Budget 2011: an IT contractor’s financial review
To explain the details of last week’s Budget and what it means for your pocket, this year and beyond, CUK approached Tony Harris, founder and managing director of Contractor Money, the leading independent financial adviser to IT contractors.
INDIVIDUAL SAVINGS ACCOUNTS
The positive news of Budget 2011 for ISA-holding contractors was the chancellor’s confirmation that the annual allowance for an ISA will increase to £10,680 from April 5th 2011. From that date, contractors will be able to invest up to £5,340 in cash with the remaining allowance in stocks and shares or, alternatively, the entire £10,680 can be invested in stocks and shares.
But squeezed from index change
Seeming less positive is the Budget’s other confirmation relating to ISAs. From April 2012, the ISA allowance will increase in line with the Consumer Price Index (CPI) rather than the Retail Price Index (RPI). CPI is typically lower and so, in the current high inflation environment, this could cumulatively have a significantly impact on the amount that a contractor can save in an ISA in the future. The most recent figures show 4.4% for CPI and 5.5% for RPI. If we apply these rates to a contractor maxing out an ISA to its new limit (£10,680), the difference in growth in the allowance would be £117 lower.
Budget 2011 also announced the introduction of a Junior ISA for young savers. Scheduled to open on November 1st this year, the annual allowance for investment will be set at £3,000 a year and the funds will be locked in until the child reaches their 18th birthday. It looks set to work in a similar way to the standard ISA, meaning that it will offer tax free returns on funds that will be transferrable. If you already have a Child Trust Fund then the annual allowance on these accounts will be increased from £1,200 to run in line with the Junior ISA allowance.
In the current climate
For adults, unfortunately, an all-time-high in inflation means that it is hard to find cash-based savings that will offer an inflation-beating return in today’s market. As a result, cash ISAs are falling in popularity. In response, we are noticing a surge in enquiries for so called ‘absolute return funds’ which aim to produce a target return. When we talk to contractors about these funds, we are not shy about pointing out a potential pitfall - relatively high commencement charges. These upfront fees have the potential to erode your profits from contracting. So we recommend a broad-based and lower-cost portfolio with a core tracker holding, but one that is without the constraints of having to deliver a fixed annual return.
With the close of the financial year, and the dawn of a new one, some providers recently sweetened their ISA offerings. Coupled with the tax free returns on offer, this explains why individual savings accounts still continue to be taken up by contractors. As before the Budget, the ISA offers a reliable and trustworthy vehicle for a contractor’s savings.
As you were
Budget 2011 was very disappointing for pension savers – “as if they didn’t exist” – according to one tax expert. But the truth is that the 2011 Budget was never going to be the most exciting for pensioners, nor the most generous one. Indeed, much of the news for pension savers was delivered in George Osborne’s Emergency Budget, in June. Today, most pension advisors are merely thankful that the chancellor’s follow-up last week didn’t contain a raft of fresh changes. What we got instead was a chancellor sticking to his guns. So he gave a green light to the lowering in the annual pension allowance to £50,000, and an all-clear to increase the state pension age to 66.
Onus on personal provision
However the Budget’s announcing that the increase to the age at which one can claim the state pension may in future be linked to an independent longevity report could prove costly for pensioners. To me, this almost certainly means we will see a dramatic rise in state pension age in the years to come and firmly puts the onus on personal provision for those contractors who hope to retire at an earlier age. Developments in medicine and science are likely to push average longevity ever higher. This could be significant because there is currently no cap on how high the retirement age can go.
The state pension (continued)
According to Budget 2011, the state pension is going to come under a further review as a result of the Hutton report. It has been suggested that the current pension arrangement be altered to provide a flat rate state pension, which everyone would be entitled to. Although this flat rate is only in its early stages, it is widely expected that the amount will be approximately £140 a week. If so, this move would be a positive step towards clearing confusion out of the state pension system, partly by ensuring equality. It should also ensure that lower earners are not penalised for making more modest pension provision, whereas currently their state benefits can be scaled back in proportion to any private pension income they receive.
Salary sacrifice = lower tax
Elsewhere in the chancellor’s annual report, the 1% increase in National Insurance from April 5th is confirmed. To counteract this, contractors operating through an umbrella company can make use of a salary-sacrifice arrangement to invest in a pension scheme. Doing so will benefit the contractor on contributions up to £50,000, thereby offering the chance to lower your tax take, with a saving of 39% for basic rate taxpayers and 49% if higher rate. For a small number of contractors this move is a no-brainer – as the effective saving rate will be a whopping 69%!
Tax merger = sacrifice of salary sacrifice
Perhaps the most expected announcement of the Budget was the chancellor’s interest in merging National Insurance and Income Tax (IT). All that has been promised is a consultation which won’t be over quickly. Still if realised, aligning the IT and NI regimes could potentially have a significant impact on pension tax relief as salary sacrifice (where contractors save Income Tax and Employers’ and Employees’ NI by investing directly into a pension before taking their salary) will be greatly affected. Predictions doing the rounds at present are that higher rate tax relief on pension contributions may be scrapped altogether to simplify the process of combining the two taxes. The most prepared contractors might therefore consider a ‘buy now while stocks last’ approach, and make use of any spare funds by investing to gain the maximum tax relief available.
Once-in-a-lifetime opportunity if you act now
For now at least, pension investment gives you a great opportunity to reduce the amount that the taxman will be due at the end of the tax year, and there is still time to act before April 5th 2011, whether you want to top-up or start afresh. Contractors and the self-employed obviously need to bear in mind that once invested, pension monies are largely inaccessible until you reach 55. That said, depending on your circumstances, you can potentially invest up to a massive £255,000 between now and April 5th. Any sum invested could not only make a potentially significant difference to your retirement fund, but would have also allowed you to transfer money from company into personal hands very tax-efficiently.
Remember, it is unlikely that contractors will be able to invest anything like this amount of money into a pension in one tax year ever again - because from 6th April 2011, the new annual allowance of £50,000 will apply. Contractors and the self-employed ready to act must however be aware that complex ‘input period’ rules may already apply to them, which would mean that they already fall under the new, smaller annual allowance. But investigate: in certain circumstances, there do seem to be steps that can be taken before April 5th to change the dates that determine which allowance applies to contributions you make in 2010/11.
From 1 October 2011, a new duty on high-strength beers, and a reduced rate of duty on lower-strength beers to encourage their production and consumption, will be introduced. At present, 4p is being added to a pint of beer; 15p added to a bottle of wine and 54p on a bottle of spirits. For whisky drinkers, £7.15 of each litre they buy is now duty.
Fair excise duties on tobacco help with reducing the deficit and support health objectives, the government says in Budget 2011. While keeping the hikes it inherited, the government will restructure cigarette duty and hike the duty on hand-rolling tobacco by an additional 10%.
On the road
For contractors who drive for their sins, the chancellor was in a forgiving mood. The planned 1p hike in fuel duty that was meant to hit this week was scrapped, and he announced a further 1p reduction in the existing rate. It is hoped that this will ease the pain at the pumps for everyone from small businesses to individual drivers. Even those on-contract can benefit as, alongside the 2p saving, the mileage allowance for those who drive for work purposes was notched up 5p (for the first 10,000 miles).
From what I’ve seen, the overall effect is already starting to produce favourable results. Fuel is one of the key areas impacting inflation at the moment with prices being affected by the conflict in the Middle East. Both the chancellor’s gestures to drivers will be a relief to the vast majority of households and businesses that are feeling the pinch from higher living and operating costs.
This is part 1 of a two-part guide, based on the comments of Tony Harris at Contractor Money.Part two will review the implications of Budget 2011 for contractor mortgages, taxes and investments.