A sting in the tail for Middle Britain

Savers should beware of the pitfalls behind the headline tax changes

KENNETH CLARKE said his Budget would help people who save, particularly those in what he called "middle Britain". But behind some dramatic headline changes, says Clive Scott-Hopkins of independent adviser Towry Law, he has not in fact given a lot away. Here are some pitfalls - and opportunities - among those main savings measures:

Cut in tax on savings accounts to 20 per cent from 25 per cent.

The Chancellor said 14 million savers would gain pounds 5 in every pounds 100 of interest and that the average pensioner would gain by pounds 75 a year, and some by as much as pounds 500. But even a pounds 75 gain implies a total savings balance of pounds 30,000 - which most people will not have.

The move only really benefits basic-rate taxpayers. But for most people the gain will be marginal - equivalent to perhaps just 0.25 per cent more interest on their balance. And higher rate taxpayers will still be liable for 40 per cent overall.

Another point that will limit the effect of the tax cut, according to Tim Jones, senior manager at accountants Binder Hamlyn, is that "90 per cent of the [retired] population get 90 per cent of their income from pensions". Pensions continue to get taxed at 25 per cent for basic-rate taxpayers.

Moreover, whether savers notice the benefit of the tax cut in their after- tax interest depends on whether building societies keep their overall rates up. The tax cut does not come in until April. Meanwhile, societies have already trailed potential savings rate cuts by reductions in mortgage rates of typically 0.25 per cent at the end of last week.

Tax-free benefits on mortgage payment policies, ill-health insurance and long-term care plans.

"I'm sure the insurance industry will latch on to this [sales opportunity] quickly," says Elspeth May, personal financial services partner at KPMG. But in practice, many of these benefits were already tax-free. In May, the Chancellor announced that he planned to make mortgage payment policies tax-free and that he would backdate the tax exemption. With policies that pay an income if you cannot work through ill-health, called permanent health insurance, the first year of paid benefit is tax-free anyway, and policies typically do not start paying until you have been off work for between three and 12 months. So to benefit from the extension of the tax- free status after the first year, PHI policyholders will have to be unable to work for between a total of 15 to 24 months, depending on the policy. Insurers fear an upsurge in fraudulent claims (see facing page) and are likely to reduce the proportion of salary you can insure. This will mean lower premiums but a lower benefit in year one. The Chancellor said policies paying long-term care benefits should be tax-free. But currently if benefits are paid direct to the nursing home, they are tax-free anyway.

Doubling or more how much of their savings people can keep and still get Government help for nursing home fees. Also possibility of more flexibility on pensions to help pay for care later.

"This will ease the pain but not solve the problem," says Paul Seymour of Continuing Care Conference, a lobbying group. Mr Scott-Hopkins described the various long-term care measures as "a bit weak". The increases in savings levels mean that people with assets worth less than pounds 10,000 are not asked to make any contribution to nursing home fees, but that people with assets of more than pounds 16,000 will still get no state help. Ms May questioned the idea of taking a smaller pension in the early years of retirement with the aim of leaving more to pay for care later on. "Most people don't have enough money in their pension fund anyway," she says. And the alternative, paying for long-term care insurance has problems. Insurance cover for nursing home fees for life might roughly cost a one- off premium of pounds 20,000 for someone in their 60s or 70s, says Mr Scott- Hopkins. That in turn might give cover for nursing home fees of pounds 20,000 a year until you die. But this is a lot of money for the risk. Jonathan Fry of independent adviser Premier Investments suggests instead saving by using tax-shelters such as personal equity plans.

Some advisers fear long-term care insurance will be strongly sold to older people who do not want to be a burden on their children and who do not want to run down their estates. Since the Budget promised further consultations "shortly", with the aim of providing more state help for people who planned ahead, savers might well be best advised to hold off buying. Towry Law has produced a guide to long-term care costs, available free to readers on 01753-554400.

30 per cent increase in inheritance tax threshold to pounds 200,000.

The Chancellor said this would take another 7,500 estates a year out of the tax, which bites at 40 per cent above the threshold, leaving the remaining 15,000 estates that still fall into the net paying pounds 18,400 less tax.

"One thing we're all up in arms about is that the increase doesn't come in until April," says Binder Hamlyn's Mr Jones. "Basically, it's hard luck if you die between now and April." Advisers said people should not assume the tax could now be ignored and that the tax still threatens plenty of "middle England". Houses are included, and it is not normally tax-efficient to give them to children and be able to continue living there.

60-year-olds can now buy National Savings' Pensioners Guaranteed Income Bonds, paying 7.5 per cent fixed a year.

The reduction in the qualifying age from 65 makes available a popular fixed-rate bond to more pensioners living off their savings. Already nearly 250,000 people have bought the bonds, which have the attraction of paying gross. But by shopping around, savers of whatever age may well get a better deal. As of Friday, Birmingham Midshires building society's Millennium Bond offered 7.75 per cent fixed for tying up your money for four years, instead of the five years required by the Pensioners Bond.

The Budget for savers

Tax on savings accounts cut to 20 per cent.

Tax-free benefits on insurance policies for mortgage payment, ill-health and long-term care.

Loosened means test for help with long-term care costs. Further help to follow.

Total of 7,500 estates a year taken out of inheritance tax net. Tax- free threshold up 30 per cent to pounds 200,000.

Age qualification reduced to 60 for buying Pensioners Guaranteed Income Bonds, which pay interest of 7.5 per cent.

Savings period for Saye employee share schemes and qualification for profit sharing schemes giving free shares reduced to three years. Share option scheme reintroduced.

AIM stock market companies and Enterprise Investment Schemes free of inheritance tax.