Tax breaks will help investors’ profits bloom

Investors are essential to Chancellor Kwasi Kwarteng’s mission to grow the economy. 

As a result, there were a number of announcements in his mini-Budget on Friday that will affect pensions, savings and investment portfolios. 

Dividend duty drop helps entrepreneurs 

Investors who receive a high level of income from investments will receive a tax cut from April next year, the Chancellor said. 

Fresh start: Bloom and Wild benefited from start-up schemes that have now been extended

The tax rate on dividend payments for basic rate taxpayers will fall from 8.75 per cent to 7.5 per cent and for higher-rate taxpayers from 33.75 per cent to 32.5 per cent. Additional rate taxpayers will have their current rate of 39.35 per cent abolished altogether. 

In reality, only investors with big portfolios pay tax on dividends as investments sheltered in pensions and Individual Savings Accounts (Isas) do not attract it. And everyone has an annual £2,000 tax-free dividend allowance. 

Laura Suter, head of personal finance at investing platform AJ Bell, calculates that an investor would need to have a portfolio of more than £50,000 yielding 4 per cent to benefit. However, she points out that company directors who pay themselves in dividends are likely to make huge savings. 

‘Someone receiving £50,000 of dividends a year will save £3,288 next year in comparison to this year, while those taking £10,000 of dividends a year will be better off to the tune of £548,’ she says. 

Start-up schemes receive a big boost 

Three schemes that afford investors major tax breaks for supporting start-up businesses received a major boost in the Budget. 

Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EISs) and Seed Enterprise Investment Schemes (SEISs) are vehicles that allow investors to put their money into companies that are still privately-owned or that are too small to list on the main London Stock Exchange. 

Companies that have successfully used the schemes to grow include flower delivery firm Bloom & Wild, recipe box firm Gousto and burger restaurant Five Guys. Some of the firms in which you can invest have great growth potential, but they can also be more volatile and the risk of losing most or all of your money is far greater than in more traditional portfolios. 

Because of the risks, the incentives for investing are high. For example, VCTs and EIS schemes offer income tax relief of up to 30 per cent, while SEIS schemes offer up to 50 per cent. There is also inheritance tax relief available on EIS and SEIS schemes. 

Because they are riskier, they tend to be considered only by wealthy, experienced investors who have used up all of their other allowances for Isas and pensions. 

The Budget confirmed that VCT and EIS schemes would continue – until now there was a so-called sunset clause, which could have seen the industry shut down in 2025. The SEIS scheme was also extended.

Individual investors’ annual allowance for SEIS schemes will double to £200,000, while the maximum a company can raise under the scheme has also risen from £150,000 to £250,000.

Top earners to pay less tax on savings interest 

Taxpayers currently in the additional rate band will be able to earn up to £500 interest on their savings without paying any tax from April. 

Under the current system, only basic rate and higher rate taxpayers get a personal savings allowance – of £1,000 and £500 a year respectively.  Additional rate taxpayers have none at all. 

But from April, the additional tax rate, which taxes earnings above £150,000 a year at 45 per cent, will be abolished. 

Additional rate taxpayers will become higher rate tax payers and will therefore get a personal savings allowance. 

Pensions can invest in infrastructure 

The current cap on fees for workplace pensions is to be relaxed, Kwarteng said. 

At the moment, savers cannot be charged more than 0.75 per cent a year for the management of investments in their pensions. 

This is to protect savers from having their investment returns eroded by unjustifiably high fees. 

However, the Chancellor wants pension funds to be able to invest in major infrastructure projects, which would help to boost growth in the economy. The Government has committed itself to ambitious targets on nuclear, solar and wind energy, for example. 

Until now, pension funds have argued that this type of investment is too expensive to deliver under the current 0.75 per cent fees cap and so have shied away. 

Becky O’Connor is head of pensions and savings at investing platform Interactive Investor. She says: ‘For some time, the pension charge cap has been labelled as a blocker to private investment by pension funds in big infrastructure projects, because investment managers haven’t been able to deliver them and also keep charges for workplace savers under the 0.75 per cent cap.

‘These big investments, are costly but also have the potential to deliver growth for the economy and also for investors.’ 

But watch out as pensions stung 

Savers are set to get slightly less tax relief on pensions from April. 

Basic rate taxpayers receive tax relief at 20 per cent, which is their current income tax rate. However, from April the basic rate will fall to 19 per cent.

The income tax cut is, of course, largely good news as workers will keep more of what they earn. But the fallout is that pension tax relief will also drop to 19 per cent. Helen Morrissey, senior pensions analyst at investing platform Hargreaves Lansdown, says: ‘Instead of getting an extra £20 for every £80 you contribute, you will now only get £19 for every £81.’ 

While the one percentage point cut to tax relief to 19 per cent may sound small, it can add up over years of pension saving. 

Consultancy Barnett Waddingham has calculated that a 40-year-old basic-rate taxpayer earning £37,500 and contributing 12 per cent of their pay into a pension is likely to find their pot is worth £5,700 less when they come to retire as a result of the change. This amounts to a reduction in income at retirement of about £360 a year. 

People who are currently additional rate taxpayers will find that their pensions tax relief also falls in line with their income tax level, from 45 per cent to 40 per cent. This will mean that instead of getting an extra £45 for every £55 they contribute, they will now get £40 for every £60. 

The changes only tax place from the new tax year in April. Therefore, savers who can afford to do so could benefit from putting more money into their pensions before then to take advantage of the more generous rates.