MARKET COMMENT
Tax-free Dividends and Savings

By Christopher Spink
February 6, 2001

Carburton Street, London -- Yesterday's proposals by the Conservatives to reform the current system of taxation on savings interest and dividend payments make a lot of sense. If they win the election, the Tories plan to scrap tax on any interest that basic rate income tax payers have to pay on savings kept in the bank or building society. In addition this group will no longer have to pay tax on dividend payments.

Shadow Chancellor Michael Portillo reckons that nobody earning less than £32,000 will have to be penalised for planning his or her financial future. That's good news. These reforms sound slightly American, based on the US system of flexible tax-free savings plans, such as Rule 401(k)s. Higher rate income tax payers will have to pay tax on savings and dividends at the same level as previously.

At the moment there are holes in these plans. Will ISAs, introduced by the present Government, be scrapped? These savings accounts allow people to put £7,000 away each year. Dividends are still taxed within an ISA for basic rate income tax payers. £3,000 can be put away as cash. Interest earned on this is tax free.

So in theory these proposals would make ISAs pretty redundant, apart from if they still gave exemption from capital gains tax. The Tories did not mention what they might do with this fiendishly complicated tax.

Pension problem

Those put off using pensions stand to benefit most from these reforms. The personal pensions, introduced by the last Conservative government, have been much abused. The stakeholder pension, due out shortly, has failed to appeal to the low earners for whom it was intended. The Treasury's Individual Pension Plan, rather like the US's Rule 401(k) scheme, is still on the drawing board. In short, pensions are in a mess.

These flexible plans will allow the majority of people to save without penalty. You will not be taxed on income or earnings you make from money on which you have already paid basic rate income tax. Pensioners already receiving income, rather then reinvesting it, will benefit the most. Most only pay basic rate income tax. So the income they make from cash savings or dividend payments will not be taxed.

This could finally nail home the point that pensions are not tax-free savings vehicles but inflexible beasts that merely defer of payment of tax until retirement. These tax changes should encourage those on lower incomes to save, benefiting the whole nation. Of course there is one drawback to these proposals: the Opposition party is suggesting them not the Government! The Tories will have to win to implement them!

Where Next?

ISA Centre | discussion board
Pension Centre | discussion board
Taxes Centre | discussion board
Portillo's proposals