The news that individual savings accounts (Isas) are to remain a permanent feature of the UK’s tax-free savings landscape has been greeted with muted enthusiasm. While financial planners are pleased that Isas will remain with us, many were disappointed that the Government did not commit to raising the annual allowances from the current £7,000.

Moreover, figures from the Way Group, a firm of investment managers, suggest that many savers, in particular the elderly, are in danger of being hit by inheritance tax (IHT) charges because they hold on to their Pep and Isa savings for too long. The Way Group’s figures suggest that about 165,000 investors aged 70 and over have Pep and Isa portfolios worth at least £100,000.

Paul Wilcox, Way’s chairman, says that many investors are hanging on to these Pep portfolios without appreciating the tax position. “Investors have been seduced by the Government into accumulating investments within a ‘tax-free’ wrapper,” he says. “But many do not realise that their hard-earned savings suffer a punitive IHT sting at death, whereby their families potentially lose 40 per cent.”

Many older investors hold significant equity-based investments within their portfolios but have made no provision to transfer these portfolios into alternative schemes to shelter their savings. Mr Wilcox says: “It is worrying that so many investors do not gift their portfolios into a flexible trust for their beneficiaries,” While the rich tend to take IHT planning seriously, it is often families with more modest — if still significant — wealth that tend to lose out.

Gordon and Rose Johnson, of Bridgend, South Wales, are a case in point. The couple, both 74, have accumulated considerable assets over the years, using their maximum Pep allowances and switching to Isas in 1997. The couple, who used to run their own business manufacturing rehabilitation equipment for the disabled, have built up a portfolio worth about £250,000 in Isas and Peps alone.

Although they have already taken care of standard IHT planning, including the setting up of discretionary will trusts, they are concerned about the IHT bill that their two daughters could face.

“The money has been hard to come by and we want to protect it as much as possible,” Mr Johnson says. The couple’s independent financial adviser, Richard Harry, of HHPG, has advised the Johnsons to encash their tax-free plans. Mr Harry says: “The benefits of income tax and capital gains tax relief provided by the Pep and Isa portfolios are likely to save about 1 per cent a year if the money is fully invested in fixed-interest funds. But this short-term benefit compares with a 40 per cent IHT charge that the estate would suffer under present arrangements.”

One way to avoid the tax charge is to encash up to the nil-rate band (£285,000) of the Pep and Isa savings and gift the money in a flexible trust. Assuming that both Gordon and Rose live for a further seven years, this money will then fall outside of their estate.

Mr Harry recommends the Way Flexible Inheritor Plan, which allows the donors access to their money, as well as gifts or loans of assets to beneficiaries. “This is useful if long-term care is needed because the costs can then be withdrawn,” he says.

Encashing Peps and Isas is less painful from a tax point of view than encashing investments that are not held within tax-free wrappers, since there is no capital gains tax to pay.

Mr Harry believes that by moving their money from Peps and Isas to a scheme to mitigate IHT, the Johnsons may be able to save more than £100,000. He says: “Many clients think that their savings are already in a tax-free environment. But if the estate values are substantial, savers are merely growing their investments for the Chancellor to take advantage of it.”

He advises savers to use their full Isa allowances through middle age. “When you get to your sixties and seventies, depending on your capital, you need to look at estate planning and switch to an IHT-mitigation arrangement.”

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