Saving savings? A tax and low-income perspective

Many of the points within the report resonated with Kelly’s own research for her 2017 thesis entitled ‘The complexities of government-incentivised savings for people on low incomes’ for which she was awarded Fellowship of the CIOT. 

Kelly covered four areas when speaking at the event:

• The effectiveness of incentives
• Holistic guidance or advice is needed for low-income savers
• The need to look at tax and benefits impacts of savings schemes in the round
• Potential pitfalls: simplifications in one area can cause complexity in others

Kelly Sizer: Government incentives to save

The first point to consider around government incentives to save is to what extent they are effective. Here, it is important to draw out something that has come up when talking about the effectiveness of pensions tax relief as an incentive to save. That is, that for incentives to work – for them to influence behaviour – people have to know about them. Furthermore, they have to understand them, which can be difficult, especially when you take into account the different incentives and rules for different savings products.

The Resolution Foundation’s research has highlighted that one problem with the Help to Save scheme (for which eligibility is limited to certain tax credits and universal credit claimants) is a lack of awareness of its existence. Where people know about the scheme, the feedback is largely positive. Under current plans, Help to Save is due to close to new savers from September 2023, but many would like to see that date extended, or indeed the scheme to be made permanent. If it does continue, the Resolution Foundation suggest that one way of addressing lack of awareness/low take up might be to automatically open Help to Save accounts for eligible benefits claimants and give them information about the scheme to help them understand it and make use of it.

This sounds like a great idea in principle. One cautionary note, however, is that such a strategy does assume that paying in to a Help to Save account is the right course of action for that whole population. It omits any consideration of the wider picture and potential knock-on effects.

For example, automated opening of accounts could be a potential area of conflict with auto-enrolment into workplace pensions. Might people be tempted to opt out of their employer’s pension scheme in favour of short-term saving into the Help to Save scheme, effectively bolstering short-term financial resilience at the price of longer-term security? Both schemes provide a government incentive, but arguably Help to Save has the added attraction of shorter-term accessibility.

At a time when living costs are increasing and the ability to save is already likely to be squeezed, it would be necessary to consider whether auto enrolment opt-out rates would increase if more people were encouraged into Help to Save, given that there is only so much money to go round.

Guidance for low-income savers

The above leads us to think about the difficulties of considering short-term savings incentives in isolation. It is hard to divorce consideration of someone’s shorter-term financial needs from their wider circumstances and longer-term situation.

Those with the lowest incomes are the most likely to have insufficient savings for a rainy day. They are also least likely to be able to afford financial advice to help them look at their situation in the round, understand their savings options and choose the most appropriate path for them. The same people are also those who need to navigate both the complexities of the tax system and welfare benefits system when weighing up their options.

So where can they turn? They are likely to need to self-serve using publicly available guidance. Much is provided online, but it can be bamboozling if trying to piece it all together and navigate it alone.

When pensions freedom was introduced in 2015, the government set up a service – PensionWise – allowing people aged 50+ to access free guidance, via a telephone or face to face appointment, to help talk them through their options. Whilst this type of service has its limitations and may not be a direct replacement for individual advice, feedback is generally positive from those who have used PensionWise.

Might this suggest that a similar ‘SavingWise’ service could help people struggling to make choices relating to shorter term savings?

Tax and benefits interactions/impact of savings

The CIOT’s Low Incomes Tax Reform Group obviously has the tax system at the heart of its work. However, given the low-income focus, such work inevitably strays into areas where the tax system overlaps with welfare benefits. Tax advisers are well aware that the tax system alone is complex. Yet once you start considering the tax and benefits issues together, the complexity gets even deeper.

Policymakers therefore need to look at savings policy and government incentives in the round, taking into account both the tax and benefits implications of savings schemes. There are indications that this may not always have been done to best effect in the past when introducing new policy.

For example, we have the Lifetime ISA as an incentivised saving scheme for those looking to purchase a first property or to save for their retirement. Yet if someone saving into the Lifetime ISA hits a difficult spell – loss of a job or a downturn in trade, for example – and needs support, they could find themselves unable to get universal credit because their Lifetime ISA is taken into account as capital.

This might be fairer in future when Lifetime ISA holders aged 60 or over can access those savings without a penalty. But it seems a rather disjointed policy to force younger Lifetime ISA holders to draw down on those savings and suffer a 25% penalty on withdrawals. Indeed, someone in this situation might be disincentivised from returning to saving if their finances improve.

There are perhaps two possible ways of addressing this problem. One is to change the Lifetime ISA rules to be more flexible, allowing some penalty-free access for a rainy day. Indeed, the government recognised this issue with the temporary suspension of penalties on Lifetime ISA withdrawals in the earlier part of the Covid-19 pandemic.

The other is to consider whether Lifetime ISA savings could be disregarded from the universal credit capital assessment. Such a disregard could perhaps be limited to the first 12 months of claiming universal credit, if policymakers did not wish to make it open-ended. The government did in fact say last year that they would review whether the Lifetime ISA could be disregarded from the universal credit assessment, but it has since been reported that this review has been shelved.

Similarly, Help to Save accounts are not disregarded from the universal credit capital assessment. So if a couple claiming universal credit were both to open one and save the maximum over a 4-year period, with the bonuses added, they would amass £7,200 between them. They would then have household capital above the lower capital threshold of £6,000, after which the DWP start to calculate a notional income or ‘tariff income’ based upon the amount exceeding £6,000. This seems to be a disincentive to make maximum use of these accounts - rather an incongruous result, given that they are targeted at certain benefits claimants.

The complexities of simplification?!

The Resolution Foundation’s paper talks about the complexities of the 0% starting rate of savings and the personal savings allowance, and that these may be of limited value to those in most need of being incentivised to save.

Many might agree that these tax reliefs seem to be needlessly complex – for example, the personal savings ‘allowance’ is a misnomer, given that it is actually a nil rate of tax. If we had a blank sheet of paper, we probably wouldn’t start from where we are now. Yet care needs to be taken that apparent simplification of parts of the system does not, paradoxically, create complexity!

For instance, we mustn’t forget that the introduction of the personal savings allowance was accompanied by another policy change – the move from banks paying savings interest net of a basic rate tax deduction at source to instead paying it gross, with no tax deduction.

Those following LITRG’s work over many years may recall that prior to the personal savings allowance, there were in fact problems for some lower-income people. For example, those with overall income within or just above their personal allowance could easily lose out, by overpaying tax. This was because they were either:

• failing to register for their interest to be paid gross (using the R85 process – the forms not even well understood by some of the banks and building societies who were administering them); or
• not claiming back the tax that had been over-deducted from their savings.

These problems were resolved by the move to gross payment of interest. There was also an administrative saving for HMRC from having fewer refund forms to process. Changing or removing the starting rate for savings and personal savings allowance could therefore ‘reopen old wounds’ in this respect. And if banks continued to pay gross interest, there could be a reversal of the previous problem – that is, people finding they had underpaid tax on interest.

In conclusion, when making change, there are perhaps no easy answers, particularly as one eye needs to be kept on the detail, with the other focusing on the bigger picture.