Universal Credit will not encourage saving, IFS warns

16 Feb 16

The government’s Universal Credit reforms will create “huge disincentives” for families receiving the payment to have more than £6,000 in savings, according to an analysis by the Institute for Fiscal Studies.

In an examination of the tax treatment of various ways to save, the think-tank found the Universal Credit plan to replace six existing benefits with one payment would change saving incentives “substantially”.

Currently, tax credits treat savings in the same way income tax does, the report stated. The tax credit taper is akin to facing a higher marginal rate of income tax and income contributed to, generated by or withdrawn from different assets affect tax credit withdrawal in the same way as income tax liability.

By contrast, calculations for Universal Credit eligibility take stocks of wealth into account in a way the current benefit system does not, the report stated. Assets below £6,000 are ignored, so UC provides no disincentive to save up to that amount, but “liquid” savings – defined as non-pension, non-housing assets – in excess of this will be penalised “heavily”.

If claimants have savings above £16,000, then entitlement to Universal Credit is removed altogether. Between £6,000 and £16,000, they act to reduce the money awarded not according to the actual income generated but by an assumed income. The amount of assumed income is £4.35 per month for every £250 of assets. At an annual rate of return of almost 21%, this is substantially higher than rates of return commonly available in the market, the IFS noted. Each £1 of assumed income then reduces Universal Credit entitlement by £1.

The review acknowledged there are obvious benefits to targeting means-tested support on those who have low wealth as well as low current income. However it also means people who think they might be eligible for UC in future have an extremely strong disincentive to save more than £6,000 in liquid assets.

By contrast, pension contributions are treated more favourably under UC than the current tax credit system. Pension contributions are deducted from income in both cases, but the higher taper in Universal Credit means a greater net benefit as a result.

Rollout of Universal Credit, which has been criticised by auditors and MPs, has been delayed due to problems with the technology needed to implement the change. It is expected to be completed in 2018.

Overall, the paper found that savers face a complex and changing array of different tax treatments, but pensions remain the most tax-efficient major form of saving. For a basic rate taxpayer a contribution to a pension by their employer with a net cost of £70 is worth the same as a £100 contribution to an ISA.

Stuart Adam, one of the report’s authors, said millions of people’s savings will be taken out of the tax net altogether through government changes set to take effect from April. These will regard £1,000 of interest income, £5,000 of dividend income and £11,000 of capital gains in any year as tax free.

“The last few years have seen radical changes announced to the taxation of savings,” Adam added.

“Ideally people might make savings decisions based on the underlying risks and returns of different assets. But taxes and charges can significantly change the relative attractiveness of different savings options. If people are unsure about how taxes and charges might change, their decisions become even harder.”

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