Lifelong fixed mortgage rates of less than 4pc offer a way to beat death duties
For most retired households, the plunge in interest rates since the financial crisis – including last month’s arguably mistaken cut by the Bank of England – has been disastrous.
Returns on cash accounts have fallen by an average of 75pc just since 2012. So here’s a nice surprise. The one area where older, wealthier households can benefit from falling rates is in the field of lifelong mortgages. They are cheap enough now to have become a potentially effective way to avoid death duties.
Big providers are slashing rates by the week, down now to as little as 3.78pc fixed for life. And you can repay some of the debt as you go, meaning you’re able to limit the overall cost to your estate of the loan.
In essence you’re weighing up the certainty of inheritance tax on the one hand against the cost of borrowing on the other.
Say you’re aged 78, have a property worth £1m, ample pension income but modest additional savings.
You borrow £250,000 now against your home and give it to your children. Under inheritance tax rules, you need to survive seven years for this to fall outside your estate and thus escape the 40pc inheritance tax that applies to everything above your individual £325,000 allowance (£650,000 for married couples). There is also, to come in future years, an extra family home allowance – but let’s discount that for now.
The £250,000 you raise to give to your children would otherwise have triggered a £100,000 tax bill. So that’s what you’ve got to beat.
At 3.78pc (taking the current best rate from Legal & General), interest on £250,000 comes to about £9,500 a year.
You repay the maximum allowable 10pc of the original loan back each year (£25,000) out of surplus pension income, or your children themselves contribute from their incomes.
Say you die in seven years aged 85. Number-crunching by Key Retirement, a leading adviser in this field, puts the total interest cost (so excluding your capital repayments) at £52,999. You have safely avoided the tax liability and have made a considerable saving.
Say you die in 10 years, aged 88. Now the interest on the loan amounts to £65,199. Again, a worthwhile saving. If you die in 15 years aged 93, the interest comes to £78,489.
In this scenario you would need to live to age 100 – that’s 22 years after taking out the loan – for the total interest cost to narrowly exceed the death duty bill of £100,000 that would otherwise have been due.
Even if you did live to 100, meaning interest costs on the debt would total £101,766, do not forget that your children would have had the benefit of £250,000 for more than two decades.
Of course, as I’ve written before, this issue isn’t only about avoiding tax. It’s also about the potential value to younger members of your family
On a related subject, there was a time when I could ring up any accountant in the country and ask for expert assistance when writing a piece such as this, aimed at helping people pay less tax. Not any more. Lawyers and accountants don’t want to be publicly associated with anything that appears to encourage the practice of paying no more tax than the law requires.
A tone of righteous hysteria has crept into discussions of tax avoidance. Instead of attacking legislation – either for being poorly constructed or for taxing insufficiently – a moralising group (not only on the Left) is now rounding with McCarthyist fervour on those who wish not to pay needless tax.
This drift into regarding legitimate tax avoidance as immoral or a failure of patriotic duty is dangerous, because it clouds the real problems in our tax system: over-complex, vague and bodged legislation. Taxpayers shouldn’t have to cough up voluntarily for deficiencies in law. The famous judgment by Thomas Tomlin in the Thirties, while cliched, is true: “Every man is entitled if he can to order his affairs so that tax … under the appropriate Acts is less than it otherwise would be.”
Lord Thomas Tomlin, the High Court judge who famously ruled that taxpayers could legitimately ‘order their affairs’ to reduce their tax bills