The Government is facing mounting calls to take action to address the cost-of-living crisis, with inflation for April hitting a 40-year high of 9%.
Tom Selby, head of retirement policy at AJ Bell, considers five measures that could be introduced to increase people’s incomes and help them access long-term savings.
1. Cutting basic rate income tax to 19% / unfreeze income tax bands
“The Chancellor has already announced plans to cut income tax from 20% to 19%, but from 2024. Now he’s facing calls to bring that cut forward, but it’s not the bumper tax-saving giveaway that many are hoping for.
“In fact, over five years the move is wiped out by the Chancellor’s plans to freeze the income tax bands until 2026 – which represents a far bigger tax grab than many realise – so if he really wants to help with the cost of living squeeze, he needs to revisit the freeze to income tax bands.
“As we can see from the figures below, the move to bring forward by a year the plans to cut basic-rate tax from 20% to 19% will only save someone on £25,000 a year £143, while someone on £50,000 a year will save £377 in tax – the maximum saving. While that will give people some breathing space, taxpayers will still be paying far more in tax than if Rishi Sunak had left the income tax system alone and not frozen tax bands.
“Someone on £25,000 a year will still be paying £1,284 more in tax between 2022 and 2027 compared with a system with a 20% tax rate and unfrozen bands, while someone on £50,000 will pay £5,396 more and someone earning £80,000 will pay £7,997 more.
“The effect of freezing the income tax allowance has been turbo-charged by rising inflation, because if the income tax thresholds weren’t frozen, we’d be expecting them to rise with inflation – though in reality the Chancellor might well have baulked at increasing thresholds by 8% or 9%.
“The frozen income tax allowances mean millions of people are going to get dragged into the higher tax bands. Based on OBR forecasts, we calculate that the personal allowance would reach £15,300 in 2026/27 if uprated in line with CPI, but will only sit at £12,800 if frozen until 2025/26.
“Likewise the higher rate threshold would reach £61,200 in 2026/27, but under the current system we can expect it to sit at just £51,200.
“The examples assume earnings rise in line with average earnings forecasts from the OBR, and that in Scenario A, income tax thresholds would have risen in line with the OBR CPI inflation forecast.”
|
Annual salary |
Tax saved by bringing cut to 19% basic-rate tax forward a year |
|
£25,000 |
£143 |
|
£50,000 |
£377 |
|
£80,000 |
£377 |
|
Income tax payable 2022 to 2027 |
||||
|
|
A. Pre-budget March 2021 |
B. Post Spring Statement |
C. Proposed plan now |
|
|
Annual salary |
Tax rate of 20% and inflation linked thresholds |
Tax rate falling to 19% in 2024 and frozen theesholds |
Tax rate falling to 19% in 2023 and frozen thresholds |
Additional tax due between pre-budget March 2021 vs Proposed plan now |
|
£25,000 |
£13,214 |
£14,642 |
£14,498 |
£1,284 |
|
£50,000 |
£40,949 |
£46,722 |
£46,345 |
£5,396 |
|
£80,000 |
£104,912 |
£113,286 |
£112,909 |
£7,997 |
Sources: AJ Bell, ONS, OBR
2. Bringing forward next year’s state pension increase
“The ship has, in some ways, already sailed on the state pension triple-lock, with the Government deciding to ditch the average earnings link for 2022/23. This meant the state pension rose in line with September’s 3.1% CPI inflation figure last month – roughly a third of the 9% increase in inflation we saw in the year to April 2022.
“If the earnings link had been retained then the state pension would have risen by 8.3% in April – still below the current inflation rate but a considerably chunkier income boost versus 3.1%. This would have meant someone in receipt of the full flat-rate state pension would have seen their weekly income bumped to £194.50, rather than £185.15.
“To put it another way, the move cost retirees receiving the full flat-rate amount £9.35 per week – or £486.20 over the course of the year. In a world where prices are skyrocketing that income could have made a difference.
“Given the challenges millions of pensioners are facing, there have been calls to bring forward next year’s planned increase to help with the cost of living today.
“Doing this would present practical challenges in terms of updating DWP’s systems – something Chancellor Rishi Sunak has been at pains to point out. However, we saw during the pandemic how quickly the Government machine can motor into action when an economic emergency rears its head.”
3. Cutting the Lifetime ISA exit charge
“The Government reduced the Lifetime ISA exit fee to 20% during the Covid pandemic, to reflect the fact that lots of people would have to withdraw their money due to losing their job or seeing their income fall. This sets a precedent and shows that it’s easy for the Government to implement a reduction.
“With the cost of living soaring and wages failing to keep up, it’s inevitable that some will have to dip into their Lifetime ISA savings just to pay their bills and meet the rising cost of food, petrol and energy bills. The Government could reduce the exit fee to 20%, so it just reclaims the Government bonus. It will give people a bit of breathing room to dip into their savings and not face the punitive exit fee for doing so.
“Someone who withdrew £2,000 from their Lifetime ISA would save £100 if the exit penalty was cut from 25% to 20%, representing a much-needed boost to help pay the bills.”
4. Cutting VAT for businesses
“If the Chancellor is going back to his pandemic playbook for ideas, he could re-introduce the cut to VAT for hospitality businesses. Restaurants, pubs and hotels have all been hit by rising energy and food bills, meaning many have to make the difficult decision to put up prices or make smaller profits – or do a bit of both.
“During the pandemic VAT for these businesses was cut from 20% to 5% for more than a year, before it was raised to 12.5% in September last year until the full 20% rate was reinstated at the end of March. The move was touted as helping to cut prices for individuals, but in reality many of the more than 100,000 businesses affected kept the VAT saving for themselves in order to boost their takings after the lockdown drought.
“That means any cut to VAT would likely benefit businesses more than consumers. However, if it stopped prices rising by so much it would protect consumers from some cost increases and also have a dampening effect on inflation. In 2021/22, the cut to 5% for half of the tax year and 12.5% for the other half cost the treasury £4.7bn.
“Someone going out for a meal costing £60 now would see their costs reduce by £7.50 if VAT was cut to 5% and all that saving was passed on to customers. Likewise, a hotel booking costing £200 would be subject to £25 less VAT if the rate was cut.
5. Increasing the ‘money purchase annual allowance’ to £10k – or scrapping it altogether
“It is inevitable as rising inflation squeezes incomes that more people will turn to their retirement pots to help make ends meet, either for themselves or for loved ones. As things stand, those who take taxable income from their defined contribution (DC) pot risk seeing their annual allowance slashed from £40,000 to just £4,000 – permanently. What’s more, they will lose the ability to ‘carry forward’ unused allowances from the 3 previous tax years.
“This so-called ‘money purchase annual allowance’ (MPAA) has always sat uncomfortably in a world where working patterns in later life are increasingly flexible and people often dip into their retirement pot while continuing in employment, either full or part-time. However, it feels like a particularly harsh punishment during a time when millions of people are facing severe financial strain.
“What’s more, it risks storing up future problems, severely restricting the ability of Brits to rebuild pensions accessed flexibly during the current crisis. Ideally we would like to see the MPAA scrapped altogether as part of a move to a single, simple annual allowance for DC savers. At the very least the Treasury should increase the MPAA back to £10,000 – the level it was set at when first introduced in April 2015.”
