Frustrated? Blame the Chancellor

Budget review: People with personal pensions will suffer, says Nic Cicutti
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The Independent Online
The Iron Chancellor, or "Flash Gordon", as he will be known after his pounds 30m tax gift to the film industry, has given Labour's first Budget for 18 years. What should we make of it?

A combination of minor relief tinged with some frustration. Let's take relief as the first reaction, both figuratively and literally. Speculation, encouraged by the Treasury, had centred on the possibility that Gordon Brown might abolish mortgage interest relief at source (Miras).

Miras, at 15 per cent, is worth about pounds 30 a month on interest-only home loans of more than pounds 30,000. By cutting it to 10 per cent from April, the Chancellor has limited the hit to pounds 10 a month.

Similarly, his move to raise stamp duty to 1.5 per cent on property purchases above pounds 250,000, rising to 2 per cent for properties above pounds 500,000, avoids punishing buyers in the south of England.

Paradoxically, however, the fact that his measures to cool the housing market have turned out far less stringent than expected raises the near- certainty of further pain for borrowers, with mortgage rates likely to go up by up to 0.75 per cent in coming months.

A rise on that scale could add at least pounds 30 to the cost of a typical pounds 50,000 loan. For existing and new borrowers, the logical step must be to seek haven in a fixed-rate or discounted product until the storm ahead has passed.

There will be some surprise at the Treasury's decision not to bring Inheritance Tax exemptions down from their pounds 215,000 ceiling. Equally, this is an area where no more concessions are likely from this Government.

The frustration is mostly linked to Mr Brown's move to abolish tax credits for pension schemes.

Again, this announcement came as no surprise. Yet the effect on certain pension schemes will be heavy.

Forget, briefly, final-salary company occupational schemes. Despite some estimates suggesting an increase of between 2 and 3 per cent in payroll costs, this is by no means certain.

Research by Johnstone Douglas, a leading employee benefit consultant, suggests the effect will be far more muted, largely because UK pension schemes do not invest in UK equities alone, but also gilts and international equities. Also, the reduction in corporation tax to 31 per cent will offset the loss in tax credits. The additional cost will be of a more manageable 0.5 per cent, the company predicts.

Yet this is not the whole picture. For 9 million people with personal pensions, plus several million more who are members of money-purchase schemes (where there are no defined benefits and the final pension fund buys a retirement annuity), there is little or no escape. They do not benefit from the cut in corporation tax, yet their funds will lose future tax credits.

A person aged 35, hoping to retire at 60, will find he or she must set aside about 1 per cent more income each year into the pension or face a cut of up to 25 per cent in retirement income. For someone earning pounds 20,000 a year, this means an extra pounds 400 a year must be found. Even with tax allowances at 23 per cent, the cost will still be around pounds 25-pounds 30 a month to fund the same level of pension at retirement.

On the other hand, those about to buy an annuity in the next few months should find they can buy a slightly better retirement income, as gilt yields rise to reflect City views that the Budget was not strict enough and interest rates rise accordingly.

Uncertainty also affects many areas of savings, especially in the context of Mr Brown's announcement that Labour plans to introduce a new Individual Savings Account in 1999.

It is not clear what form this ISA will take and whether the tax advantages of PEPs and Tessas will be allowed to match it.

Realistically, one must assume that PEPs are on their way out over the longer term. In the short term, they are a particularly attractive option. They will retain the tax credits denied pensions for two more years. It is unlikely that existing PEP investments will be retrospectively penalised.

This means that if you have pounds 6,000 to spare this tax year and next, PEPs are the natural place for your money. The tax difference may only be pounds 100 or so between the PEP and a pension, but over 30 years compound growth rates mount up.

The clampdown on so-called "protected" venture capital trusts (VCTs), in which half the invested funds were invested with banks, is welcome. VCTs were set up to encourage investment in smaller companies. Risk is part of the generous tax concessions available and it is right that this should be restated.

Finally, what can we say about the abolition of tax relief on private medical insurance (PMI) premiums for those over 60? To be expected, and in a curious way, a good thing.

The majority of health emergencies that strike older people are not generally treatable under PMI. The danger was that people were being tempted into PMI by tax incentives rather than real need. No more, thank goodness.

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