Ahead of Wednesday’s budget we look at how the wealthy fare in Toryland Britain. A shorter version of this article was published on Wings earlier today.
Last week Treasury officials briefed that there would be no change to pensions, despite a widely circulated consultation on a Pension ISA with no tax relief on investment, or an alternative model based on flat rate tax relief on pension payments.
The result has been that those with money to invest have been putting in as much as they can in case tax relief is abolished with the introduction of a Pension ISA, or a flat rate of tax relief introduced. Higher rate taxpayers (40% tax refunds) and additional rate taxpayers (45% refunds) would lose out – poor souls.
Pension tax relief costs the Treasury around £35 billion a year . The problem with the Pension ISA is there is no tax relief on contributions but when the pension is taken it is totally tax-free. This would inhibit people saving for retirement and reduce future tax revenue. The pension industry preferred the idea of a flat rate scheme, if there was to be a change.
I wrote about this last November, showing how a flat rate could encourage people on lower incomes to save and reduce the tax give away to the wealthy who do not need a ‘get out of higher rate tax card’ to provide for retirement.
Table 1 shows the present tax relief on a pension investment of £3,600 a year. At £240 a month it is not a small investment for most people. The Treasury then chips in £720 over the year. A 40% taxpayer gets twice as much tax relief and the 45% taxpayer gets £1620 paid by the Treasury.
Once you then look at what high-income earners can put into a pension and the ability to add unused allowances from the previous three years it is obvious how the Treasury suddenly got worried about the sums they are paying out to support pension contributions of high earners. The Treasury is bleeding money to the well off.
A flat rate of relief at either one third, or 25% is obviously more progressive and would encourage more to save for retirement and remove the high cost of tax relief to the wealthy. Some of us think that is the way to go to make society fairer.
Just how tax efficient, or exploitive, the present system is for high earners has been amply demonstrated by Chris Giles in last Thursday’s Financial Times.
I am going to build an illustrative story around the figures Chris Giles used in his article because this is not the end of the tax saving potential for high earners.
Our fictional high earner is paid just under £150,000 a year so he qualifies for 40% tax relief. He has £40,000 in unused allowances and plans to invest the full amount in case the rules change. He only has £14,000 available but help is at hand.
I think we should give him a name, this man about town in London, bit of a chancer but also shrewd when it comes to how things work in Toryland. Lets pick a name, purely at random. Boris.
To invest the maximum of £40,000 before the tax year-end, Boris needs to find another £26,000. He has good contacts and a bit of asset backing so he goes along to his friendly bank manager and borrows £26.000. With the funds in place Boris places his bet, sorry investment, and those very nice people at the Treasury pay him 40% in tax relief amounting to £16,000. Back to the bank to pay off part of the loan, leaving just £10,000 outstanding.
Our Boris is over 55 so he can decide to move to drawdown and take 25% of his new pension pot tax-free. That will do nicely – exactly £10,000 to pay off the bank. As Chris Giles explains an investment of £14,000 is now a pension investment worth £30,000 that he can invest for his future. Nice cash if you can get it.
The story does not end here because there are other exploitive, sorry tax efficient ploys to play if you are a Tory cream cat. Cool Huh!
Our fictional Boris, absolutely no connection to anyone living or dead, was left a portfolio of gold mining shares by his Auntie B. We won’t go into why she was always referred as Auntie B. Gold has risen in value in recent months. At the end of November last year gold was trading at $1061 and is now $1246. When the gold price rises this leverages the price of gold mining company shares. Boris calculates he is sitting on a profit of just over £11,000 on these shares. As he hasn’t used his capital gains tax allowance and the tax year is running out he could take the profit to pay off the £10k left on the bank loan and leave the full £40,000 in his new pension pot.
Boris is married to Clarinda who works in the city at something or other, never quite explained. She is also a higher rate taxpayer and has used the same process as hubby Boris to turn £14,000 into a new pension pot of £40,000. Clarinda is only 52 so she cannot move to drawdown and still has £10k left on her bank loan. What to do? Boris suggested a punt on some very depressed shares.
It is one of the big miners everybody is getting out off. Short sellers saw blood and drove the shares down further. Shorting is where punters bet on a share price falling further. Boris thinks the shares have hit bottom and the short sellers will have to bail out or lose money. When the short sellers close their position the share price rises and the bargain hunters buy shares they would not have touched with barge pole just days before. The company is Anglo American, a clapped out miner who own De Beers, the diamond company. Clarinda likes diamonds.
On 5 May 2015 Anglo American shares were at £11.66 but by 13th January 2016 the shares are trading at around £2.32. Boris thinks they will recover to around £4.00, which they do by mid February, but cool Clarinda holds on and sells on 7th March for £5.92 a share. She bought 3000 shares at £2.32 at a cost of £6960 and cashed out at £5.92 for £17,760 and a profit of £10,440 after costs. Perfect, Clarinda can pay off the last of the bank loan and use the profit against her Capital Gains Tax allowance.
For an investment of £14,000 Boris and Clarinda each have an added pension pot for the year of £40,000. Both have used most of their Capital Gain Tax allowance of up to £11,100 and had already put the full year allowance into their ISA tax shelter of £15.240.
Our fictional Boris and Clarinda earn a total of £295.000, give or take the odd perk. They also have money in stocks and shares and pay the maximum into ISAs every year where there is no further tax on dividends and no Capital Gains Tax on profits. They have each put £15,240 into an ISA and £14,000 into an extra pension. Both have invested a total of £29,240 in tax shelters. They have used their Capital Gains Tax Allowances to save £8576 of tax on £21,440. Their combined investment of £58,480 represents 20% of their combined gross income. Between their ISAs and pension contributions they have new investments now earning money on a total of £110,480. Magic.
Boris has a bit left from paying off the last bit of the bank loan and buys 6 bottles of Dom Pérignon at £112 a bottle and Clarinda buys the oysters and caviar.
Last word to Clarinda:
“Cheers George! Life is wonderful in Toryland. Who cares the Treasury is bleeding cash. IDS will just have to turn the screw on the rest of the population and get to grips with the benefits bill so ‘wealthy benefits’ can go on forever. You won’t do anything silly in the Budget will you George?”
Note: Share prices taken from Hargreaves Lansdown http://www.hl.co.uk. Allowance made for stamp duty and dealing costs. There would have been some interest to pay on the bank loans.