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Frozen tax allowances and inflation chill investors

One of the biggest concerns of recent years for many of our customers is the danger of the government introducing a wealth tax. Today, many of us face an even greater threat – stealth taxation.

The government need not afford the shame of introducing a new tax on wealth. It can do very well by freezing existing tax breaks. We have entered a fiscal ice age when it looks like it will hurt savers the most. Almost all base tax credits are frozen – some for several years.

Today inflation stands at 7.8 percent (including housing costs for property owners) and is expected to exceed 11 percent in October. Few of us expect last week’s rate hike to give a major boost to our savings. Savings accounts are so far behind inflation that your cash will halve in real terms in about 14 years.

Our research shows what the fees at the beginning of the fiscal year – April 2022 – would have been if they had followed inflation. More recent price increases are likely to exacerbate the damage from these tax freezes this year.

But let’s see where we are now. It adds up. The worst is the estate tax (IHT). The zero rate threshold has been frozen at £325,000 since 2009-2010. If it had increased in line with inflation, it would now be £427,951 – a difference of £102,951.

The no-stay IHT band has been frozen at £175,000 since 2020-21 and, like its partner, will remain in the fridge until at least 2026. Adjusted for inflation, it would now be £184,867. For a couple who die today, leaving behind an eligible estate that crosses the thresholds, the impact of these freezes could be an additional £90,255 in IHT. It could be as much as £110,666 if you think the nil home rate band should have risen in line with home prices.

In addition, we must not forget that the bond is reduced to the zero rate of the property, reducing the fee by £1 for every £2 an estate is worth more than £2 million. If that had increased in line with inflation, it would be £2,244,194 today.

As for life, one of the most hated tax barriers for my clients is the lifetime retirement benefit. It is considered not only punitive, but also diabolical and unnecessarily complicated. The threshold (frozen as of 2020-21) should now be £1,133,606 by our calculations. This could mean an additional tax charge of over £33,000 for those who exceed the limits and withdraw the excess in cash. And then we first look at the phasing out of pension contributions for high earners or the effects of sharp reductions in pension contribution limits over the past 20 years.

Income tax thresholds have barely risen since 2019, costing a base rate taxpayer £164 this year, a higher rate taxpayer £494 and a supplementary rate taxpayer £2,173. I have previously written about how those who earn between £100,000 and £125,140 lose £1 of their personal allowance for every £2 they earn over £100,000. These people actually pay a marginal rate of 60 percent tax on income within this bracket. As wages rise, more people get stuck in them.

The taper was introduced in 2010 and has remained at that level ever since. Adjusted for inflation, it should now start at £128,969 – a difference of £28,969. This means an additional tax cost of at least € 5,028 for someone who loses the full personal allowance.

What can one of us do about this?

Use your allowances

The obvious first step is to make sure you’re making the most of the benefits available – and if you expect to be affected by IHT, start planning now. If you’re retired and can afford it, consider getting more out of your general investment accounts and Isas than out of your pensions.

Money in a pension fund is currently shielded from IHT. Use any unused Isa allowance to shield money outside of a tax wrap to protect it from capital gains and dividend taxes. These tax-sheltered funds can also pass to a surviving spouse or registered partner.

Invest smart

Everyone has different circumstances and needs, but we generally recommend customers save up to two years of annual expenses in cash. Many rich people have way too much cash. In the past decade this has not been particularly problematic, but with current inflation it is.

You could say that investing in bonds and stocks has not been a smart move in the past year. But history suggests that the time to invest is the most painful. If you invest today, consider injecting money into investments to reduce the risk of bad market timing.

give it away

Your greatest gift to your children is not to be a burden to them. Make sure you have what you need — and remember when budgeting for potential health care costs later in life so they can rise with inflation and then some. If you have a surplus after that, consider giving it away.

The second major concern of most of my clients is the financial situation of their children and grandchildren. My generation feels blessed. Many of us had free college education, affordable housing, and final salary plans. To give a similar benefit to those graduating today would take a significant six-figure sum. Giving money is the topic of another day – it’s not as easy as it sounds – but it is now the subject of many client meetings.

To spend

Finally, what about publishing it? I’ve seen too many clients delay retirement because of the income or status that comes with a job, only to encounter life-altering events such as dementia and terminal illness shortly after they finally stop working.

I have a client who was successful enough to retire in his fifties. He and his wife travel the world and stay in Airbnb homes. Others have gone back to college; one is writing a book. I have enormous admiration for them.

Accumulating wealth is hard work. It shouldn’t become a burden to us once we’ve managed it, making us worry about preserving it. Remember that as your savings are eroded, your dreams become more expensive. Live the life!

Charles Calkin is a financial planner at asset manager James Hambro & Partners

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