Savings attract tax relief but lose benefits

Nigel Williams, 3 April 2014

20.8% Interest

A cash investment paying 20.8% per annum would not need to be advertised. Investors would be queuing round the block to take advantage. Anyone receiving that rate of interest would be duly grateful to the Chancellor for increasing the tax-free savings that could be included in an ISA.

Any investor knows that if something seems too good to be true, it usually is. Sadly, no-one is freely offering that rate of return. It is what the chancellor deems anyone claiming benefits can earn on any capital above £6,000.

Tapering approaching a cliff-edge

Even more extreme returns are available. The notional income is 0.4% per week, but rounded up to the nearest pound. The first penny triggers a weekly reduction of 85 pence in means-tested benefits. That penny is deemed to get a return of £44.23 per year, or 4423%. Without the rounding up, the cost to the saver is still 18%. The message is clear. If you have savings, you are expected to cash them before claiming benefits. Yet early encashment usually brings penalties and keeping the money accessible drops the returns even further below the rates those savings are expected to earn.

Savings without interest

Obviously, circumstances have changed since those rules were set. After the credit crunch, cash savers have been expected to content themselves with not losing their capital. A meaningful rate of interest is asking too much. When Greek or Cypriot deficits became unsustainable, the term ‘haircut’ was used to denote depriving a saver of a large fraction of his or her life’s savings, as if it would readily grow back. Improving conditions for savers looked like one of the kinder actions in the 2014 budget. That makes it especially sad that the chancellor used his largesse to favour people that needed no further encouragement.

Three decades of tax-free allowances

From 2014-15 the annual allowance, per person, for an ISA is £15,000. Since the introduction of PEPs and TESSAs in 1986 and 1990, there has been no shortage of vehicles to protect savings from tax. Those allowances accumulate each year. Careful use of the allowances comfortably give a saver over £100,000 of tax-free savings. From 2014-15, wealthy savers will be able to put aside more than a full-time minimum wage, with no tax to pay on the interest.

Perverse incentives

Tax on savings creates strange incentives. A small allowance makes one reluctant to withdraw savings for fear of losing the privilege for ever. Meagre returns can look better than genuine investments simply because of their tax status, so some bad decisions get taken. The immense marketing effort among financial services companies that surrounds the end of each tax year leaves me wondering who is the major beneficiary of these investments. Providers only need to offer a gross return marginally better than net returns elsewhere.

Savings as an alternative to welfare

Tax on interest is only really intended to guard against avoidance by people that can engineer their remuneration in the form of interest rather than salary. In other respects, a healthy level of saving lets people protect themselves against temporary financial shocks. Buttressed with a modicum of savings and, better still, a supportive spouse, an unemployed worker from middle earnings may well survive until finding the next job without even visiting the job centre. From a vantage point of earning a salary, only housing benefit looks like an enviable quantity. The rest is a lot of hassle for little money.

The Chancellor needs to rethink his attitude to savings in the light of this comparison. The level of individual savings worth encouraging with tax advantages should be commensurate with the savings allowed before tapering means-tested benefits. At £16,000 of savings, a benefit recipient is deemed to receive £40 per week, plus an initial disregarded sum of £24. At a more realistic 1% interest rate, that weekly income requires not just £16,000 but over £300,000. If that looks like too much, it is largely because savers have been receiving only derisory interest for some years. When easy-to-access savings are once again paying around 4% and are ahead of inflation, the economy will be a step closer to being rebalanced. Until then, we should remember that savings are the individual alternative to welfare. If we force people not to save so they can qualify for benefits, then we trap them in the safety net.