By JOHN SPIERS 24/04/2009
Listening to Alistair Darling’s latest Budget brought back memories of Dennis Healey’s performances in the 1970s – a most disagreeable experience. First there was the scale of the nation’s problems. As usual, the Treasury is well behind the curve in measuring the impact of the slump on borrowing requirements. The latest estimate of needing to issue £220 billion of gilts next year is staggering and yet even this could turn out to be too optimistic. The EU recommends a maximum budget deficit of 3% of GDP, ours will be over 12% next year – more than three times that of Argentina. We may not be in such a dire state as Ireland but that is the way we are heading. Darling’s projection of GDP growth of 3.5% in 2010/11 is a complete fantasy. This forecast was actually an increase on the estimate in the pre-Budget report a few months ago! Meanwhile the cost of bailing out the banks (net of recoveries) continues to escalate. Darling estimates £20-50 billion, the IMF predicts £135 billion.
When you’re in this kind of mess you need some clear thinking on the measures that might help to turn things round. Our economy needs to be rebalanced with a greater emphasis on saving and investment, rather than consumption. We also need to encourage entrepreneurship. It is Business that ultimately generates all of our tax revenue and without a thriving commercial sector we have no hope. So what did we get? A big increase in Income Tax, the effective ending of pensions tax relief for the highest earners and a bribe to go out and buy a motor car, most of which are manufactured in Europe and Japan! Sorry, there was an increase in the ISA allowance but even with this welcome move Darling showed again his complete lack of understanding of the realities of running businesses. The increased allowances are due to start from April 2010 but for those of us over 50 we can start earlier, from October 2009 (or on our birthday if it falls in that six month period!). Dealing with this temporary measure will cost ISA plan managers millions in IT and training costs for zero long term benefit. Since most ISA savers are already over 50 it just makes no sense to add this complication.
The benefits of tax relief on pension contributions have repeatedly been over-egged by many in the financial services industry. Since any income from a pension (excluding the 25% tax free cash sum that still remains in place) is liable to tax, for most high earners the real benefit used to be just 10% (40% relief on 25% of the contribution). Following the proposal to raise Income Tax to 45% the position worsened because you would be paying a higher rate of tax on your future income leaving a net benefit of only 6.25% (10% minus 5% x 75%). Now that the future top rate of tax will be 50% the benefit could be a mere 2.5% (10% - 10% x 75%) if your income in retirement is very high! If you earn over £150,000 the position will be much worse after April 2011, potentially only receiving relief at 20% but paying up to 50% tax on the income! So for most high earners the days of contributing to pensions are nearly over and there are measures to prevent excessive topping up during this tax year. On the other hand, it may be that those earning between £100,000 and £150,00 are able to obtain the equivalent of 60% tax relief by getting their personal allowance restored! The repeated moving of the goal posts over pensions is another major disincentive for anyone embarking on a very long term savings plan.
If pensions are ruled out, then where else do you look to plan for retirement once you have made maximum use of ISA reliefs? The obvious place is for investments generating capital growth since that is taxed at ‘only’ 18%. Therefore, we expect to see further launches of funds designed to generate all of their return in the form of capital and with low volatility. Zero dividend shares look more attractive but there are only a limited number of these. For investors prepared to take more risk, the tax benefits of VCTs and EIS are in effect worth more. Taking account of the tax efficiency of your investments is going to be crucial.
There is likely to be a change of government next year but so far the Tories have given little away over their plans for encouraging saving. However, it’s hard to see how they could make things worse!