Complex rules are too taxing for UK savers

The rules surrounding savings, pensions and life policies now have so many bolt-ons that even the experts cannot understand how they are taxed.

This is making it even harder to save for the future, with roughly half failing to set aside enough for retirement.

The Office of Tax Simplification (OTS) has called for an overhaul, as savers are unaware of the tax allowances, with experts backing its call for urgent change.

TAX TRAPS Many are confused by the overlap between the individual savings account (ISA), the personal savings allowance (PSA) and dividend allowance.

These rules mean that 95 per cent do not pay any income tax on their savings, but many are still confused over where to put their money.

ISAs allow you to save up to £20,000 this year with all returns free of income tax and capital gains tax.

Under the 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 means savers can earn £2,000 income from stocks and shares each year before paying tax.

This was cut from £5,000 in April, causing further confusion.

Rachael Griffin, tax and financial planning expert at Old Mutual Wealth, said conflicting tax 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.”

Schemes designed to be simple, like ISAs, have become bewilderingly complex.

As well as traditional cash and stocks and shares ISAs, the range now includes Junior, Flexible, Inheritance, Innovative Finance, Help to Buy and Lifetime ISAs.

Griffin added there are strange quirks in the rules: “For instance, a 16-year-old can hold both a Junior ISA and an adult cash ISA at the same time, but not an adult stocks and shares ISA.”

The Lifetime ISA, or LISA, was designed to encourage first-time buyers and the self-employed to save for a property or retirement but complexity has hit take-up.

The scheme is open to those aged between 18 and 39, although they can continue contributions until age 49.

They can pay in up to £4,000 a year with a 25 per cent government top-up adding £1,000, but with penalties for early withdrawals.

Federation of Small Businesses national chairman Mike Cherry said the penalties are deterring many: “The huge savings deficit is storing up real trouble for the future. Some had hoped the LISA would crack the problem. Clearly, that’s not been the case.”

The OTS has called for ISA simplification, while the Association of Accounting Technicians would like to see a single “Everything ISA”, combining all the options.

Patrick Connolly, certified financial planner at Chase de Vere, said there are too many different taxes with varying terms and conditions, which cause confusion.

“Most people are unlikely to be aware how much they are paying in tax and could end up with unnecessary bills,” he said.

Pension freedoms introduced in 2015 allowing the over 55s to withdraw cash from their retirement pot have also caught many in a tax trap.

The first 25 per cent of any withdrawal is tax-free but the rest is taxable, with savers overcharged by £100million under HM Revenue & Custom’s “tax first, questions later” approach.

Griffin warned a much-needed overhaul could take time due to antiquated HMRC systems.