Charegable gains and personal allowance revisited - a nasty shock

grey_gym_sock

the whole top-slicing method of taxation is very strange. you've been caught by a unlucky aspect of it. but then you can win or lose massively from it depending on what tax band ends up applying; such policies are generally taken out with the aim of cunningly getting a lot of income taxed only at basic rate, so you can't really claim that the aim was to pay the right amount of tax and you got stung: the aim surely was to minimize tax, and it backfired. the lesson i'd learn is to avoid using products which are taxed in such a complex way.

actually, another unnecessary complexity is the whole idea of withdrawing the personal allowance, as opposed to having a 60% tax band for the slice of income above £100k. and that's not something you can opt out of.

thelordgiveth

Grey Gym Sock

The aim was quite different, namely to put the policies in trust and thus exclude them from the scope of IHT. Still a positive outcome even with a higher rate income tax hit.

I agree that top slicing has its downright bizarre aspects but it's not actually the top slicing that is the problem as such. It is the change, made 24 years after the policies had been taken out, to the way such chargeable event gains impact on the personal allowance. That then impacts on top slicing, if the gain is large enough.

Your reference to "the right amount of tax" is a bit odd on forums which have an awful lot on them about minimising your tax burden. The aim was to pay the right amount of tax according to the law as it stood for most of the lifetime of the product. What I've been stung by is effectively a retrospective shifting of the goalposts. Apply it to new investments, fine. But applying it to longstanding investments which (in all probability, though there is a deafening silence so far on this point) the investor can do damn all about? There are probably plenty of others who will be hit; what about some advice for them on what to do now?.

I suspect that many of those regularly earning over 100K a year would find a way of opting out of a 60% tax rate. But not someone whose income is of normal levels but gets a massive boost in one year from a chargeable gain.

grey_gym_sock

i don't understand the IHT position. you said earlier that this tax hit reduced the estate, so effectively only 60% was lost - but now that the idea was to exclude the policies from the estate.

on "the right amount of tax" ... you were both asking for practical advice about minimizing tax, and suggesting it's a bit unfair. i was replying to the latter. the main point of this forum is definitely the former.

though it's not entirely clear-cut, i wouldn't call this retrospective taxation. you wouldn't call it retrospective if tax rules change while somebody is in the same job, and the new rules apply to their future earnings.

on how to avoid this issue if somebody else has a similar policy ... my best guess (and i don't know much about this) would be to surrender parts of the policy in different tax years - if that's possible.

if earning over £100k, the most obvious way that i know of to avoid the 60% is to make higher pension contributions. though this is not so useful for ppl with mostly investment income and pensions, rather than earnings.

thelordgiveth

Grey Gym Sock

One of the problems here is that things fold back on themselves!

The proceeds of the policy are indeed outside the estate, but additional income tax bill will have to be paid from the estate, thereby reducing the amount of IHT to be paid (there is a question on the IHT form to which you respond with the net amount due, which then gets deducted from the estate; of course more usually it is a tax refund). So (not quoting actual figures) if the tax hit is £10K, the estate is reduced by £10K and the amount of IHT due is £4K. The net hit to the eventual beneficiaries is thus £6K rather than £10K.

I entirely agree about "future earnings", and I did say that it would be perfectly fair to apply the amended rules to new investments. Logically, though, most of the chargeable gain was built up before the rule change (as the annualisation of the gain for top slicing calculations implicitly accepts). The illogicality comes in treating it all as one year's income for personal allowance purposes. That's why I see it as sort of retrospective. But we're talking taxation rules here, not logic!

I believe my father did surrender parts of some policies (is it 5% per year that's allowed?). It's not clear to me whether doing more at age 91 would actually help much. I can't pretend to understand the implications but would it then count as a gift within seven years of death and thus be liable to IHT? Or perhaps not if it is in trust - my head is starting to hurt at this point.

I agree that pension contributions have traditionally been a way of reducing the higher rate tax hit, though there is talk of tightening up. The trouble is that there are options available to individuals with regular high income who can afford to have financial advisers on tap. It's not an option for those on more modest incomes who find themselves caught in the situation I have described. That's part of my reason for posting in the first place, to warn others and see if anyone has bright ideas about how to help them (I'm altruistic at heart, really!). Ideally I would have liked someone to say "oh yes, that happened to me and I got HMRC to change their mind by..." but that seems like fantasy.

Thanks for your answers, anyway.

Cook_County

The correct advice is to ask the trustees why they failed to address their duties. Similarly any attorneys appointed lifetime. As executor this is your fiduciary duty; you have no choice in relation to the beneficiaries but to go down this route; otherwise the beneficiaries may well end up coming after you.

thelordgiveth

Cook_County

Oh, right. As executor I should ask the trustees why they messed up on behalf of the beneficiaries. Except the beneficiaries and the trustees are exactly the same two people, one of them being me.

You also seem to be very sure that someone has messed something up but you haven't even started to explain how. Until the 2010 Finance Act this loss of the personal allowance thing wasn't an issue. Do you have some suggestions as to what action the trustees could have taken to improve matters after 2010, rather than just assuming there must have been something? That would perhaps be of more practical help to other than telling them that they really must pay professionals.

I appreciate all replies, but it's hard work sometimes!