PERSONAL FINANCE:The Government wants us to save less and spend more, which is why Dirt tax increased in the Budget – so what's a determined saver to do?
IN A BID TO kick-start consumer spending, the Government took steps in the Budget to make saving less attractive. However, if you are determined to continue building up a rainy-day fund, there are ways of avoiding the extra costs coming down the tracks.
As a result of last December’s Budget, the rate of Deposit Interest Retention Tax (Dirt) increased by 2 per cent from January 1st. This will bring the rate to 27 per cent on ordinary deposit accounts (where payments are made annually or more frequently).
On longer-term deposits, such as tracker bonds, the State will take a 30 per cent slice of your interest. Unfortunately this tax on savings is likely to remain high for the foreseeable future, even if a new Government is elected.
So what, if anything, can you do to reduce your exposure to Dirt while maintaining a cash reserve?
The most attractive solutions to the problem are provided by that staid State institution, An Post.
Its three-year savings bond attracts a return of 10 per cent tax-free, if it is held for the full term. This translates to an annual equivalent rate (AER) of 3.23 per cent.
Financial adviser John Lowe of moneydoctor.ie notes that banks would have to offer a gross rate of 4.42 per cent on a 12-month savings product in order to match this. This is because Dirt would be applicable at 27 per cent from January onwards.
If you’re willing to lock your funds away for five and a half years, An Post savings certificates offer a market-beating 21 per cent return. This is equivalent to 3.53 per cent AER, or 4.82 per cent gross if you factor in the Dirt that would apply to competing products.
Lowe says that this level of return is “a lion’s roar” away from anything else offered on the market.
The next-best product is Investec’s recently launched 12-month online deposit account, which offers a fixed interest rate of 3.6 per cent AER, but Dirt applies to this and you have to deposit at least €20,000.
Individuals can invest between €100 and €120,000 in An Post savings bonds, and between €50 and €120,000 in savings certificates. Another attraction of saving with An Post is that 100 per cent of your money is State guaranteed, and will continue to be so even if the Government’s blanket deposit guarantee is eventually lifted, because it is State-owned.
If your priority is minimising your Dirt bill, then the special term accounts offered by some credit unions represent another alternative.
With a three-year special term account you can earn a dividend of €480 a year without having to pay any Dirt. Dividends of up to €635 a year can be earned Dirt-free on five-year accounts.
Dirt is charged at 25 per cent (increasing to 27 per cent in 2011) on dividends in excess of these limits. The dividend rate paid depends on the individual credit union, and to avail of the tax benefits your funds must be left in the account for the full term.
The National Solidarity Bond launched earlier this year by the Government is also looking more compelling in light of the impending Dirt hikes.
The bond is a 10-year investment, offering a gross return of 50 per cent. This includes 10 annual payments of one per cent, which are subject to Dirt tax, but the 40 per cent lump-sum bonus payable at the end of the 10-year savings period is tax-free.
If you’re not willing to lock your money away for a decade, then the new four-year National Solidarity Bond that the Government is proposing to introduce in the new year might be more appealing.
As yet, the terms of the new bond are unknown, except that it will pay a coupon each year and a bonus for those who hold the bond to maturity.
However, in order to compete with An Post’s product range, it may have to offer an extra sweetener, so it is one to watch for the future. If your savings are already in an account that attracts Dirt, it’s worth double-checking that you’re not paying tax unnecessarily.
For instance, you are entitled to receive deposit interest without any deduction of Dirt, or get a Dirt refund, if you are 65 or over and your income (and your spouse’s) for the year will be below the relevant annual exemption limit. Also, certain people with disabilities can receive deposit interest without any Dirt deduction.
The Budget also heralded a number of changes that will make pensions considerably less attractive as a means of saving for retirement.
From January 2011, personal pension contributions will no longer qualify for PRSI relief. Neither will they be exempt from the new universal social charge.
In addition, the annual earnings cap that determines the maximum tax-relievable pension contributions that an individual can make will be reduced by almost 25 per cent from €150,000 to €115,000.
More worrying still is the Government’s plan to reduce the maximum rate of income tax relief available on pension contributions from 41 per cent to the standard rate of 20 per cent between 2012 and 2014.
So does the traditional pension model still stand up, or should workers consider alternatives?
Ian Mitchell, a consultant with Deloitte Pensions and Investment, says although less attractive, pensions still represent a reasonably tax-efficient way of saving for retirement – at least for 2011.
He points out that if an individual is on the higher rate of income tax, they will still receive relief at 41 per cent on their pension contributions next year, and his advice is to maximise top-ups in 2011 while the higher rate relief is still available.
“There isn’t a vast array of alternatives [to pensions] coming forward,” he says. “You can invest in a gross roll-up bond or a savings plan or whatever, [but] you’ll pay Dirt coming out.”
You’ll also miss out on any tax relief if you opt for a non-pension long-term savings vehicle. “It’s difficult to see how that’s going to beat a pension,” he says.
