Chancellor driving savers into Isas

The FTSE 100 remained broadly flat on 8 March but the pound fell to its lowest level against the dollar since January, down 0.5 per cent as his announcements failed to lift the currency out of its ongoing decline.

Richard Buxton, head of UK equities at Old Mutual Global Investors points out: “The market reaction in the immediate aftermath of the speech was muted. 

“Gilt yields rose a tiny bit (in other words, prices fell), sterling weakened a little relative to other major currencies, and equity markets edged up slightly. It was all, unsurprisingly, very unremarkable.”

For investors, the biggest announcement from the Budget was the cut in the tax-free dividend allowance which is set to drop from £5,000 to £2,000 in April next year.

The annual dividend allowance has been put to the sword by Philip Hammond less than a year after his predecessor George Osborne introduced it.Tom Selby

As Mr Hammond explained in his statement: “It allows each director/shareholder to take £5,000 of dividends out of their company tax free, over and above the personal allowance.

“It is also an extremely generous tax break for investors with substantial share portfolios.”

Tax wrappers

The chancellor suggested half the people affected by this reduction are directors/shareholders of private companies, while the rest are investors in shares with holdings worth typically over £50,000 outside Isas.

Tom Selby, senior analyst at AJ Bell, comments: “The annual dividend allowance has been put to the sword by Mr Hammond less than a year after his predecessor George Osborne introduced it.

“The cut from £5,000 to £2,000 in April 2018 will make it even more important that investors make full use of the tax allowances available through Isas and Sipps.”

He advises investors and advisers will need to think carefully about which investments they hold inside and outside of tax wrappers. 

“They will want to ensure that high dividend-paying investments are held within Isas and Sipps to minimise the impact of the dividend allowance cut.” 

For many in the industry, it was yet another sign the government is pushing more people into saving through an Isa product of some kind, having nearly doubled Isa limits since 2010.

The Lifetime Isa is also due to launch in April this year, adding to the range of tax-efficient wrappers available to clients.

Moving the goalposts

Ben Russon, vice president, portfolio manager in the Franklin UK equity team, agrees: “Clearly the reduction in the tax-free dividend allowance from £5,000 to £2,000 is an incremental negative for those investors that have sizable portfolios outside of tax-wrappers, and represents yet another example of the government continually shifting the goalposts with regards to the long-term savings industry.”

Les Cameron, head of technical at Prudential, adds: “The previous dividend allowance of £5,000 allowed investors to hold around £150,000 of equity-based portfolios tax free. 

“[The] announcement of a reduction of this allowance to £2,000 will slash the size of the portfolio that can be held tax efficiently by over 50 per cent. 

“As a result we expect to see an increase in the use of tax-efficient wrappers such as Isas, pensions and investment bonds as investors seek to mitigate their increased tax exposure.”

Laith Khalaf, senior analyst at Hargreaves Lansdown, explains how to beat the dividend allowance cut using Isas.

"An investor has a portfolio worth £100,000, invested in a fund yielding 4 per cent. With the current allowance the £4,000 dividend is free from UK tax.

"However, with the dividend allowance being cut to £2,000, the following amounts of tax would be payable, depending on the investor’s tax status," he says.

Source: Hargreaves Lansdown

Mr Khalaf continues: "However, by using the full Isa allowances through to 6 April 2018 (when the cut comes in), the investor could shelter £55,240 of their portfolio from the taxman - £15,240 in the 2016-17 tax year, £20,000 in the 2017-18 tax year, and £20,000 on the first day of the 2018-19 tax year (6 April 2018).

"Based on the same 4 per cent assumed yield that would mean £2,210 of dividends being paid into the Isa tax-free. £1,790 would be generated by the investment remaining outside the Isa but with the £2,000 dividend allowance no tax would be payable."

He points out in this situation, the investor has completely avoided any additional tax stemming from the reduced dividend allowance by making judicious use of their Isa allowance each year.

During his turn at the despatch box this time, Mr Hammond also confirmed the rate on the new National Savings & Investment Bond, which he had announced at the Autumn Statement 2016.

The NS&I Investment Bond will offer a rate of 2.2 per cent over a three-year term for investments of up to £3,000 and will be available for 12 months from April 2017.

This is a stark reminder that savers continue to suffer and interest rates on cash have not kept up with inflation.Adrian Lowcock

The Share Centre’s chief executive Richard Stone suggests the bond will appeal to some investors in an environment where returns on cash available elsewhere are relatively negligible. 

He added: “However, for investors willing and able to take a greater level of risk with their capital it is worth noting that a basic FTSE 100 tracker is currently yielding an income of over 3 per cent a year, which can be earned tax free where the investment is held in an Isa account – albeit accepting that over the three-year period the capital is at risk.”

Keeping up with inflation

But Adrian Lowcock, investment director at Architas, believes the NS&I Investment Bond is a bad deal for savers, although he admits it will appeal to those who enjoy the security of a government backed savings bond.

“But the fact is, even though the  NS&I Investment Bond has one of the most competitive interest rates out there inflation is still expected to rise faster. This is a stark reminder that savers continue to suffer and interest rates on cash have not kept up with inflation,” he points out.

“The NS&I Investment Bond will pay 2.2 per cent interest a year. This is below the OBR’s predicted level of inflation for 2017 (2.4 per cent) and 2018 (2.3 per cent) and only makes savers money in real terms in 2019 when inflation is expected to drop to 2 per cent.”

In the absence of real returns on many cash savings products, investments in financial markets are now a more attractive option for savvy Brits.Richard Flax

Mr Lowcock adds: “At the very least one key objective of any saver or investor should be to grow their money in line with, if not ahead of inflation to ensure you maintain the spending power of those savings. As such many savers will need to look to other, riskier investments to potentially secure a higher return.”

For Richard Flax, chief investment officer at digital wealth manager Moneyfarm, the Budget was not for savers who are facing rising inflation and record low interest rates.

“In the absence of real returns on many cash savings products, investments in financial markets are now a more attractive option for savvy Brits,” he notes.

“The chancellor’s continued clampdown on tax avoidance in [the] Budget suggests that Brits will be best served by continuing to focus on simple and transparent investment solutions, such as stocks and shares Isas.”

eleanor.duncan@ft.com