Another Tax Year, Another Turn Of The Tax Screw…
The new tax year is now well underway and while there has been one welcome change on the income tax front, most of the numbers look all too familiar.
And Freeze…
Back in March 2021 the then Chancellor and now Prime Minister, Rishi Sunak, announced that for 2021/22 he would be increasing income tax allowances and bands (outside Scotland) in line with inflation (then a modest 0.5% to September 2020) but would subsequently apply a freeze until April 2026. At the time it did not seem a big deal – freezing allowances and thresholds was a standard Treasury trick to squeeze out some more revenue and, with inflation so low, it was not much of a squeeze anyway.
And Then…
Inflation took off and what had looked like a minor tax rise loomed ever larger. To add to the taxing pain, in the wake of Liz Truss’s mini-Budget, Jeremy Hunt used his Autumn Statement 2022 to add another two years to the freeze, meaning that it would last through to the end of 2027/28. In addition, he chose to:
· reduce the dividend allowance to £500 in 2024/25 (from its then £2,000);
· cut the capital gains tax annual exemption from £12,300 to £3,000 over the same period; and
· as the coup de grace, slash the starting point for additional rate tax (top rate in Scotland) by nearly £25,000 from 2023/24.
The National Consequences
In its Economic and Fiscal Outlook report accompany March’s Budget, the Office for Budget Responsibility (OBR) provided a good summary of the impact of these freezes.
| 2024/25 | 2027/28 |
Personal allowance |
|
|
With indexation | £15,220 | £15,990 |
No indexation | £12,570 | £12,570 |
Higher rate threshold |
|
|
With indexation | £61,020 | £64,190 |
No indexation | £50,270 | £50,270 |
Number of taxpayers |
|
|
With indexation | 34.0m | 35.1m |
No indexation | 37.2m | 38.9m |
Number of higher rate taxpayers |
|
|
With indexation | 4.3m | 4.5m |
No indexation | 6.3m | 7.2m |
Number of additional rate taxpayers |
|
|
Threshold kept at £150,000 | 0.7m | 0.8m |
Threshold cut to £125,140 | 1.2m | 1.3m |
The big jump in the number of higher rate taxpayers combined with the effect of the cut and freeze in the additional rate threshold means that by 2027/28 more than one in five taxpayers will be paying more than basic rate.
The Personal Consequences
The impact of this tax standstill is becoming more apparent:
· Some people whose only income is their state pension have suddenly found themselves liable to tax for the first time.
· A growing number of people with dividend income, whether from collective investments or direct shareholdings, also have a new tax liability.
· Higher interest rates and a frozen personal savings allowance (£1,000 for basic rate taxpayers, £500 for higher rate taxpayers) have similarly created fresh tax bills on savings income.
· Wage increases are proving less beneficial for those who have moved into higher tax bands.
The One Piece Of Good News
The Budget did increase one tax threshold, the adjusted net income threshold at which the high income child benefit charge (HICBC) starts to bite. This had been fixed at £50,000 since its introduction in 2013 and, with indexation, would have been about £70,000 in this tax year. Instead, the Chancellor increased the trigger to £60,000 and doubled the band over which the HICBC operates to £20,000 (i.e. from £60,000 to £80,000). The result is that 1% of child benefit is lost for each £200 of income over £60,000.
If you were caught by the HICBC in the last tax year, check your position in 2024/25. Unless your income exceeds £80,000, you will be better off. BUT if you stopped child benefit payments – as many caught by 100% HICBC did - you will need to restart them as soon as possible to benefit.
The ratchetting up of tax makes tax planning all the more relevant. Sometimes it is possible to achieve meaningful savings by relatively simple changes, but at other times complexity is unavoidable.
Lifetime Allowance RIP(ish)
On 6 April 2024 the pension lifetime allowance (LTA) officially disappeared, thanks to 100 pages of technical legislation in the Finance Act 2024 and 20 pages of regulations.
However…
The abolition did not go quite to plan. Two days before the allowance’s demise, HMRC issued a newsletter saying that ‘there would be further minor technical changes made through a second set of regulations’ without specifying when regulatory round two would happen. To the pension cognoscenti the hiccup did not come as a surprise.
From the moment that the Chancellor announced he would abolish the LTA in less than thirteen months, there was considerable scepticism that such an ambitious timetable could be achieved. The LTA first appeared in the Finance Act 2004 as a cornerstone of what at the time was called ‘pensions simplification’ (sic). Over the next two decades the LTA was subject to successive bouts of further legislation, which both amended its terms and built upon it.
In Practice…
HMRC’s newsletter says ‘…schemes should ensure that members are aware of the need for further legislative changes. As a result, members may need to wait until the regulations are in place before taking or transferring certain benefits. This is to ensure that their available allowances and tax position do not need to be revisited later in the year.’ Fortunately the ‘certain benefits’ mentioned are a small, esoteric, mix, so if you are drawing benefits or making a transfer, you may not have to wait for the new regulations to arrive.
The Long Shadow Of The LTA Remains
While the letter of the law and regulation is that the LTA is no more, its ghost is still to be found haunting pension legislation. For example:
· The normal maximum total lump sum that you can draw free of tax remains at £268,275. That just happens to be 25% of the old standard LTA of £1,073,100.
· The normal maximum lump sum death benefit that can be paid free of tax on death before age 75 is £1,073,100 – the old LTA again.
· Both lump sum figures may be higher if you have any of the various transitional protections dating back as far as 2006. All those protections revolve around the appropriate LTA at the time they were introduced.
The corollary is that you cannot now forget about any LTA protection you have, even though the LTA has disappeared from the statute books. The advice is the same now as it ever was: if you have any form of protection, do not take any action without first seeking advice.
Has Anything Really Changed?
The end of the LTA has removed the corresponding LTA tax charge of up to 55% that could arise on benefits exceeding the LTA. In many circumstances the lump sum limits outlined above will mean that the same excess will now attract income tax in the hands of the recipient, whether that is you or your beneficiaries.
The net result is that exceeding what was the LTA (plus any transitional uplifts) is less taxing than it once was, but still may be something to avoid. At worst you might find yourself in the situation where you receive less tax relief on your pension contribution than you (or your beneficiaries) end up paying on the benefit. At best, the opposite could be true. Just to add to the allowance complexities, the annual allowance remains, which places an effective ceiling on tax-relievable total contributions in a tax year of between £10,000 and £60,000, depending upon your income.
And will it all change back again?
When Jeremy Hunt announced, in March 2023, that the LTA would be culled, the Shadow Chancellor, Rachel Reeves, said that a Labour government would reinstate it. This remains the party’s position, although some pension experts believe that realpolitik will mean the pledge ends up having a low or no priority. If nothing else, the huge effort that has gone into not quite legislating to kill the LTA in 13 months is a disincentive to revisit the subject.
The final(ish) end of the LTA will be an irrelevancy for most people, just as was the LTA itself. However, if you are – or might be – affected either by the disappearance or the possible reinstatement, now is the time to review your retirement planning.
ISAs 25 Years On
On 6 April ISAs reached the grand old age of 25. When they first appeared, in April 1999, they were seen largely as a rebranding by the then Labour Chancellor, Gordon Brown, of two schemes introduced by his Conservative predecessors: Nigel Lawson (Personal Equity Plans – PEPs) and John Major (Tax Exempt Special Savings Accounts – TESSAs). Since that far off day, ISAs have undergone many changes.
A success story?
The latest figures from HMRC show that, in April 2022, there was £742bn invested in adult ISAs, of which 38% was in cash ISAs and virtually all the rest in stocks and shares ISAs. On the face of it, that is an impressive figure – about 28% of the current total government debt.
A different picture emerges from the timelier statistics published by the Investment Association (IA). Their data is less comprehensive, covering only stocks and shares ISAs of its members and the five large investment platforms. The IA also presents the ISA flows as a net figure, that is subscriptions in less amounts withdrawn. The results might surprise you:
Source: Investment Association March 2024
From April 2023 to February 2024 the IA recorded a net outflow of £4.7bn, although March 2024 will almost certainly see an inflow. The outflow from stocks and shares ISAs recorded by the IA has a parallel in cash ISAs, where the HMRC statistics show a £28.8bn drop in total investment value between April 2020 and April 2022.
The Case For Isas Now
Go back to May 2022 and, for many investors, ISAs offered little advantage over direct investment, a fact that helps explain the net outflows. Two years on, the changes to taxation explained elsewhere in this newsletter have brought new potential tax liabilities for many investors. Over the same period, the rise in interest rates from near zero to around 5% has meant many savers are no longer protected from tax by the frozen personal savings allowance (£1,000 for basic rate taxpayers and £500 for higher rate taxpayers).
The corollary is that the tax advantages provided by an ISA are now more relevant to investors and savers. As a reminder, within an ISA:
· All interest is free of UK tax;
· All dividends are also free of UK tax (although withholding tax may apply to foreign dividends);
· Capital gains are free of UK tax; and
· All HMRC reporting is handled by the ISA manager – you have nothing to put on a tax return.
The ISA annual subscription limit is £20,000 – the same as it has been since 2017/18. For a higher rate taxpayer investing in a UK equity income fund with a typical yield of about 4.5%, that could translate into a tax saving of over £300 a year, assuming their dividend allowance is already used elsewhere. There could also be capital gains tax savings – cumulative growth of more than 15% would be enough to create a gain above the 2024/25 annual exemption.
Despite the focus on tax year end subscriptions, the optimum time to invest in an ISA is early in the tax year, to maximise the period of favourable tax treatment.
Footnote: The UK ISA
One of the well-trailed non-surprises of the March Budget was the UK ISA. This is currently still at the consultation paper stage, so there are no firm details. It looks likely to have a maximum subscription of £5,000 a year (in addition to the normal £20,000 ISA limit) and to be restricted largely or entirely to shares and bonds issued by UK companies and, possibly, UK government bonds (gilts). Transfers will be restricted to prevent money leaking into ordinary stocks and shares ISAs.
These probable investment constraints have met with some criticism – the UK now accounts for less than 4% of the world’s stock markets by value. Given an election is due by January 2025, there is no certainty that the UK ISA will become a reality.
The British Savings Bond
One ‘teaser’ contained in the March Budget was the promised launch by National Savings and Investments (NS&I) of the British Savings Bond. “We will make it easier for people to save for the long term,” was how Mr Hunt heralded the new bond in his Budget speech.
Four Weeks Later…
NS&I revealed the full terms of the new bond four weeks after the Budget. It turned out not to be new at all, but the latest (71st) iteration of two existing products, the Guaranteed Growth Bond (GGB) and the Guaranteed Income Bond (GIB). Both offer a fixed rate for three years of 4.15% AER (4.07% monthly for the GIB). Anyone who had been hoping for a pre-election ‘sweetener’, similar to George Osborne’s Pensioners’ Bond before the 2015 election would have been disappointed. The rates were both about 0.5% below what could be found in the open market.
A Reminder…
The uncompetitive rate for the new bonds should not have been a surprise. NS&I rarely come near the top of the league tables because, if they did, it would probably indicate that the government was overpaying for its borrowing. In 2022/23 NS&I raised a net £10bn. To put that into context, in 2024/25, the government plans to borrow £265bn through the sale of government bonds (gilts), mainly to institutional investors. In other words, NS&I’s fundraising is close to loose change for the Treasury.
If you have any savings with NS&I, make sure you check what interest rate you are earning. The British Savings Bond’s 0.5% gap from the top rate is narrow compared with some products. For example, the Direct ISA is paying 3%, a rate that several instant access cash ISA providers beat by more than 2%.
Inflation and Interest Rates
The latest (March 2024) reading for inflation shows that the CPI is running at an annual rate of 3.2%, its lowest since September 2021 and a long way from October 2022’s peak of 11.1%. The latest projection from the Bank of England is that inflation will ‘fall to slightly below the 2% target’ in the current quarter.
Source ONS, US Bureau of Labor
So Interest Rates Are On The Way Down..?
No, not immediately. The day before the inflation numbers were published, the Office for National Statistics reported that average earnings (excluding bonuses) were growing at 6% a year for the December 2023-February 2024 period. That will not please the Bank of England, even before April’s 9.8% increase in the National Living Wage arrives in the earnings statistics. The Bank, along with many economists, do not believe such levels of earnings growth are compatible with 2% inflation.
There is another inflation figure that the Bank will be eyeing, which is the USA’s. March USA CPI inflation was 3.5%, slightly higher than expected and enough to further dampen hopes for the number of cuts in US interest rates the Federal Reserve will make this year. That figure was six or seven at the start of the year (equivalent to cuts of 1.50%-1.75%), whereas now it is one to two (0.25% - 0.5%). Although the Bank will say it makes its own decisions, it will not want to stray too far from the actions of its US counterpart, for fear of weakening the pound against the dollar (and thereby increasing UK inflation…).
The Bank expects UK inflation to rise slightly in the second half of 2024, albeit for technical reasons. All of which leaves the pundits predicting that the Bank (Base) Rate will start 2025 probably at the same 0.25%-0.50% below the current level as are the predictions for US rates.
Inflation has fallen sharply, but that is not the same as declining prices, which require deflation. Thus, the CPI in March 2024 was nearly 23% above its January 2020 reading.
Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FCA does not regulate taxor benefit advice. This newsletter is provided strictly for general consideration only and is based on our understanding current law and HM Revenue & Customs practice as at 17 April 2024 and the contents of the Finance (No 2) Bill 2024. No action must be taken or refrained from based on its contents alone. Accordingly, no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.