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THE PRE-BUDGET REPORT (PBR), in paragraph 5.32, says this about the level of savings in the UK economy:
'Traditional measures of aggregate saving, such as the saving ratio, often fail to reflect this variety [of asset-building activities] and to highlight the positive impact asset growth has had on households' balance sheets in recent years.'
A cynic might translate this as 'the saving ratio has dropped like a stone in recent years, but we're not planning to do much about it'. A quick glance at the figures available from the Office for National Statistics shows that the first part of this interpretation, at least, is more or less true. The saving ratio measures the proportion of post-tax income that households save rather than spend. It was never below 9.3% in the years from 1990 to 1997; it has never been above 6.5% thereafter. Whilst it can be argued that the low point was in 2000 with a ratio of 4.9%, and that this has now recovered to about 5.5%, historically we are saving far less of our income than we used to.
As the PBR itself acknowledges, the level of savings is important:
'Assets and savings provide opportunity and independence throughout life, flexibility to adjust to unforeseen events, and financial security in retirement.'
Too few people with too few savings means more income support and more people claiming the minimum income guarantee in retirement — which in turn means more tax for those in work to pay. So what incentives, particularly tax incentives, does the PBR offer to improve the saving ratio?
ISAs
The fundamental requirement for a long-term savings product is that it is long-term … Although ISAs were announced in 1999 with a ten year lifespan, it is worth listing the main changes that have affected them in their five year life so far:
* 1999 — ISAs introduced with a £5,000 limit, extended to £7,000 for one year only. Available to over 18s only, three components or three mini-accounts, with (broadly speaking) a '50% recognised exchange listed' requirement for collective investments in the stocks and shares element. Tax credits repayable until April 2004.
* 2000 — £7,000 limit extended until April 2001. Depositary interests included from 13 December.
* 2001 — Those aged 16 or over can open cash-only ISAs. £7,000 limit extended to April 2006. Change to the Revenue's view on which stock exchanges in European Economic Area countries qualified.
* 2002 — From 1 October all accounts (including existing ones) must be transferable, with a concessionary exception for certain accounts already in existence that offered fixed returns over a period of up to five years.
* 2003 — Where invalid ISAs are opened (i.e. opening second or subsequent ISAs in a year) they are eligible for 'repair' from January 2003. Guaranteed returns excluded from stocks and shares element from November.
* 2004 — Repayment of tax credits stopped from April. Extension of guaranteed returns exclusion to UCITS (undertaking for collective investment in transferable securities) and funds of funds.
Although some of these changes are fairly minor, they have all added to a climate of uncertainty around ISAs.
The future
The future of ISAs is even more complex. From April 2005 the insurance element is to be abolished — it has never really been very successful, with few policies being sold. All life assurance and the new medium-term stakeholder products will go into the stocks and shares component; anything that is relatively risk-free will be treated as part of the cash component. This was announced in the 2003 PBR.
The final move is the announcement in this PBR that the Government 'plan' to extend the existing higher limits through to 2009. The report proudly points out that this means taxpayers will have had £70,000 in tax-relieved savings over the ten years, rather than the original £50,000. But anyone trying to plan his future savings in 1999 would have been planning on the basis of £52,000, and even the extended limits are a lot less than the combined TESSA and PEP figures.
Even worse, someone who is now trying to plan his future savings is still not absolutely certain that he will be able to invest £35,000 over the next five years — it might only be £29,000 — and has no certainty at all about what happens after 2009. Since investment advisers normally suggest at least a five-year window for equity investment, some commitment to at least allowing existing ISAs to run for a further five years from 2009 would be welcome.
Saving Gateway
A pilot project which is to be extended, according to the PBR, is the Saving Gateway. The idea behind this is that those on low incomes or claiming benefit will be able to save comparatively small amounts into a scheme which is advertised by the Government as providing tax-free 'matching funding' — one pound from the Government for every pound that is invested. Strictly speaking, the Government money was paid as a bonus, because it was only paid when the account matured, in a similar way to SAYE schemes.
The pilot schemes offered pound for pound matching up to a maximum of £375 in total, to be saved at up to £25 a month over a period of eighteen months. Not surprisingly, the biggest problem was persuading people that there was no catch, and that you really did get double your money back. Once they realised that the offer was genuine, it was quickly taken up
However, hidden away in the details of the scheme is a potential tax problem. Here is what the terms for the product, from the Treasury website, say:
'The Government contributions (the matched payments) will be treated as capital payments for tax purposes. As capital payments, they will be covered by the £7,000 annual capital gains exemption. In the event that you exceed your annual tax-free capital gains allowance in the year in which you receive your matched funds, the Government will top up your matched payments so that the net effect is that they are received tax-free.'
Presumably this is simply to prevent the need for legislation that exempts the payments until the scheme is rolled out nationwide, but it seems an odd way of approaching it.
Child Trust Fund
The main focus on savings in the PBR was the Child Trust Fund (CTF). This was first announced in the 2003 Budget, with entitlement backdated to children born in or after September 2002. There has been a subtle change of emphasis over the intervening period. Initially the talk was about the 'endowment' provided by the Government, and ensuring that all children had a stake in the wealth of the country. In the PBR this is now expressed as a way of helping children to start saving, and the emphasis seems to have shifted to the £1,000 a year that relatives and friends can contribute.
The reason for this can be seen in the detailed proposals for the CTF issued in October 2003, although as explained below the figures appear to be incorrect. The proposals contain illustrations of the real value of the fund which might be expected to accrue by age 18 based on various assumptions. If the only money that ever went into the CTF was the £250 initial endowment, then according to the original figures the value in real terms at age 18 would be £456, which scarcely amounts to a stake in the nation's assets.
Rather more worrying, however, are the assumptions this is based on. According to the report these were that the nominal growth on the fund would be 7%, inflation would be 2.5% and the effect of charges was ignored. The proposals contained a note that the figures are consistent with FSA guidance. The percentages are, but they are intended for use with actual figures for charges. This would suggest that the figure of £456 should be lower. However, when you put through the calculation based on 7% growth and 2.5% inflation, the real value appears to be £550.
Whilst I have not been able to get to the bottom of that mystery, the Inland Revenue has told me that it is issuing new figures. These are based on 4.5% real growth (basically the same as 7% nominal less 2.5% inflation) but now also include the effect of charges of 1.5%. As a result, the illustrative return on £250 is a real value of £421 at age 18.
Trust fund babes?
To make a real impact, there have to be further contributions into the fund by parents or relatives. Up to £1,200 a year can be contributed, and payments made by parents will not be caught by the settlement rules. The Treasury suggest that regular monthly contributions of £40 a month, increasing by inflation, would result in a fund worth just over £12,000 in real terms at age 18.
This is certainly the answer to the query often put by parents and grandparents — what is the best way for me to put away a small monthly contribution to my child/grandchild's future? Many parents who can afford to do so will probably consider using some or all of the Child Benefit for this purpose, godparents may well make gifts at baptism, grandparents may make regular gifts or lump sum payments on birthdays and at Christmas. Even the child is allowed to contribute, and may well be encouraged to save some of his pocket money. But is this also the way that parents should be saving serious money, for example towards their children's university education?
Probably not, and almost certainly not until they are teenagers and parents can predict with some confidence how they will handle money. The problem is that at age 18 the money belongs to the child, regardless of whether it came from the Government or from relatives and friends. You may well have been religiously saving the £1,200 a year maximum so that Sebastian can pay his top-up fees to study law at Bristol, but Sebastian might blow it all in a gap year spent partying in Ibiza. The problem with the Child Trust Fund is that it does what most trust funds would try to avoid doing — it gives the capital to the beneficiary at age 18 with no strings attached.
Financial literacy
But the Government has plans to deal with this. By the age of 18 Sebastian will have regularly been taught about his finances, using his CTF as a teaching aid. Personal financial education is part of the curriculum now, and the intention is that it will provide appropriate information about the CTF for children at different stages of their education.
Presumably to help foster this, the CTF regulations provide that the annual statement about the account must be sent to the child, although it can be addressed 'care of' the responsible person if he or she is the contact — normally one of the parents. So young Sebastian trots off to school one morning with his CTF statement in his backpack ready for his teacher to explain what it means. Inevitably the children start comparing statements. Sebastian received £250 to start his CTF off, whereas Wayne who sits next to him had £500. 'But that's not fair, Miss!' complains Sebastian. One hopes that the Department for Education and Skills, with whom the Treasury is co-operating, will provide politically and pastorally acceptable ways for teachers to explain that the £500 goes to children from poorer families.
Wayne, on the other hand, will quickly realise that his much heralded stake in the nation's wealth at 18 will be a mere fraction of the amount that Sebastian will receive at the same age, and he might be forgiven for being disillusioned, though not for taking it out with his fists on Sebastian afterwards in the playground. All in all, perhaps the most important financial lesson that children will learn about their personal finances from the CTF is that they should keep them private …
Conclusion
There is really very little here to persuade taxpayers to save more and spend less. There is uncertainty about ISAs, the Saving Gateway is only a pilot, and the Child Trust Fund is simply not a sensible vehicle for saving large amounts because of the unrestricted access at age 18. The PBR itself admits that tax incentives can encourage people to save. It is a shame that it hasn't acted on its own advice.
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