longer term.
It is the skill of the magician to get you to follow what they want you to follow – the exact same method as adopted by Chancellors in recent times.
Although we think that ISA allowances should be maximised, where appropriate, and that pension flexibility is broadly a good thing, we also believe that it is important not to be seduced by these additional measures, at the expense of better ways of financial or tax planning. For example – how many people are using their ISA allowances but not using their £3,000 per year gift allowance? Millions at a guess. And in a high proportion of cases this will be an error in financial planning terms. The money salted away into ISAs will probably have limited lifetime tax saving (if any at all) but if this money is then in the saver’s estate on death it could easily be subjected to 40% tax. The number of people being caught up in IHT is increasing quite significantly year on year.
So instead of £3,000 going into ISAs why are these savers not putting the money into a trust arrangement using the gift allowance? Because they don’t know the option is there! Or it is not touted hard enough or explained well enough.
It may well be that in any one year this makes limited difference, but project ten years in the future and these £3,000 annual allowances add up to £30,000 for an individual and £60,000 for a couple (ignoring any growth or return on the money during the period). So imagine a couple who use their gift allowances each year, they can build up a pot of £60,000 which is now outside of their estate for IHT (and has other advantages e.g. the money is now outside Local Authority assessment for care fees, not true if it is in an ISA) – which could represent a saving of £24,000 against future IHT liability. In an ISA the money would not be safe from this tax threat.
This is an incredibly simple example, and there are many factors (in the main, all beneficial) in considering how to utilise the £3,000 gift allowance and using a trust to deal with this, but our core point is this: that it is an allowance which the government doesn’t want to promote too heavily because it has real meaningful long-term tax saving, whereas the ones they do want to shout about, if you look at the Treasury’s own long-term forecasts, either have limited tax saving (for you, the investor) or indeed, the exact opposite, they raise taxes.
Don’t let the tax tail wag the investment – or financial planning – dog! Don’t let the populist headlines around pensions and ISAs deceive you into thinking the government is being overtly tax-friendly towards you, don’t let them sway you into using certain allowances at the expense of using others, which may be better. At the very least, every individual close to retirement or in retirement, who is looking to use their ISA allowance should explore how they can also use their £3,000 gift allowance. We are here to help individuals and couples do just that.
