In a move that has attracted a fair amount of early praise, the Conservatives have announced their plans to remove all tax liability on savings income that falls below the threshold for higher-rate tax – currently £32,785 – before deducting the personal allowance.
This was stated to be in response to the savings ratio having fallen from 10.6 to 3 per cent over the last four years. Savings income includes interest, dividends, interest distributions from unit trusts and interest from gilts and other interest-bearing securities including the income element of purchased life annuity payments.
There are also plans to restore to non-taxpayers the facility to reclaim the 10 per cent tax credit in respect of UK dividends. The Conservatives, in quoting the reduction in the savings ratio, also referred to the £5bn a year “stealth tax” that took the form of the abolition of the tax credit reclaim on UK dividends received by approved pension schemes.
So, the first round has been fired in what appears to be set to be a key battleground – taxation.
If these changes are implemented, it would seem to diminish the need for the Isa for those who would qualify for the tax freedom on UK dividends and savings income. Of course, the Isa wrapper also gives freedom from capital gains tax in respect of disposals of investments within the Isa.
For most basic-rate taxpayers, however, the annual CGT exemption – currently £7,200 – would be ample to ensure tax freedom. This is especially so in respect of gains made over the relatively long term as taper relief, which reduces chargeable gains by up to 40 per cent, applies before the annual exemption. This means that if the full taper relief were available after 10 years, a tax-free gain of £12,000 could be made. This is because the £12,000 gain would be reduced by 40 per cent to £7,200 and the annual exemption then used to ensure tax freedom.
Of course, even if an Isa is not necessary to provide tax freedom on income and gains, some form of collective investment might still be attractive to investors who are less likely to make extensive direct purchases of equities or for those who wish for their equities to be managed within a tax-free zone at the level of the fund, which a unit trust, Oeic or investment trust would offer.
The Conservatives' proposals are in line with the principle of tax neutrality for savings. Savings outside a pension wrapper would continue to be made out of after-tax income but would, at least for a basic-rate taxpayer, be tax-free when taken. After all, savings represent deferred consumption.
Regardless of whether the Conservatives are able to implement these proposals, it will be interesting to see how far they move the idea of greater tax freedom and simplicity for savings and investment on to the political agenda.
We are already witnessing a reasonable head of steam behind the idea of moving away from the compulsion to buy an annuity out of pension funds at age 75. The recent private member's bill proposes that, once an annuity is secured sufficient to provide income up to the minimum income guarantee level, the remainder of the fund should be used in any way that the investor wishes.
The proposal is remarkably similar to the Irish provisions that have attracted favourable comment. Of course, to maintain the principle of tax neutrality, any amount taken from the fund, whether by way of annuity or withdrawal, would be taxed as income as the contributions and investment returns have been respectively tax-relieved and tax-free.
The Conservatives have already committed themselves to reforming the rule for compulsory annuity purchase at age 75. They have gone further with their thoughts on pensions with plans to privatise the basic state pension. This has come in the form of the idea to permit workers in their 20s to take a rebate and opt out of the basic state pension by funding their own scheme. The study on which this proposal is founded states that, for someone starting to save at age 25, a 3 per cent real rate of return would deliver a pension equal to the state pension and a 5 per cent return would produce 63 per cent over the state pension.
In considering the viability of these proposals, it should be borne in mind that with any reward comes risk. The post-war real rate of return on equities has been 7 per cent. However, it is predicted to be more like 4 to 5 per cent in the future.
After some reflection, the Conservatives are understood to be a little cooler about the opt-out idea. This has been prompted by the very real expectation that rates of return on pension fund investments are likely to continue to be considerably lower than in the past. It is now thought that a person aged 25 opting out would need to save around £750 a year rather than the originally proposed £500 pin order to replace the basic state pension.
It is understood that the pension proposals are still likely to form part of the manifesto but will be presented as an aspiration as opposed to a fully-costed pledge.
All in all, the Conservatives have caused quite an initial splash and ensured that the tax debate gets off to a lively start. No doubt it will accelerate towards and beyond this year`s Budget on March 7.