Budget 2021: How to limit the damage


Chancellor Rishi Sunak hailed his Budget as heralding “a new age of optimism”. But hard-pressed taxpayers could be forgiven for thinking otherwise.

While wages are climbing and set to rise further, for most people the gains will almost certainly be eaten away over the coming years by inflation, tax increases and rising mortgage costs.

The government will have more to spend, particularly on health and social care, but the average household is likely to see only slim increases in pre-tax real income and a decline in after-tax take-home pay.

“Of course I would not like it to be there,” said Sunak, commenting on the earnings outlook over the next few years. “It’s been caused because this country suffered the biggest shock it has suffered for 300 years.”

Certainly Covid-19 has contributed to the coming economic squeeze. But the government is also taking the opportunity to boost public services to plug the holes left by a decade of austerity and to spend more where the voters have demanded it — on healthcare.

FT Money takes a look at who will be hit and how, and the steps householders and savers can take to soften the blows.

Rising bills and stagnant wages

Taxpayers must pay the bills at a time when their own budgets will be squeezed. As the Budget documents reveal, the independent Office for Budget Responsibility (OBR) expects real wages (pre-tax) to rise by only 3.9 per cent by 2026-27, well under 1 per cent annually. The Resolution Foundation calculates that by around the same time, the average household — on an annual income of about £30,000 — will be around 2 per cent worse off, due to tax increases. For the better-off, the decline is 3.1 per cent.

The screws will be applied through the increase in national insurance and dividend taxes announced this year, combined with the silent effects of leaving tax thresholds unchanged in the face of inflation, so that they bite deeper year by year in real terms.

All this comes against a background of persistent pay stagnation. As the OBR shows, by 2024, real wages will have risen by just 2.4 per cent in 16 years — compared to 36 per cent in the previous 16.

CPI Inflation

The impact is very unequal, because the wealthiest households have been cushioned over these years by soaring investment gains. As the Institute for Fiscal Studies puts it: “The primacy of asset accumulation and the importance of asset holdings over the possibility of getting better off through earnings, is being maintained well into a second decade.”

So householders should save money if and when they can — and invest it. They can make full use of the available tax breaks, including Isas, pension pots, reliefs on property and annual capital gains tax allowances. Those planning to pass on money to heirs can exploit concessions in the inheritance tax regime, including making lifetime gifts well before their dotage.

Savers cannot assume that the current concessions will last for ever. While the mooted increases in capital gains tax and the possible tightening of IHT rules did not materialise this time, the next Budget is only six months away.

Those with investment portfolios should look carefully at their investments in bonds, including gilts, which tend to fare badly when interest rates rise.

Equities can offer some protection, particularly shares in solid income-generating sectors, such as consumer staples. More adventurous wealth managers argue that investors should not entirely abandon tech stocks. While they have not traditionally been seen as sound bets in times of higher interest rates, the scale of today’s technology revolution suggests that the best tech companies will be highly profitable and reward patient shareholders.

Mortgage rates on the increase

But even before looking at their assets, householders should review their debts, mortgages especially. As interest rates are going up, property owners would do well to pay off what they reasonably can and renew fixed-term loans at the best rates available, because they may not be around much longer.

Banks and building societies have already started pushing up rates on fixed-term mortgages, in a sign that the era of ultra-low rates is fading fast.

Barclays on Friday increased rates on a suite of its mortgages by up to 0.35 percentage points, following upward rate revisions over the past two weeks by HSBC, Santander, Halifax and Nationwide. Having pulled their cheapest deals, several lenders no longer offer any fixed rates below 1 per cent.

“Anything below 1 per cent is really just clinging on now,” says David Hollingworth, associate director at broker L&C Mortgages.

Markets expect a rise in the Bank of England base rate to come sooner than previously anticipated, with the monetary policy committee meeting next week. This is already influencing the cost of funding for lenders as well as their willingness to lend at ultra-low rates.

Aaron Strutt, technical director at mortgage broker Trinity Finance, says some of the rate increases were “quite big” but cautioned that there was still time for purchasers or those with an option to remortgage to lock in a good-value rate. “There’s no doubt rates are going up . . . But even if they go up by 0.5 per cent or another 1 per cent they will still be incredibly cheap in historical terms.” 

In its forecasts spelling out the effects of inflation, the OBR says the costs of mortgage interest payments will rise sharply in 2023, peaking at a year-on-year rise of 14.8 per cent in the second quarter.

“The figures show that homeowners need to be braced for a big leap in mortgage costs,” says Laura Suter, head of personal finance at investment broker AJ Bell.

House price forecast

First-time buyers are likely to feel hardest hit by a rise in mortgage interest rates, she adds. “Some have borrowed up to their affordability limit to get on to the property ladder, and so will find additional monthly costs harder to swallow.” 

Getting on that ladder in the first place is also likely to be more difficult. The OBR changed its view — expressed only in March — that house prices would take a fall of 1.7 per cent in 2022. Instead, it thinks they will rise by 3.2 per cent, explaining its change of heart by pointing to the boom prompted by the “race for space” and a stamp duty holiday.

For one segment of the property market, there was a potentially worrying suggestion buried in the OBR report. Landlords on this occasion escaped any fiscal hits after adverse changes in previous Budgets. But the OBR report erroneously stated that stamp duty for purchasers of second homes and buy-to-let in England and Northern Ireland rise would rise from 3 to 4 per cent. The implication is that this was considered by the government.

“It suggests the policy was on the table but withdrawn at some point,” says Aneisha Beveridge, research director at estate agent Hamptons International. “It makes sense when you consider that the equivalent transaction tax rate is already 4 per cent in Wales and Scotland.” 

At a purchase price of £240,000 — the average for landlords, according to Hamptons — additional home buyers would pay £11,900 in stamp duty under a 4 per cent surcharge rate, compared with £9,500 on 3 per cent or just £2,300 for primary residence purchasers.

The OBR says: “Unfortunately, the reference to SDLT was included in our supplementary annex in error. The measure was not included in our forecast and the government has made no change to SDLT in the Budget.”

Landlord investors, still feeling the pain from previous tax and regulatory changes, may not feel entirely reassured.

Protect your investment portfolio

For retail investors, responding to inflation is paramount. Higher inflation clearly threatens to erode the value of cash piles. But with price increases heading toward 4 per cent or higher, many securities investments could also lose value. “The starting point of our investment portfolios is to deliver inflation-beating returns,” says Ines Uwiteto, private client manager at 7IM.

When planning their finances, Uwiteto says people should focus on how their actual costs are going up, because this can differ markedly from the average inflation stats quoted by the chancellor. “For my clients this figure tends to higher than the headline inflation number,” she says.

At the same time, the 1.25 percentage point tax rise on dividends after the first £2,000, announced by the prime minister in September to raise £600m for health and social care services, will take a bite out of investment incomes.

But however worrying the prospect of higher inflation and higher taxes, the first advice from many investment experts is not to overreact with a rush of portfolio switches.

The chancellor’s policies will hit higher earners further down the line

“We should keep our hair on,” says Andrew Bell, chief executive and co-manager of the £2.2bn Witan Investment Trust. Unless investors have a short-term need for their capital, “staying the course usually makes more sense”.

Still, the UK economic outlook does call for investors to review their portfolios and ensure they are well positioned for the road ahead.

“Traditional forms of inflation protection are extremely overvalued,” says Guy Foster, chief strategist at wealth manager Brewin Dolphin. He notes that inflation-protected bonds look “very unattractive” because inflation is already elevated while the inflation-adjusted price of gold is historically high.

Mainstream bonds look unappealing to many investors as their relatively low fixed returns offer particularly poor value when inflation rises. In a classic bonds and equities portfolio, distaste for bonds would normally mean appetite for stocks. But analysts note that equities have been in favour for so long that many portfolios are already very much skewed towards stocks.

Some companies also draw concern over high valuations, particularly the tech stocks dominating US indices. Bell says investors need to be “choosy”, but there are still opportunities to be found. “Many parts of the equity market are more reasonably priced than the technology market leaders.”

When picking stocks for a time of rising inflation, Foster says: “We tend to look for companies who can push through increased prices because of the strength of the competitive advantage. Many industrials are good examples. The makers of small but important components are often best placed to push through their pricing increases.”

Money managers also say the prospect of higher inflation makes it a good time to look beyond stocks and bonds. “Investors should broaden their asset allocation to include the likes of property, infrastructure and commodities,” says Andrew Hardy, senior portfolio manager and investment strategist at Momentum Global Investment Management.

Hardy argues these alternative assets can provide “both diversification and returns” but cautioned that investors need to be aware that they can’t buy and sell these illiquid assets as readily.

A popular way for retail investors to access alternatives is through listed UK investment trusts, which hold their assets within a listed company.

Personal finance experts also note that investors need to remain aware of the continuing freeze on personal tax allowances, including on capital gains tax. For those with large profits, realising gains each year to make use of annual allowances can make sense.

As for pensions savings, the chancellor held off from making any further cuts to pensions tax relief, which governs how much can be saved, or grown, in a pension pot before tax charges apply.

In the Budget the main pension saving tax-free allowances, including the Lifetime and Annual, were preserved at current levels, of £1.073m and £40,000 respectively.

But while there was relief that Sunak did not swing his axe, experts warn that he will take a silent cut from wealthier savers with larger pension pots, by freezing savings allowances despite the rise in inflation.

UK bank rate

A key area of concern is the lifetime allowance (LTA), which has been dramatically cut over the past decade and was frozen at £1.073m in the March 2021 Budget. Previously the LTA had risen each year in line with inflation.

Canada Life, a pension provider, has calculated that had the LTA increased with inflation in April this year, and 3.1 per cent from April 2022, in line with the same rise in the state pension, it would be near £1.112m or around £40,000 more than today.

The LTA squeeze is set to continue with the OBR forecasting CPI inflation to average 4 per cent in 2022, and the LTA remaining at its current level until 2026.

Analysis by Aegon, the pension provider, has found good investment returns could put at risk many people who might today consider hitting the LTA cap as a remote possibility.

“The lifetime allowance is effectively punishing those who have done the right thing and saved regularly over the course of their lives,” says Steven Cameron, pensions director with Aegon. “With inflation on the rise, that punishment is greater and more wide reaching, making it an area that requires reform in the years ahead.”

Aegon calculates a 6 per cent investment return over the next nine years would take someone with a £686,000 pension fund today over the LTA threshold, and potentially exposed to tax, even if they do not contribute a penny more to their pot.

The Budget and your money

More generally, millions of pensioners will see their incomes directly squeezed, following the government’s decision this year temporarily to suspend the Triple Lock, which sees the state pension rise by the higher of inflation, average earnings or 2.5 per cent. With wages growth reaching 8.8 per cent, the government opted to increase the state pension next year by inflation, or 3.1 per cent.

“While a 3.1 per cent increase in the value of the state pension might feel like good news, with the chancellor warning inflation could run at 4 per cent over the next 12 months, pensioners are set to feel the pinch from a real term cut in their retirement income,” says Tom Selby, head of retirement policy at AJ Bell, an investment platform.

But savers planning to supplement the state pension with investment income need to take care. Becky O’Connor, head of pensions and savings, with Interactive Investor, a DIY investment platform, says: “Inflation at a level of 4 per cent becomes hard to beat even when investing in the stock market, so long-term investors will have to box clever to beat it. Some may feel they are being pushed out of their risk comfort zone in order to do so.”

Reporting by James Pickford, Josephine Cumbo, Stefan Wagstyl and Joshua Oliver



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