Looking after the family finances in the aftermath of the pandemic

A review of the 2021 Budget in the context of other thinking

If you have read my discussion of the Wealth Tax proposed by the Wealth Tax Commission in my previous article you will know that I am concerned at the likely financial cost, to a minority of moderately wealthy families, of the pandemic.  In this article I look at the effect of the 2021 Budget proposals (the ‘Budget Report’) to try to guess the ways in which this Government will raise further funds in later years.  The message to take away is ‘Don’t delay, this may be your last chance to save the family finances’.

    ‘Don’t delay, this may be your last chance to save the family finances’.

    First, some moral issues.  At this tax consultancy, we have always striven to calculate, and arrange for clients to pay, ‘the right amount of tax’.  We have never advocated the use of highly artificial schemes.  We concentrate on using the network of rules and exemptions that are clearly set out in the legislation.  If that involves detailed work, so be it; but we keep within the law.  We do not put forward ideas that are likely to fall foul of the General Anti-avoidance Rule.

    The context for our clients

    Many of our clients are family men and women.  Many of them are, shall we say, no longer in the first flush of youth.  Many have built up businesses and savings.  If they have read the other articles on this website, they will be concerned that, in due course, they will be asked to contribute substantially to paying down the debt incurred by the Government in supporting people during the worst of the pandemic.

    What may be new for these families is how close they have come, this year, to needing Government help.  Children who secured good academic qualifications and employment have seen their jobs vanish and have been on furlough, with no certainty of returning to full-time work.  Suddenly the way that public money is spent means more to the elderly population than it did before.

    The pandemic has hit those who rely on savings and investment income

    The pandemic has hit those who rely on savings and investment income.  Tenants have been unable to afford rents and have secured reductions.  Companies have postponed or cancelled dividends.  Whilst those on final salary pensions, such as retired public sector workers, will have kept their income, most other pensioners will have had to manage on less or draw on capital to make good the shortfall.

    ‘Scarring’ and other possible effects of the pandemic

    ‘Scarring’ is the term used to describe the situation in the economy that may arise where the money that people have not been able to spend, because shops and cafes were shut, never in fact gets spent.  People lose confidence and hoard cash.  That behaviour may delay the recovery.

    In a different way, those who rely on rents and dividends, and who have had to dip into capital, may well underspend to make good the shortfall.  They may fear the return of the virus.  That will also slow down and economic recovery.  That in turn depresses tax revenues. 

    They may fear the return of the virus…  That in turn depresses tax revenues. 

    The Budget Report describes how our spending has fallen over the last year and hopes that it will recover; but still puts the effect of scarring at 3% of Gross Domestic Product.  It sees domestic spending as being subdued now, but rising in 2022.

    Where does tax money come from and where does it go?

    Very roughly, the Budget Report tells us that Income Tax brings in 24% of public revenue, followed by VAT and National Insurance Contributions at about 18% each.  Excise is about 6% and Corporation Tax about 5%.  The two taxes that trouble our clients the most, namely Inheritance Tax and Capital Gains Tax, do not bring in enough to be mentioned as shares in the relevant table in the Report.

    The Government spends roughly 34% of its money on ‘social protection’ and on ‘personal social services’, 23% on the NHS and 12% on education.  The Budget Report does not break that figure for social protection much but it probably includes the State pension.  Expenditure is currently much greater than income.  The chancellor has made it clear that that is just not sustainable in the long term.  Money must be found to pay down debt: that is where you and I come in.

    Money must be found to pay down debt: that is where you and I come in.

    What are the Budget proposals most relevant to private individuals?

    After explaining the support for people for as long as the pandemic lasts, the proposals are, broadly:

    • to get borrowing back under control;
    • to freeze the thresholds for personal taxes;
    • not to increase the rates of VAT or Income tax just now;
    • to increase Corporation Tax, whilst keeping the rate for smaller companies low; and
    • to spend on training and skills.

    IHT

    The Nil-rate Band (‘NRB’) for IHT is frozen at £325,000 until 2026.  The Residence NRB is frozen at £175,000 until 2026.  The point at which estates begin to lose RNRB is kept at £2,000,000. 

    CGT

    The Annual Exempt Amount for CGT is frozen at £12,300 until 2026; and the figure for most trusts is kept at £6,150 until 2026. 

    Income Tax

    The personal allowance goes up to £12,570 but stays there until 2026.  The points at which tax becomes charged to higher rates will be frozen until 2026.

    NICs

     The thresholds for NICs will go up in the year 2021-22 but will then be frozen.

    Pensions

    The Pensions Lifetime Allowance is frozen at £1,073,100 until 2026.

    Savings

     The first £5,000 of savings income still escapes tax.  The ISA contribution limit stays at £20,000 whilst that for JISAs and Child Trust Fund accounts stays at £9,000.

    What about a savings product that the public might support?

    What about a savings product that the public might support? The Budget Report mentions the proposed issue of Green Gilts and a Green product from N S & I.  That may in part steal Keir Starmer’s thunder, in that he advocates some kind of savings product aimed at the unspent savings currently held by individuals.  The main difficulty is that the government simply does not need to pay the kind of interest rate that would tempt the public.  To offer, say, a three-year bond at 4% to pensioners might gather some votes but would prejudice taxpayers generally.   

    Will these measures pay for the pandemic?

    It doesn’t look like it.  The forecast yield from the major proposals for changes to present tax levels looks like this (figures are in millions).

     2020/212021/20222022/232023/242024/252025/26
    Income Tax0negligible1555365557908180
    VAT0055125135165
    IHT01570165290445
    Pension LTA-1080150215255300
    CGT0negligible5102030

    As you can see, the real weight of the changes affects income rather than capital.  That emphasis helps those who are ‘asset rich but cash poor’.  That is perhaps what you might expect of the Conservative Party.  Meanwhile, HMRC will take on more staff and will put them to work going after promoters of tax avoidance and in policing compliance generally.  That must be right: it cannot be fair that most taxpayers observe the rules whilst a few flout them.

    That emphasis helps those who are ‘asset rich but cash poor’. 

    So what about the Sword of Damocles hanging over moderately wealthy families?

    Believe me, it’s still hanging there.  All we have at present is a stay of execution.  The 2021 Budget does not remove the threat of reform of CGT.  It does not remove the possibility of a Wealth Tax.  The Government has decided that this is not the time to raise taxes sharply, merely to let the tax yield rise gradually with inflation.  That may not be enough.

    Consider the document ‘Reform of inheritance tax’  (‘IHT Reform’), published by the All-party Parliamentary Group on inheritance and intergenerational fairness (‘APPG’).  At page 5 of IHT Reform the first option that they examined was to do almost nothing and to retain the present tax.  That is, of course, exactly what the Chancellor has just done.  Given the current pressures on his time, that is understandable; but the APPG felt that the strength of public feeling and intergenerational issues mean that ‘this is no longer a tenable option’.

    The second option considered by the APPG was to ‘tinker’ with the tax but they felt the Government should be bold and move to a tax that reflects changes in modern society.

    A new flat-rate gift tax or a successions tax?

    The option preferred by the APPG was to replace IHT with a new flat-rate gift tax or a successions tax.  As with my review of the proposed Wealth Tax, there is no substitute for reading the whole of IHT Reform but some of my readers may lack the time to do so.

    What might that new tax look like?

    It would be at a relatively low level, so that it was not really worth trying to avoid it.  With that low level, there would be little need for exemptions.  It would be a flat-rate tax on all lifetime gifts.  The rate would be around 10%-20%.  There would be an annual exemption of £30,000.  There would however be no Nil-rate Band in lifetime.  There would be a ‘death allowance’ of £325,000.  There would be no tax-free uplift on death for CGT.

    This new tax would be levied on all assets, including farms and businesses.

    Exemptions would remain for transfers to spouses (or civil partners) and to charities.

    Alongside the new tax, there would be a reporting regime for all gifts over £10,000 in value, to help HMRC get a feel for what is really going on in the economy.

    How different would that feel?

    Tax advisers would notice the difference, but few would shed any tears for them. Forms might become much simpler.  Dealing with an estate on death might be significantly simpler.  At present we have a situation where, for example, calculating the IHT on an event affecting a trust can actually cost more than the tax in issue.  That cannot be right.

    Dealing with an estate on death might be significantly simpler.

    The big changes that families might notice are these. 

    Farms and farmhouses 

    Relief is currently available at 100% or at 50%.  That would go.  Tax may be paid by instalments.  It would no longer make any sense for a wealthy person to choose to live in a farmhouse mainly in the hope of securing relief from IHT.  That would affect land prices.  Land that had been kept with houses, just to make them look like farmhouses, would be sold off to ‘real’ farmers nearby.

    Shares and other investments in small trading companies

    Relief is available at 100% or at 50% on certain business assets.  Over recent years, investment houses have exploited the relief to construct portfolios for passive investors.  Without the relief, the values of those shares would fall overnight, since the market for them is narrow and many have yet to establish strong balance sheets.

    Without the relief, the values of those shares would fall overnight.

    Family trusts

    At present, an individual may, without immediate tax charge, settle up to £325,000 into a lifetime trust for, say, the educational costs of grandchildren.  That would go: any gift to a trust would be taxed like a gift to an individual.  There would be an annual tax on discretionary trusts.

    Long-term assets pregnant with gain

    At present, such assets are kept in the family until death, to secure the tax-free uplift.  That would go.  Instead, the person inheriting the asset would take over the historic cost.  On eventual disposal, the entire gain would be taxed.

    So what can a prudent family do today?

    In brief, a great deal more than if the Chancellor had brought in wholesale reform in the 2021 Budget, as advocated by the APPG or by the Wealth Commission.  The present system is indeed complicated and outdated; but many advisers (the better ones) know their way around the present rules.  Any family with significant assets should:

    • make a list of what there is;
    • think what is most important to their family; and
    • get advice.

    It must make sense to use the exemptions and reliefs from IHT and from CGT that currently exist, before they are removed.  Failure to plan leaves the family open to the risk of a big and nasty surprise.

    Failure to plan leaves the family open to the risk of a big and nasty surprise. 

    Put yourself in the position of the Chancellor.  He does not want to raise taxes yet, but will need to do so before long.  He has made no commitment not to raise IHT or CGT.  Wealthy families are ‘ripe for plucking’.  If the Chancellor did intend to bring in either a Wealth Tax as described in my earlier article, or a Gift Tax as suggested by the APPG, would he tell Parliament (and the public) beforehand?  It was a specific feature of the proposed Wealth Tax (see my article) that ‘Doomsday’ might be defined as a date before the tax came into effect, to prevent forestalling action.

    Taking all this into account, we may currently be in a unique position to put in place tax-saving transfers that escape the new rules when introduced.

    If the Chancellor did intend to bring in either a Wealth Tax, as described in my earlier article, or a Gift Tax as suggested by the APPG, would he tell Parliament (and the public) beforehand? 

    Let’s work together