This article was published in the May issue of Master Investor Magazine
Last month I mentioned Professor Parkinson's take on our tax system... “It's designed to tax income when you're living and capital when you die.” This time round let's look at what happens when we exit this mortal coil. On what has been called “Capital Punishment”.... taxing wealth you managed to accrue despite the best efforts of HMRC over the years.
A couple of quotes I came across again reminded me of what happened when, as an IFA (since January 1973), folks would come along looking for advice on their finances. Most of them just wanted to consider the short term. "How do I get better returns now? How do I beat inflation (which hit 26% year on year in 1975/6)? How do I pay less tax?” Always short term. The long term was, well far too far away to bother about and frankly was for another day.
Urgent or Important?
So what’s Urgent and what’s Important? Is there a difference? Former US President Dwight Eisenhower wasn’t in any doubt. He said “I have two kinds of problems: the urgent and the important. The urgent though are not important, and the important are never urgent.” American author Rick Warren agreed adding “The number one problem in our society today is short-term thinking.”
And that’s the problem for wealth builders today no matter their age. Investors still focus on what appears to be urgent or short term. They get sucked into must-have investment opportunities, or react to revolving headline worries, instead of focusing what’s important. For the avoidance of doubt, that’s long term goals and protecting themselves and their families against dying too soon or living too long-- proactivity as opposed to knee jerk reactivity.
There’s plenty written about what happens when you live too long and haven’t focussed on the important. Both here and in the US there’s hardly a week that goes by without one report or other discovering that far too many of us have hardly a bean to rub together when we reach retirement.
A study in the Wall Street Journal recently surveyed would-be baby boomer retirees asking what kept them awake at night. As you’d imagine for this age cohort (as I can confirm) sadly it’s not what it used to be. Approaching retirement their sleepless nights were down to either money worries (48%) or health concerns (42%). However while Jim Mellon so eloquently reminds us that science continues to make progress with rapid advances in healthcare leading to increased longevity, it’s difficult, if not impossible to make improvements to your wealth when you’ve already long missed the boat.
All this suggests that unless we start thinking soon about what’s really important, most of us will fall well short of a decent retirement income. So if I were you I'd have a good think about that today if it hasn’t yet occurred to you. Chasing the next small-cap ten- bagger, or panicking at each headline “worry” should be filed away under “looks urgent but not really important.”
The “art” of taxation
According to Jean Baptiste Colbert (1619 to 1683), Louis XIV’s precocious finance minister, the art of taxation “consists of plucking the goose so as to obtain the most feathers with the least hissing.” Let's also remember what US founding father Benjamin Franklin said over 200 years ago: “Nothing is more certain than death and taxes.” It’s still the case today. And as we live much longer on average these days it’s even more important to consider taxation as it’s far more complex than in Franklin’s day. Never mind Brexit - what about your own exit?
The UK Tax code today is 17 times the length of War and Peace and equally impenetrable. At 10 million words it’s 66 times the length of Hong Kong’s tax code, according to bean counters at Artemis. And a significant proportion of that complexity is to scoop up even more tax from us when we exit this mortal coil.
Tax on death has been around formally in the UK since 1894. Prior to 1975 it was called Estate Duty, more popularly known as Death Duties (though not popular with families short-changed by it no doubt). It was a nasty tax because it taxed the deaths of both husband and wife. That stopped fortunately when it was replaced by Capital Transfer Tax, but the top rate of that tax was 75%. So the next time you moan about Inheritance Tax (IHT) (which appeared in 1986) be thankful it's a flat 40%.
Because we don’t pay attention to what's important, because we’ve “plenty of time to think about” our exit, and because IHT triggers on the second death of Spouses and Civil Partners, penalises heterosexual couples plus those not bothering with a will, IHT tax receipts are exploding. Last year HMRC pocketed £4.9 billion, up 150% from only
15 years ago.
Where there’s a will there’s a way
So first up, get a will written. It’s astonishing how many intelligent and wealthy folk still don’t have a will. Or if they do they haven’t bothered to update it for years. And as mentioned above, heterosexual couple with a few bob you are especially vulnerable to IHT thanks to far fewer reliefs and rights.
Even billionaires have been known to assume it’s not important to get a suitable will drawn up. Twenty seven years ago Australia’s richest man Robert Holmes died of a heart attack aged 53. He’d allegedly carried around in his briefcase for a year a draft will which he never got round to signing. He died intestate leaving tax authorities, advisers, his wife and four kids to fight over the spoils. His profession? He was a lawyer!
My tax colleagues tell me surveys still show that between a third and forty per cent of folk die intestate. Lawyers are among the worst I’m told. Something up here in Scotland we call “Cobbler's Bairns.” Some years ago at an Investment Trust dinner I shared a table with Scotland’s great and good. From a table of ten only one admitted to having a will. (It was a fairly boring occasion so the discussion on death sprung up as some light relief).
Regardless of whether it’s Scots or English law, if you die without a will you’re leaving one hell of a mess for your family - long delays, unwelcome complications, and most probably a tax bill that would have you turning in your grave. Dying intestate and without any sensibly thought-out plan is like running through a dynamite factory with a burning match.
So do yourself a favour. Go get advice. Get that will put in place now. And make bloody sure there are no horrible surprises for those left behind. Make sure there's access to funds for those left behind carrying the can. If you don't like the idea of much of your hard earned wealth being grabbed by HMRC: do something about it. Simple and cheap life assurance in trust is uniquely effective at providing liquidity and avoiding IHT.
Any idea what it’s like to be left behind with an estate locked up for a year or more? It gets even worse if HMRC reckon there’s an IHT bill to pay. And if the next Government brings in the stiff increased charges for probate there’s another bill to pay. This is all important and urgent stuff to see to. Stop kidding yourself, start today.
Got extra to give away now?
In the good old days (before 2006) if you wanted to give away to the next generations while keeping control it was customary to use trusts. This was not the typical discussion subject at dinner but trusts were pretty effective in reducing tax. Alas, not any more thanks to Gordon Brown and George Osborne.
Those who specialised in setting trusts up and looking after their compliance requirements may not like it, but with top rates of income and capital taxes applying these days, setting up new trusts to give assets away to the following generations is back to running through the dynamite factory with a lit match. Not a good idea.
As Brexit approaches, however, it may make sense to learn a tax efficient lesson from our European cousins (who had no trust legislation) in how they've coped with transferring wealth to the next generations with some control.
As hinted above, in the UK such transfers have worked in the past through legal structures such as “Accumulation and Maintenance Trusts.” Not any more - unless you're happy to watch HMRC pocketing even bigger slices of the kitty.
Who wants to see children or grandchildren get unlimited access to your money when they're young? In the old days even having access at age 25 for some was too early, dangerous even. But changes to trust laws mean that to avoid extra taxes they would have full access at age 18. Sounds like the dynamite factory again. So does Europe offer escape?
Brexit and tax planning
Inheritance planning is big business in Germany, Spain and Italy in particular where wealthy investors are just as keen to pass wealth on to future generations to avoid capital taxes on death. Not hidebound by the inflexibility, tax inefficiency and high costs associated with UK trusts it's no surprise their alternative solution is attractive. What may come as a surprise to UK residents is these flexible efficient plans (based on mainstream insurance regulations) have been available to them under EU cross-border rules. And there's every chance they will continue to be attractive long after Brexit.
What are these little known plans? One we have used for a few years now very successfully is “The Accumulation and Maintenance” plan marketed by Luxembourg based wealth management group Lombard International Assurance, who are subject to the strongest investor protection regime in Europe. It has almost £78 billion under management and is probably the leading product innovator in European inheritance planning.
Avoiding the constraints now imposed on UK trusts, it uses life assurance law instead to provide a simple tax efficient solution to anyone in the EU who plans to gift wealth to the next generations. The gift is still a Potentially Exempt Transfer, and it lets you, the donor, choose the age that the inheritance passes to them with no age or time limit. So control is maintained. Income rights can be passed on too.
So, for example, funds can be gifted using the plan to provide a “legacy” pension for them at say 55 or later to assist their retirement income. Or a number can be set up in sequence with an aim to cover house deposits, marriage, retirement and so on.
Such plans make clever use of insurance law. Which brings us back to Brexit. In the UK a contract's taxation follows its legal status. This means if a single investment life policy of a UK resident client of Lombard is legally regarded by the UK Government, no distinction is made between EU or non EU insurers. So the taxation of the policy (and benefits) will not be adversely affected in future even if it originated in the EU as in the case of the Lombard solution.
Thanks to the Luxembourg base the plan rolls up free of Capital Gains Tax, so the underlying investments - a wide range of collective funds - can by managed without UK trust CGT constraints, and there's only internal withholding taxes on reinvested income, not top rate UK income tax.
It is regarded that this simple tax and IHT effective gift alternative using straightforward insurance contract laws will continue to be valid long after Brexit comes along, whenever that is, now we have another election in the way.
"I Love EU" sang the Super Furry Animals (I'm assured by a younger friend). Even the most fervent Brexiteer will surely love the simplicity of this EU inheritance planning tool both pre and post Brexit!