Over the last couple of weeks, I’ve been speaking with advisers about Rachel Reeves’ second Budget – looking at both the economic backdrop and the increasingly opaque, increasingly unprogressive direction of the tax system.
And while it’s tempting to focus on the Chancellor’s tricks, tweaks, and trip-ups, the real takeaway is simpler: robust financial planning matters more than ever. When I tallied up the impact on my own finances, I realised the Budget has shaved over £60,000 off my net worth. How do I arrive at that number?
Inheritance tax: the frozen threshold effect
Freezing the IHT threshold at £325,000 for the next five years will see its real value decline by the cumulative effect of inflation. Using the Office for Budget Responsibility (OBR’s) figures for the Retail Price Index (RPI) over that period, I make the cut in the real value of the threshold to be £44,324.
That translates to an extra £17,729 IHT down the line. I’m 65, and while optimistic, I’m not betting on immortality – or on this threshold being put back up in real terms. For many clients planning to pass on wealth, this is a very real loss.
Income tax allowances: a slow squeeze
In the same way that IHT thresholds are being eroded, the same thing is happening to the tax-free Personal Allowance and the Basic Rate Income Tax band. Cumulatively, inflation is expected to chip 15.8% off both, over the next five years.
For a higher rate taxpayer, that means:
- paying 40% on £1,715 more, costing £686 in cash (from erosion of tax-free element)
- 20% on an extra £5,143, giving £1,028 less in cash (from erosion of basic rate band)
Together, that’s an overall loss of £1,700 of cash income a year for a higher rate taxpayer. For a 70-year-old, that’s broadly equivalent to a capital hit of around £50,000. A more exact figure depends on your personal annuity rate and/or drawdown rate among several other assumptions.
The direction of travel is clear: thresholds stay still, clients fall into higher tax bands, and disposable income quietly shrinks.
So, what should clients do?
The ‘behavioural’ response is to do nothing and see what happens. But if you assume these hits are inevitable, is there a more proactive approach?
Of course, it all depends on individual circumstances, but I suggest this is a strong prompt to do some simple estate planning for those clients with investment assets greater than the aggregate of their lifetime needs for consumption with a decent amount of contingency, headroom and capital covering capacity for loss.
If excess wealth is left untouched, there’s a good chance it will eventually be taxed at 40%.
And that’s where advisers can add real value. Here are two ideas to consider.
Student loans: the hidden double hit
I don’t like to see the explosion in the amount of debt many young people are carrying. A real evil of this Budget in my eyes is the freezing of the student loan repayment threshold which means a double hit to those paying them off:
- their tax allowances shrink in real terms
- more of their income is captured for loan repayments
Contributions to the Student Loans Company from the Bank of Mum & Dad (or Granny and Grandpa) mean a lot to young adults, looking to cover their mortgage or childcare. Unlike a gift of cash which might be wasted, loan repayments generate a continuing bump up in net pay.
Using pension contributions to support the next generation
Another powerful tool for those with excess wealth to create long-term benefit for offspring and grandchildren is to make pension contributions on their behalf.
For young adults edging into the higher rate tax band, the benefits are twofold:
- long-term savings they can’t access (or accidentally spend) until age 57+
- a valuable tax credit on the contribution - sometimes arriving as a direct HMRC repayment
A rare moment where everyone can say: Thanks, Mum. Thanks, Dad. Thanks, Financial Adviser.
Helping clients build long term family wealth
At Parmenion, we can help set up SIPPs, Junior SIPPs, and regular contributions, helping clients turn these ideas into long-term benefits for their families. Feel free to contact us today if you need a helping hand.
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Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.