The Office of Tax Simplification (OTS) has called for an overhaul of the tax rules surrounding savings, pensions and life policies – arguing that, because they are so complicated and have so many bolt-ons, that they are deterring people from saving.
Even some pensions experts, they claim, are baffled by the rules.
In particular, many savers are confused by the overlap between ISAs (individual savings accounts), the personal savings allowance (PSA) and dividend allowance.
While 95% of savers do not pay any income tax on their savings, the rules still leave many confused over the best place to put their money.
Rachael Griffin, tax and financial planning expert at Old Mutual Wealth, said: “Relics of the past are lingering in the tax system and, when combined with additional rules, have created something like Frankenstein’s monster.
“Instead of being a coherent well-oiled system, the taxation of savings has had numerous bolt-ons, which makes the whole thing confusing for the industry let alone consumers. The issue with the savings industry is not that it isn’t working but that, in some respects, it’s easier for people to take on debt than to ascertain the most tax efficient way to save.”
She added that “A personal tax roadmap would go a long way in helping people understanding how to navigate what seems to be a multi-dimensional maze of tax and provide transparency to the tax payer.”
Old Mutual also flags up the very real potential for savers to be overtaxed: “The overpayment of tax on lump sum pension withdrawals is a flaw in the tax system that needs to be urgently addressed, says their pensions expert Iain Brown.
“The problem was triggered by the introduction of pension freedoms in 2015 and is now reaching epidemic levels. The Office of Tax Simplification notes this area is not easily understood by consumers and calls on HMRC to change its procedures, however, with the PAYE system dating back to 1944 it is currently unable to cope. Changes are unlikely to be swift and the concern is that solutions will not be quick enough for current pensioners.
“In the meantime, there are ways to avoid overpaying tax. The overpayment issue arises because of the tax code generated when a large lump sum is withdrawn from a pension. However, if a pensioner chooses to take smaller payments, say three x £10,000 rather than one £30,000, a different code is generated which means the payments are taxed at a basic rate and there is no need for a reclaim.”
While the first 25% of any withdrawal is tax-free, the rest is taxable, and unwary savers have been overcharged a total of £100 million under HM Revenue & Custom’s approach of “tax first, ask questions later”.
The tax rules you should know:
* ISAs allow you to save up to £20,000 a year free of income tax and capital gains tax.
* With PSA, the first £1,000 of savings interest is free of tax for a basic rate taxpayer, falling to £500 for 40 per cent taxpayers.
* The dividend allowance lets savers earn £2,000 income from stocks and shares each year before paying tax. (previously £5,000).
* The max tax free from pension fund is 25% and under pension freedoms this may be taken as one or a series of withdrawals… with checks made to ensure no more than 25% of fund is withdrawn tax free.
