By Jorge Morley-Smith
It was an exciting Summer Budget for savers. Other than the introduction of a National Living Wage, the headline announcement was a wide consultation on pensions tax relief.
This consultation calls for a simple and transparent tax regime that will help accentuate tax incentives for long term saving; increase personal responsibility for saving; and enhance people’s engagement with the savings products that they buy or are auto-enrolled into.
But there were other measures in the Budget – such as changes to dividend taxation, along with previously announced increases in ISA limits, and various add-ons to the ISA regime – that suggest some joined up thinking by the Chancellor on savings taxation.
The government seems to be appealing to people to make use of savings products for key life milestones, such as buying a house, now incentivised through help-to-buy ISAs, or retirement. The hope is that stronger links between the financial sector and its ultimate customers will result in increased transparency, competition and greater variety of products.
The tax system can play a role in that. But there is scant evidence on the extent to which tax incentives motivate people to save, particularly those in the lower-income brackets and for whom the need to save for retirement is most urgent.
One issue is whether the tax incentives are clear enough. Anecdotal evidence on pensions suggests that they are not. The tax break for ISAs, however, is clear to everyone – even if it is far less generous than the tax relief on pensions.
The other issue is whether the incentives are targeted at the right people. The pension tax regime is often criticised for providing greater incentives to higher-rate taxpayers and not those on lower and middle incomes.
But this is a feature of most tax incentives – they have a greater impact to those on higher marginal rates. More fundamentally, the current system merely seeks to tax income when individuals have the benefit of it (i.e. on retirement) and at the relevant marginal rate at that point. Some might argue that the only universal incentive lies in the tax-free lump sum.
The government has tried to change this by introducing new incentives for savings in the form of a personal savings allowance, which exempts the first £1,000 of interest for basic rate taxpayers, and a new dividend allowance, which exempts the first £5,000 of dividend income. These, combined with higher ISA limits, now mean that individuals must have accumulated a significant pot of financial assets before they have to pay tax on any income.
The quid-pro-quo is higher rates of tax for those receiving dividends in excess of £5,000. In practice this will effect few portfolio investors, but may have a more significant impact on business owners. The overall effect is an increase in the progressiveness of tax incentives.
Addressing the need for simple and transparent tax incentives that are appropriately targeted is absolutely right. The government has brought together a number of issues in a package of welcome announcements. However, the key to any regime for long term saving will be the ability to maintain consistency and stability, and that has been ominously absent in recent years. It’s time to sort it out once and for all.
Jorge Morley-Smith is director, tax, at the Investment Association
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