Brown takes billions from 'tax-free' Isas

The Sunday Times - 04/02/2007

The chancellor stands to make three times as much in inheritance tax on the savings schemes as he ever gave in tax breaks, writes David Budworth.

THOUSANDS of investors who have saved diligently into Peps and Isas to take advantage of the tax perks might be better off just giving the money away - or spending it.

A new study calculates that the chancellor stands to pocket a Pounds 15billion inheritance-tax (IHT) windfall from Pep and Isa savers when they die - nearly three times the amount of other taxes that investors have saved during their lifetime.
The average IHT bill for someone who has taken full advantage of Pep and Isa allowances since 1987 could be Pounds 116,000, according to Bates Investment Services, an adviser. But they would have saved only Pounds 42,000 in income and capital-gains tax (CGT).

Putting money into the tax-efficient schemes later in life could therefore be pointless if you want to pass it to your children, because any tax saved will be more than clawed back in death duties.

Advisers say thousands of savers, many of whom may not realise Peps and Isas are subject to death duty, should consider ways to reduce their IHT bill, such as making gifts. Paul Ilott of Bates said: "Peps and Isas are tax-
efficient during your life but on death the tax shelter is removed. The amount of tax saved during your lifetime can be dwarfed by the size of the IHT bill."

Investors were first allowed to put money into Peps in 1987. Isas replaced them in 1999, but existing Peps were allowed to continue. You could put up to Pounds 9,000 a year into Peps (although the allowance was lower in the early years), compared with Pounds 7,000 into Isas - a total of Pounds 144,200 over the past 20 years.

Since 1987 more than 19m accounts have been opened to take advantage of the tax perks. These have been watered down over the years, but capital gains are still free of tax and there are income-tax benefits if you are a higher-rate taxpayer.
When you die, however, your entire portfolio is added to your estate and you pay 40% on anything over the nil-rate band, which is Pounds 285,000 this tax year.
Millions of people live in properties worth more than this, so for them all other assets, including Peps and Isas, are subject to the full 40% tax.

The problem is most pressing for Britain's growing band of Pep and Isa millionaires - those who have saved the maximum every year and have enjoyed strong returns. For example, Lord Lee of Trafford, a former tourism minister and Conservative MP, has a portfolio worth more than Pounds 1m.
Since 1987 he has invested the maximum every year.
Double-digit returns from his investments in UK smaller companies have pushed his portfolio over the Pounds 1m mark. But his heirs now face an IHT bill on these investments of about Pounds 400,000. He said: "The tax advantages of Peps and Isas have been just too valuable to squander, but there is the IHT issue. I think there is a strong case for raising the threshold over which the tax is paid."
Even if you have enjoyed average returns, you could still face an IHT problem. If you invested the full amount in the schemes in every year since 1987, and your portfolio had grown at the same speed as the average UK equity fund, it would be worth about Pounds 289,500, according to Bates.
On a portfolio of this size you would have saved Pounds 11,060 in income tax over the past 20 years, assuming you were a higher-rate taxpayer. If you sold your portfolio you would avoid a further Pounds 30,520 of CGT, giving a total tax saving of Pounds 41,580.

But the IHT bill on a portfolio of that size would be almost three times more at Pounds 115,810.
The government has so far rebuffed all calls for reform and advisers are therefore urging investors to consider ways to protect their assets.

One solution is to give money away. You can make unlimited tax-free gifts as long as you survive for another seven years.
Advisers suggest you first work out how much of your Pep and Isa portfolio you will need to supplement your income in retirement. It is worth keeping this in your name because the income will be tax-free.

Any surplus assets, however, you could give away to your wife or children. You would have to sell the Isa or Pep, but the beneficiary could reinvest the money.
If you want to keep control over how the money is used you will need to set up a trust.

Since last year's budget, however, you could face a tax charge of 20% on an initial gift above the Pounds 285,000 nil-rate band. There could also be a 6% tax charge every 10 years on assets in the trust above the nil-rate threshold at that time.
HOW TO CUT INHERITANCE TAX
* If you want to pass surplus assets in your portfolio to your children, consider giving them away to avoid IHT. You can make unlimited tax-free gifts as long as you survive for seven years. You would have to sell the Isa or Pep, but the beneficiary could reinvest the money.

* If you want to keep control, put the money into trust, but gifts are subject to 20% tax above Pounds 285,000. You cannot use this allowance again for seven years so plan ahead.
* Alternatively, take out an insurance policy in trust to cover the potential IHT bill on your portfolio.

© 2007 Times Newspapers Limited. All rights reserved.
Date: 04/02/2007
Publication: The Sunday Times