Friday April 25, 05:45 PM
What is the logic of the 10% changes?
By Steve Lodge
Wealth Questions (April 12/13) identified how some older people and low earners would still benefit from the 10 per cent income tax band on savings interest. I am a 58-year-old woman earning £6,000 with additional interest from building society
savings of £1,000 (all before tax). It (Frankfurt: A0MLX5 - news) seems particularly unfair that someone on my very low income should lose out from the scrapping of this lower rate band when others with higher incomes continue to benefit from it. Just what is the logic of these changes? Francesca Lagerberg, head of the national tax office at accountants Grant Thornton, says that in fact you do retain the 10 per cent band, but only for your savings income. The first £5,435 of your earnings is covered by your personal allowance. The balance (£565) is taxed at 20 per cent which results in tax of £113, rather than the £56.50 if this earned income were taxed at 10 per cent. Your building society interest is taxed at 10 per cent. So overall, you are £56.50 worse off. The scrapping of the 10 per cent band for most people was regarded as a tax simplification measure. However, the government did not put in place adequate compensatory measures to offset the negative impact for individuals on low incomes. This week's announcement of concessions should provide at least some redress, but the details are not yet clear. Alastair Darling said he will use winter fuel payments, working tax credit and the minimim wage to offset the losses for those on lower incomes, but how this will all work is not expected to be unveiled until autumn's pre-Budget report. The income tax change remains in place, however. Moreover, the "new 10 per cent savings rate" has created further complexity and confusion. Low-income individuals under the age of 65 who lose the 10 per cent rate altogether include those with earned (non-savings) income of £7,755 or more, with savings income (eg bank interest) on top of this. The earned income no longer benefits from the 10 per cent rate. The additional savings income also misses out on the 10 per cent rate because of the order in which income is taxed - earned first. Only savings income falling within a £2,320 band above an individual's personal allowance benefits from the 10 per cent rate. Under-65s receiving pension income of £7,755 or more also lose the 10 per cent rate, because pensions are deemed non-savings income that is ineligible for the 10 per cent rate. As with earnings from employment, pension income is taxed ahead of savings interest. Individuals who are unaffected by the change include those whose incomes consist entirely of savings interest and dividends, as well as those on modest pensions falling within the personal allowance who also have savings interest. They retain the 10 per cent for the £2,320 band of interest income above their personal allowance, while dividends continue to be taxed at 10 per cent for anyone up to the higher rate tax threshold at about £40,000. Those over the age of 65 also now benefit from higher personal allowances: £9,030 for 65-74-year-olds; £9,180 for those aged 75 and above. For most, these higher age-related allowances offset any loss of the 10 per cent band. Norwich Union, my pension company, has told me that the rate of income tax relief on my pension contributions has come down from 22 to 20 per cent. Is it really the case that the government has made it less attractive for me to contribute to my pension pot? What can I do about it? Laith Khalaf, pensions analyst at Hargreaves Lans-down financial advisers, says the tax relief on pension contributions has fallen from 22 to 20 per cent from this month because the basic rate at which income tax is levied has been cut. For many, the change means that while their overall income tax bill falls, their pension contributions get less of a tax boost. This is also the case for higher rate taxpayers paying into a personal pension who will find the extra higher rate relief they can claim back through their tax return jumping from 18 to 20 per cent, but at the expense of tax relief within their pension fund. The sensible thing to do is to funnel your Budget winnings into your pension: increasing your payments by 2.5 per cent gives you the same gross contribution as before the tax changes. If you contribute monthly to a pension, your employer or pension provider may have already made this adjustment for you. However, better news for pension investors is that the tax-free personal allowance for over-65s has risen from £7,550 to £9,030, and is due to rise to £9,770 by 2011. So when you start drawing your pension, you should have an extra £2,000 or more that is tax-free. But curently you lose £1 of this allowance for each £2 of income above £21,800, down to a minimum tax-free allowance of £5,435 in this tax year. Your retirement income also stands to benefit from the drop in basic rate from 22p to 20p in the pound.
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