Russell Bruce argues that tax allowances on savings should help the many and not just the few
Lord Ashcroft’s national polls have not shown any great post-Budget boost for the Tories. Labour and Conservatives remain locked in a tight spot with both on or around 33-36 per cent support.
George Osborne produced a clever budget just before the official election campaign begain, aimed at being more “inclusive” – but only to a limited extent. No increase in tobacco, wine, or fuel duty, personal allowances raised, a modest increase in a tax on banks raising £900 million, restricting pension savings tax relief to a £1m lifetime allowance – how populist could he get?
But the real story is buried in the history of Tory budgets with not a little help from Labour chancellors over the years. This ‘secret’ millionaire tax envelope has made around 200 people millionaires who pay no tax on earnings from their £1 million portfolio.
With the changes Osborne has made during his period as Chancellor the numbers using this tax envelope to become millionaires are set to rocket.
Lots of people have these and when I tell you these are known as ISAs you will know what I am talking about. Encouraging people to save is a good idea, but do ISAs need to be as generous as Osborne has made them for those with large amounts of disposable income?
Tory Chancellors started the process off and Labour kept it going
Back in 1987 Nigel Lawson introduced PEPs (Personal Equity Plans). In the first year you could put £2400 into your PEP. Capital growth, interest and dividends were tax-free. It was slow to take off, but through successive Tory chancellors Major, Lamont and Clarke the annual allowance grew to £9,000.
The £9,000 rate was set for the first tax year of the incoming Labour government in 1997. Anybody who had taken full advantage of the allowances from 1987 to 1998 would have been able to shelter a total of £88,200 with interest, dividends and capital gains growing the value of the portfolio and all tax free.
Brown changed the rules and this was when the scheme became an Individual Savings Account (ISA). Brown cut the allowance to £7,000.
First ISA millionaire is a former Thatcher government minister
By 2003 Lord Lee, a former Thatcher Tory minister and now a Liberal Democrat peer, had become the first ISA millionaire. The Telegraph reported that the total amount John Lee, Baron Lee of Trafford, had invested was just £126,000. The remaining £874,000 was achieved from investment growth. Lee described his approach to savings as ‘patient, brick-by-brick investing and, very importantly, dividend reinvestment’.
The Telegraph added, “Lord Lee has stuck to individual shares, rather than funds, and has favoured conservatively run, family-controlled businesses.”
Lord Lee was clearly extremely successful in his choice of investments, but the important part is that he reinvested all his dividends by buying more shares. Any investment analyst will tell you that reinvesting dividend income will over the years deliver stellar results.
But the story goes on and on. In 2004 the allowance was due to be cut to £5,000 with the 10% dividend tax deducted before payment into the ISA. With an election looming, Gordon Brown reversed the decision to cut the allowance and restored it to £7,000 a year.
Alistair Darling increases the allowance just before 2010 election
Brown’s success, Alistair Darling, maintained the allowance unchanged until the tax year ending April 2008 and increased it to £7,800 for 2009. Darling then increased the allowance to £10,680 for people over 50 for the tax year ending April 2010. With another election due, the timing of Darling’s largess was obvious – the ‘party of the working class’ was reaching out to the more affluent sections of society.
During Labour’s years in power another £98,200 was added to the ISA tax shelter. George Osborne inherited the £10,200 rate and increased it each year until the annual allowance stood at £11,520. In last year’s budget he announced that is would rise to £15,000 from July 2014 for the tax year just ending. Osborne has raised it to £15,250 for the tax year starting on April 6.
Altogether, those who had been able to use the maximum annual allowance would have been able to save up to £250,130 in this tax shelter with no tax paid other than the 10% deducted from dividends since 2004. And you can take the money out tax free in later life when you need it. Under new rules announced by George Osborne you can also, from the start of the new tax year, pass the nest egg onto your family on death.
But it just gets better. A couple each have the same annual allowances so those with ample disposable income from high salaries or family wealth would have been able to put away a total of over half a million pounds. Smaller allowances, currently £4,000, are available for the children and grandchildren in a Junior ISA, which replaces the Child Trust Fund.
Encouraging people to save is a good thing, but are the scale and restrictions on these allowances fair to those of more modest means? If you do not use the annual allowance you lose it. Very few people have this level of disposable income to invest every year, especially at the new hiked levels Osborne has introduced.
It would be much fairer to introduce a lifetime allowance, as is the case with pension contributions. Osborne reduced the pension lifetime allowance for tax relief at marginal rates from £1.5 million to £1.25 million last year, and in his latest budget reduced it to £1 million.
An ISA lifetime allowance would make little difference to most people, but it would enable more to participate when they had a particularly good year, sold a property, received an inheritance, a life policy matured or their 25% pension tax free lump sum arrived.
Rather than create more and more ISA millionaires – there is already one investor with a £2 million ISA pot – it would be far fairer to allow rolling allowances – perhaps for 5-year periods.
Turning tax-free gains into permanent tax free earners
There are other allowances that help the better off shelter tax. Everyone has a £11,000 capital gains tax exemption allowance for the 2014/15 tax year, rising to £11,100 from 6th April. How many people do you know who are able to take advantage of this?
But for the lucky ones, help is at hand. To stop the capital gain earning taxable investment income in future, simply use it as part of your ISA allowance and what it then earns, for all time, is tax-free.
Running out of savings in 7 years
As Money Week’s editor wrote recently, a £1 million pension fund will buy an all singing, all dancing, index linked pension of around £26,000 a year. He bemoaned the cut in lifetime allowance to this miserable amount. Well he would wouldn’t he ?
How many would be delighted to have a pension of that size? There is clearly no need to continue to offer tax relief on a pension pot of that size. And there are options available. An alternative is to take the 25% tax-free allowance, continue to invest the remaining £750,000 and draw down the income, which would amount to between £22,500 and £30,000 based on a 3- 4% annual return. The original capital is still available instead of being traded for an annuity. The principal works just as well for those of us with much more modest pension provision.
One area of pension saving that has been growing in popularity in recent years are Self Invested Pension Policies (SIPPs). HSBC did research on retirement savings a couple of years ago. The average person in the UK will be retired for 19 years, but for most their savings will run out after 7 years. The UK’s 12-year shortfall was the highest of the 15 countries HSBC researched.
How the less well off can get money out of the Treasury
There is an interesting aspect to tax allowances that too few people know about. Those retiring should and need to think about income in later years if they have managed to put something aside or currently have a pension income that leaves a bit spare.
Every UK citizen has an allowance of £3,600 a year that they can put in a SIPP up to the age of 75. You do not need to be a tax payer, all you have to do is open a SIPP with one of the major providers and pay in £2,880 and the Treasury will top this up to £3,600 within a couple of months. You can also make monthly payments. The £720 the UK government adds represents 20% tax relief on the total. For you, this represents a 25% return in the space of weeks, which you can then invest in a range of financial funds, stocks and shares, bonds or just get paid a ridiculously low interest rate for keeping it in cash. Try getting that return from your building society.
Anybody interested in this must investigate it thoroughly. This is for information and not personal investment advice. With the end of the tax year looming, anybody with savings earning little in a low interest account has the opportunity to put in £2,880 before the 5th April deadline and another £2,880 during the course of the next tax year. Total investment £5760, total input from the UK government £1420 and the total in your account now £7,200 with no risk whatsoever. The rich have been doing this for years, but few, who could really benefit from the Treasury’s largess know about it.
Your provider will charge a fee on a SIPP account and this should be no more than 0.45% a year on investments with no charge for holding in cash.
Helping people to save is good for people and good for the economy in the long run
Both ISAs and SIPPs are good savings products and the changes in recent budgets have made these simpler and more flexible. The argument I have is we do not need to be so generous to those already wealthy, but make these savings products more accessible to those on lower incomes. I would further argue that the tax allowance on pensions should be made available to small ISA investors to enable more to provide for their future.
This would be a better use of scarce Treasury resources than continuing to heap benefits on the already wealthy in this age of austerity with penal welfare systems inflicted on the most vulnerable.
I started with opinion polls and will end with this observation. According to opinion polls about 15% of Scots intend voting Tory this May. With a 65% turnout that could amount to around 600,000 Conservative votes and I have a question for them. How many of you have the financial wherewithal to take full advantage of the very generous provision these tax shelters provide?
A few thousand at most, would be my estimate. So my next question for Tory voters is – should you really be voting for a party that is mainly concerned with those well above your own financial status?
