RPI survives

The Retail Prices Index (RPI) was given a stay of execution in January.

In recent years, the RPI has fallen out of favour. The Government – and the Treasury in particular – has preferred to use the Consumer Prices Index (CPI) for indexing tax allowances and benefits. There are two main reasons for the move away from the RPI towards the CPI:

• The way in which the two indices are calculated means that the RPI will usually produce a higher number. For example, over the last ten years to December 2012 the CPI averaged 2.6% a year while the RPI averaged 3.3% a year. For a Government anxious to maximise tax revenue and minimise expenditure, the choice is obvious.

• The method used to calculate the RPI is widely accepted as flawed, whereas the CPI follows international standards (under another label it is the EU yardstick for UK inflation).

Last October the Office for National Statistics (ONS) put forward a consultation paper with four options for dealing with the gap between the RPI and CPI. Three of these would have brought the two indices closer together by moving the RPI calculation nearer to the CPI basis. The fourth option – do nothing – was widely seen as a straw man that ran counter to the thrust of the ONS’s consultation.

It was therefore a big surprise when the ONS announced in early January that ‘no change’ was its recommendation, and that this had been accepted by the UK Statistics Authority. The decision to leave the RPI calculation untouched is good news if you have:

• index-linked savings certificates;

• index-linked government securities; or

• an RPI-linked pension.

All would have performed less well if the RPI had been engineered downwards. The losers include the Government, which might have saved up to £3 billion a year if RPI had been cut down, and private sector final salary pension schemes, whose liabilities did not fall as they had hoped.

ISA time: add more now…

As the tax year-end approaches, it is time to top up your ISA.

With February upon us, it won’t be long before the ISA supplements start appearing in the weekend papers. The end-of-tax-year rush to invest in an ISA is at once both sensible and illogical. It’s sensible because of the benefits an ISA offers:

• Dividends and income from fixed-interest securities are free of personal UK tax within a stocks and shares ISA, although dividend tax credits can’t be reclaimed.

• Interest earned on deposits is UK tax-free in a cash ISA. A flat 20% tax applies within a stocks and shares ISA.

• Gains made within ISAs are free of capital gains tax (CGT).

• ISA income and gains do not have to be reported on your tax return.

The illogic stems from the timing: why wait until the end of the tax year before taking advantage of the ISA’s tax benefits if you could have invested last April and enjoyed them since then? The answer is probably that there’s nothing like a deadline to concentrate minds, and, as a result, the marketing departments of financial services companies make the most of them.

In recent years, cash ISAs have attracted the bulk of ISA subscriptions, despite the base rate having been 0.5% since March 2009. The most successful cash ISA providers have relied upon temporary bonuses to attract investors – last year’s ISA season saw rates of around 3%, of which up to 2.5% was accounted for by a one-year bonus (now just about to end). So far in 2013, rates have been lower, with the big banks either staying their hand or deciding they don’t need the cash. Most returns on offer are now below the prevailing inflation rate.

ISA time: and add still more in the future...?

There may be an increase in ISA limits on the way.

Last month, the Office of Tax Simplification (OTS) published its final report on simplifying the tax system for pensioners. The OTS made some useful suggestions, such as saying that the Department for Work and Pensions should issue a consolidated statement of taxable benefits each year, similar to a P60. It also proposed that HMRC produces a composite notice of coding for people (probably the majority) who have pensions paid from a variety of sources. Whether either cash-strapped arm of government would make the necessary system changes is a moot point – so much so, that the OTS stressed that its proposals should be considered as a whole, and not cherry-picked.

The OTS comment has more weight when one of its policy changes is considered: the abolition of the 10% savings rate band. This would affect not just pensioners, but anyone with a low level of earned income and a high level of interest income (which could mean wealthy, non-working spouses). In practice, ‘the levels of confusion and the low level of take up’ mean that the 10% band is widely ignored. You have to claim the tax refund resulting from the 10% rate with a self-assessment return or HMRC form R40 (which cannot be completed online).

The OTS recommends that, with the 10% band scrapped, the ‘money saved [about £50 million a year] could be used to make a pragmatic above-inflation increase in the ISA limit.’ It will be interesting to see whether the Chancellor takes up the OTS’s suggestions when he presents the Budget on 20 March 2013. The politics are particularly tempting for Mr Osborne, given that the 10% savings rate band is a hangover from Gordon Brown’s era as Chancellor. In his last Budget, in 2007, Mr Brown announced that the 10% band (which he’d introduced in 1999) would no longer apply to all income from 2008/09. That left his successor, Alistair Darling, with a backbench rebellion to deal with the following year.

State pension reform

The much-delayed White Paper on the future of state pensions has been published.

When the Government issued a Green Paper on state pension reform last April, the expectation was that a White Paper would follow in the summer…then autumn…then before Christmas. It eventually arrived, suitably snow covered, in January – along with a complete Pensions Bill following close behind.

While many of the finer points are yet to be settled, the framework for the new state pension regime is now clear.

• The current two-tier state pension system, comprising of the basic state pension (BSP) and earnings-related state second pension (S2P) will be replaced by a single-tier, flat-rate pension. The White Paper assumes ‘for illustrative purposes’ that this would be £144 a week in today’s earnings terms, against a current BSP of £107.45 a week.

• You will need National Insurance (NI) contributions or credits covering 35 years to obtain the full £144 a week – five more than are needed for the current BSP. If your NI record is less a minimum period (likely to be ten years), you will receive no state pension. At present you earn BSP for each year, regardless of how few.

• The single-tier pension will be earned on an individual basis, so you will not be able to rely on the NI record of your spouse or civil partner to boost your flat-rate state pension. However, transitional provisions will apply to soften the blow.

• The new pension will rise in line with earnings once in payment. The ‘triple lock’ guarantee which applies to the BSP (the greater of price inflation, earnings growth and 2.5%) is not guaranteed to continue beyond 2015.

• The state pension age (SPA) for men and women will rise to 67, with a two-year phase-in starting in April 2026. The Pensions Bill also imposes a requirement for five-yearly reviews of SPA, with the first due by May 2017. Any change decided at review will not take effect for at least ten years.

• You will not receive any savings credit if you reach SPA once the new flat rate pension is in place. Guarantee credit will still be available, but if you receive the full flat rate pension, you will not be eligible.

• At the point when the new regime is introduced, the existing state benefits you have accrued will be converted to a ‘foundation pension’. The calculation of this is designed to ensure that what you have earned to date is not lost, but how contracted out benefits are dealt with remains unclear. If your foundation pension exceeds the new flat rate pension, then the excess will be CPI-inflation proofed before and after retirement.

• The ending of S2P will mean that if you are currently contracted out through a final salary scheme, your (and your employer’s) NI contributions will increase.  Ironically it will be the Government, as public sector employer, that will be most affected.

• The new regime will begin in April 2017, at the earliest.

All these changes will not mean the Government spends any more on pensions. The White Paper’s analysis shows that, in the long run, the Government will save money, even before taking account of the extra income from the ending of NI contracting out rebates. The corollary is that, just as the present state pension system will not provide a decent standard of living in retirement, neither will the single-tier system. But it will be simpler…

Personal allowances: the winners and losers

Personal allowances will be based upon a person’s date of birth rather than their age as of the 2013/14 tax year, with allowances for older people frozen at their 2012/13 levels.

People born between 6 April 1938 and 5 April 1948 will receive a higher allowance, with those born before 6 April 1938 receiving slightly more. So people reaching the age of 65 or 75 during 2013/14 will not see any increase to their personal allowance.

So who are the winners and losers? The clear winners are younger basic rate taxpayers who will see their personal allowance increase by £1,335 – a tax benefit of £267. But for higher rate taxpayers the benefit is just £62. People who qualify for the higher personal allowance will not see any difference because the allowance is frozen, although the income level at which the additional element is withdrawn has gone up by £700 to £26,100.

The most aggrieved will be those turning 65 during 2013/14. Instead of receiving the higher allowance of £10,500, they will continue to receive just the normal personal allowance of £9,440. The same is true for anyone reaching 75 next year but they will only lose the modest increase from £10,500 to £10,660.

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