CASH VS SHARES

NB - THIS RESEARCH WAS DONE NEARLY TEN YEARS AGO AND WAS ACCURATE UP TO THAT TIME. IN THE YEARS SINCE THE RETURNS ON CASH AND SHARES HAVE CHANGED.  NOTHING IN THIS RESEARCH - THEN OR NOW - IS INTENDED AS ADVICE. 

ORIGINAL 2016 RESEARCH AND BLOG:

The purpose of this research is to see if cash or shares give the better return over periods of investment from one to twenty years.

Most advisers would agree that over the long-term shares are the better place for money. And most would also agree that over the short-term cash is safer. But where is the time boundary between that advantage of shares over cash? Advisers often call five or ten years ‘long-term’. But there can be substantial risk of losing money over that sort of period. So where is the advantage boundary between cash and shares?

This research seeks to set parameters.

Read the Press Release which summarizes the findings.

DATA

Shares are represented by a real FTSE 100 tracker from HSBC. Chosen as a typical tracker – not cheap, not expensive, and accurate. Data from Morningstar. The numbers are the total return with dividends reinvested and after charges. It is assumed that once invested the money is left untouched to the end of the period at which time it is encashed.

Cash is represented by best buy one year bank or building society deposit accounts – referred to as ‘one-year bonds’. The data is taken from MoneyFacts Savings Selection and was collected from original copies of the MoneyFacts periodical which is published each month. One year bonds are used in the analysis as what I call ‘active cash’. On each anniversary of the investment the bond is cashed in and then reinvested in the current best buy one-year bond. In the real world there would be a time lag between encashing and having the money available for reinvestment. This point is dealt with later.

All datasets are of prices on the first of the month. Morningstar data is for the closing price on the date. It has been normalised to begin at £10,000 in 1 January 1995. MoneyFacts is published once a month and the data is for best buys a few days earlier, just before the start of the month of publication. This slight date difference is considered immaterial.

ANALYSIS OF FIVE YEAR PERIODS

The datasets run for 21 years from 1 January 1995 to 1 January 2016. For each time period of 1 to 20 years within the dataset the growth in cash (as defined) and shares (as defined) was calculated.

Let us take a five-year period for example. The calculation is of the growth in the investment over five years from an investment made on the first of a month. So a five-year period runs for example from 1 October 1999 to 1 October 2004. Twenty-one years of data is used from 1 January 1995 to 1 January 2016. Over that period of 21 years there are thus 16x12=192 possible investment periods. It is assumed that the investment is opened on day one and cashed in on the anniversary at the end of the period.

For each of the periods the growth is calculated for the tracker and for the cash. The two growth values are compared to see if tracker or cash gives the higher growth over that period. No deduction is made for tax on interest or dividends. That approximation is explained later. For each five-year period the spreadsheet counts the occasions when (a) cash or (b) shares gave higher growth. It also counts those periods in which the money in the tracker ends up less than it started.

All calculations and data are nominal – no account is taken of inflation which affects cash and tracker funds equally. Whatever measure of inflation was used it would not affect whether cash or shares gave the higher return.

The results are shown in the table

Active cash vs FTSE 100 tracker 1/1/95-1/1/2016
	5 YEAR INVESTMENT PERIODS
Cash better	109 periods. 57% of 192 periods
Shares better	83 periods. 43% of 192 periods
Shares LOSE money	46 periods. 24% of 192 periods

The table shows that for periods starting 1 January 1995 to 1 December 2010 a five-year investment in cash or shares (as defined) started on the first day of a randomly chosen month would yield a better return in cash more often than one in shares.

Investing in shares carries another risk – losing money. In 46 out of the 192 five-year periods (24%) the tracker would lose money, ending lower than it started. Cash never loses money within the Financial Services Compensation Scheme limit – currently £75,000. Above that limit there is of course a risk that the savings institution will collapse and some or all of the capital lost. Large sums can be protected if they are spread among several institutions keeping the money in each at £75,000 or below. That will reduce the interest earned as by definition not all can be in the best buy account. But the difference between the top 5 one year bonds is not that great and would not affect the overall balance between cash and shares. Further analysis assuming start dates throughout the month shows the same risk of loss with shares. Any day start: 23.82% end lower. First of month start: 23.96% end lower.

Over the 21 years from January 1995 to January 2016 the overall return for shares is 6.0% per year compound. For active cash the overall return is 5.0% per year compound. The 1.0% difference is significantly lower than the 3%-8% often quoted for the so-called ‘risk premium’ of investing in shares.

Further analysis of the five-year periods

On those occasions when shares win the gain is more than the occasions on which cash wins. Overall for the 192 five-year periods when shares beat cash they make an average return of 10.4% a year while cash when a winner makes just 5.5%. But of course when shares lose they can also lose money, as the graph shows. It also illustrates that it take a good couple of years from shares to recover from a serious fall. These falls should not be seen as exceptional – they are quite common.

In the 109 periods when cash beats shares investors had to wait an average of 23 months (median 19 months) before an investment in shares would again win. And in the 46 periods when shares produced a negative return it took as much as 42 months and as little as one period for that to be reversed. An average of 19.7 months (median 19.5). So when shares fail to perform there may be a long wait before investing in them is advisable again. But all that speaks to is when judgement might be exercised in share investments. This research is not about that. It is a comparison of using two simple rules – choose a low cost tracker vs use one year active cash. 

 

Tax

If the interest on cash had been taxed at the current basic rate then over five years the figures are closer but the balance is still in favour of cash. Shares win in 47% (91) of the 192 periods, cash wins in 53% (101). For higher rate taxpayers the calculation is more difficult as tax would also be due on dividends which would affect the comparison. Data to do that calculation is not available and is not done.

Basic rate tax is not a consideration for cash interest on ISAs or cash in pension funds as no tax is charged on it. Note that the figures used here are not the rates for ISAs or for funds which can be SIPPed which may be different from those used. Such rates are not available historically over this period.

Looking ahead from 6 April 2016 the Government estimates that 95% of cash savers do not pay tax on the interest because the first £1000 of interest earned is tax free (first £500 for higher rate taxpayers). So comparing untaxed cash returns with dividends is fair for the future.

Time lag
Active cash means taking out a one-year bond and then reinvesting the money at the best buy rate when it expires. In the past there would be a delay between the end of the bond and the money being available for reinvestment. Typically that might be up to two weeks. Modelling that is difficult. One approximation is to assume interest rates are 50/52 of the recorded rate. Doing that does not affect the balance of shares vs cash which still wins in 109 out of 192 periods.

Charges

The money taken by managers from a tracker fund as charges has fallen over the years. Today the charge on the HSBC tracker used is 0.18%. In the past it would have been more.

Summary of five year periods

Over the survey period January 1995 to January 2016, five-year investments begun on the first of each month in active cash beat a FTSE100 shares tracker in 57% of 192 periods.

Over the survey period January 1995 to January 2016, five-year investments begun on the first of each month in a FTSE 100 tracker ended the period lower than they started in 46 out of 192 periods (24%). That is almost a one in four chance of losing money. Cash, within Financial Services Compensation Scheme limits, will never lose money.

LONGER AND SHORTER TIME PERIODS

The table below gives the results for periods from 5 to 10 years. Cash wins over 5 to 9 years with an even split over ten years.

Active cash vs FTSE 100 tracker 1/1/95-1/1/2016
	LENGTH OF INVESTMENT PERIOD
WINNER	5 years	6 years	7 years	8 years	9 years	10 years
Shares better	83 periods 43% of 192 periods	67 periods 37% of 180 periods	50 periods 30% of 168 periods	57 periods 37% of 156 periods	52 periods 36% of 144 periods	66 periods 50% of 132 periods
Cash better	109 periods 57%	113 periods 63%	118 periods 70%	99 periods 63%	92 periods 64%	66 periods 50%
Shares LOSE money	46 periods 24%	35 periods 19%	13 periods 8%	12 periods 8%	14 periods 10%	15 periods 11%

Over longer and shorter periods than that the results are surprising.

Active cash vs FTSE 100 tracker 1/1/95-1/1/2016
	LENGTH OF INVESTMENT PERIOD
WINNER	1 year	2 years	3 years	4 years
Shares better	155 periods 65% of 240 periods	140 periods 61% of 228 periods	125 periods 58% of 216 periods	103 50% of 204 periods
Cash better	85 periods 35%	88 periods 39%	118 periods 70%	101 periods 50%
Shares LOSE money	64 periods 27%	64 periods 28%	71 periods 33%	60 periods 29%

Shares win over 1, 2, and 3 years; cash and shares win equal times for 4 years. Over periods longer than 10 years cash continues to dominate.

Active cash vs FTSE 100 tracker 1/1/95-1/1/2016
	LENGTH OF INVESTMENT PERIOD
WINNER	11 years	12 years	13 years	14 years	15 years
Shares better	58 periods 48% of 120 periods	44 periods 41% of 108 periods	23 periods 24% of 96 periods	3 periods 4% of 84 periods	4 periods 6% of 72 periods
Cash better	62 periods 52%	64 periods 59%	73 periods 76%	81 periods 96%	68 periods 94%
Shares LOSE money	8 periods 7%	0 periods 0%	0 periods 0%	0 periods 0%	0 periods 0%

Active cash vs FTSE 100 tracker 1/1/95-1/1/2016
	LENGTH OF INVESTMENT PERIOD
WINNER	16 years	17 years	18 years	19 years	20 years
Shares better	7 periods 12% of 60 periods	18 periods 38% of 48 periods	29 periods 81% of 36 periods	21 periods 88% of 24 periods	12 periods 100% of 12 periods
Cash better	53 periods 88%	30 periods 63%	7 periods 19%	3 periods 12%	0 periods 0%
Shares LOSE money	0 periods 0%	0 periods 0%	0 periods 0%	0 periods 0%	0 periods 0%

Cash wins over investment periods from 11 to 17 years, and among them from 13 to 16 years cash absolutely takes over. Over 14 year periods cash wins in 96% of the periods, shares in just 4%. In periods of 18 to 20 years shares win comprehensively with shares doing better in 100% of the twelve 20 year periods. Sample sizes get smaller as durations lengthen and are therefore less reliable.

For investment periods from 1 to 11 years there are always some starting dates when an investment in shares finishes lower than it started. For periods of 1 to 4 years it is always over 25%, peaking at 33% for three year periods. For 11 year periods it is 7% - one in 14. For investment periods from 12 years onwards the tracker always ends higher than it started.

These tables are depicted in the graph below.

Starting date

Further analysis of the data shows that for many starting dates from 1 January 1995 investing in shares over any possible period from one year upwards would have produced a lower return than using properly managed best buy cash. That is true for example for the whole of the two years from 1 October 1999 to 1 September 2001 and for four months from 1 October 2007 to 1 January 2008. Money invested on the first of any month on those dates and left for any period from 1 year to the maximum possible 15 or 16 years would have done better in cash than shares.

There are fewer comparable times when shares produced a higher return over every possible investment period:- 1 November 2008 to 1 September 2009 is the longest run and two earlier dates are 1 October 2002 and 1 October 2003.

Overall for investment periods of five years or more there are 38 starting dates when cash would always have produced a better return but only 24 starting dates when that was true of shares.

Total winner

Adding all the data for all investment periods from one to twenty years cash wins in 55.7% of the 2520 periods and shares in 44.3% of them. Overall cash beat shares.

21 Years

Over the whole 21 year period the tracker out-performs cash. £10,000 invested in a tracker on 1/1/1995 becomes £34,098 by December 2015, a compound growth rate of 6.0% a year. Cash achieves nearly £6000 less finishing at £28,105, a compound growth rate of 5.0%. But the low difference between the risk free cash and the risky shares is striking. Bodie (Financial Analysts Journal May-June 1995 pp. 18-22) finds that the risk of investing in shares does not diminish as time invested lengthens.

CONCLUSION

The data presented here allow the boundary between cash and shares to be set at around 18 years. Less than that there is a better than evens risk that a shares tracker will produce a lower return than a series of best buy cash accounts. For periods below 12 years there is also a risk that a shares investment will lose money. Overall, for a random date and a random investment period the safer bet is active cash rather than tracker shares.

NOTES

Tracker choice

I wanted to use a typical FTSE100 tracker that was not low or high cost and might have been picked by an unskilled investor in 1995 for which data was available. MorningStar provided the HSBC FTSE 100 Index Retail Income which fits that description and is used for this analysis. Other trackers are available of course. The five-year analysis has been repeated using HSBC FTSE 100 Index Retail Accumulation, the Marks & Spencer UK [FTSE] 100 Comp Acc, the HSBC FTSE 250 Index C Acc, and the All Share tracker M&G Index tracker A Acc.

The data are not available over the same period and have been taken from 1 March 1998 to 1 April 2016. The results from the FTSE100 trackers are almost identical with the data here. The FTSE All Share tracker shows a similar result with cash beating it in 53% of five-year periods. However, the FTSE 250 tracker has the opposite result with shares beating cash in 65% of periods. The FTSE 250 has shown particular growth recently. However, it would not have been a choice in 1995.

Another exercise using just the HSBC Acc and the M&S Acc FTSE 100 trackers from 1 January 1996 (the longest run of data available for the two) showed that over five-year periods the HSBC Acc produced a 57:43 split in favour of cash and the M&S Acc tracker showed 55:45 in favour of cash.

Of course with hindsight there will always be trackers which do better and others which would do worse. This research was not designed to do that study. It was designed to compare a typical tracker which would be chosen in 1995 over subsequent five-year periods. At that time the FTSE100 would have been the obvious choices. The figures show that the exact tracker of this type which was used does not affect the overall conclusions.

Linked periods

The periods used are not of course independent of one another as they overlap. That raises statistical problems with considering the significance of the differences. But the research was not designed to look for that. It simply says ‘if over the last 21 years I was to stick a pin in a date for an investment and then pick the investment period x, which would give me the better return, active cash or passive tracker?’ Chances are over almost all values of x it would be cash. And for all value of x<12 there is a chance of losing money in a tracker.

It also emphasises the importance of when the series starts. That is reflected in the fact that the periods when cash or shares win tend to come not at random but in blocks. The overwhelming advantage of cash over 14 years reflects the dates on which share price collapses and interest rate cuts fall.

Other studies

This research gives different results to every other study of shares vs cash. They universally state that shares do better than cash over every long-term period. The biggest and best known research is published as the annual Barclays Equity Gilt Study (BEGS). Now in its 61^st year it now covers periods from 1899. The results of the latest 2016 study are unequivocal in showing cash bottom of investment classes and, by deducting inflation, giving negative real terms returns.

Shares: The BEGS however overstates the return on shares. It uses its own total return index which records the growth of UK shares with dividends reinvested. But it does not include the impact of charges so the stated growth would not be achieved by any real investor. Charges can cost 1% or 2% a year. Even a modern tracker or ETF makes some annual charge which can be 0.5% or more, though many are less. Other charges for buying and selling shares for example are not openly stated but affect returns. Any annual charge has a profound effect over the longer term. One of the authors of the report explained to me why charges are not included in its indexes “trends in transaction costs may have varied significantly over time. It is difficult to ascertain a history of a representative transaction costs.”

My research uses a real tracker – the HSBC FTSE 100 Index Retail Inc – so represents real returns after charges. It was chosen as a typical FTSE tracker for which data were available over a 21 year period. They are rare.

A comparison of the returns on the BEGS index and the tracker used in this study from 1995 to 2015 shows that the BEGS index grows 336.80% which is compound growth over the 21 years of 7.3%. My real tracker grows 240.98% which is compound growth of 6.0%. That 1.3% advantage of the BEGS study reflects the difference between a proprietary calculated index without charges and the real world returns on a named FTSE100 tracker.

Cash: The BEGS understates the return on cash. For its analyses it uses using a cash surrogate – three month Treasury Bills and for the annual figures uses the return on four successive three-month bills. That data shows compound growth over 21 years from 1995-2015 of 3.9%. The 2015 return on Treasury Bills is 0.45%. In January 2016 the best buy instant access savings account paid 1.65% and the Bank of England average over the 12 months to 1 January 2016 was 0.47%.

For comparison the BEGS also uses the interest paid on cash in an instant access postal building society account. That data shows compound growth over 21 years from 1995-2015 of 2.7%. The Nationwide account used since 1998 currently pays interest of just 0.25% a year.

Since 1998 the BEGS has also used a now closed Nationwide postal account – Nationwide Invest Direct – which currently pays 0.25%. In past years the rate it has used has been more competitive and for some years was better than the Bank of England recorded average. But since 2008 that has not been the case. This new data show that the rate used by BEGS has consistently been lower than the best buy rates for instant access accounts recorded by MoneyFacts. Both are well in excess of the BEGS rate of 0.25%. Over the 21 years the average rates are BoE 1.59%, BEGS 2.67%, MF best buys 4.51%. Clearly using the MF best buys on instant access would make a significant difference to the returns on cash over the period. This study uses one year bond rates as part of the Active Cash model explained above. They are normally higher than instant access rates.

One of the BEGS authors tells me

“We refer to 3 month Treasury Bills as “cash” for both the US and UK. We provide UK building society data as well in order to provide an alternative measure of cash returns. We used to follow Halifax returns but since that was converted to a bank, we chose Nationwide as one of the last remaining large building societies. The source for “best buys” will change over time and may come with differing conditions such as investment amount, or holding period. Again, our aim here is to provide a consistent long run series, a measure of cash returns over a 100 years, so we use the Treasury bills.”

BEGS is correct that over the long run it would be difficult to ascertain either investment charges or real cash data. But by ignoring charges and failing to use a better version of cash the study inevitably exaggerates the real returns on shares and understates the returns on best buy active cash.

Past and future

In general the past in investment is no guide to the future. A fund which has performed well in the past does not help us decide if it will perform well in future. Indeed, costs are the key determiner of which funds do best in the long-term – the lower the cost the better. The FSA (as was) found that poor past performance did tend to persist, but good did not.

This study is not bound by that general investment rule. Over the 21 years it covers there has been great variety in both share price changes and cash returns. There is no reason to believe that will be different in the future. The safest assumption for conclusions is that the 21 year study – a period chosen simply on the availability of data – is typical and would be reflected in the future. That is because it is driven by analysis of objective data which does not arise directly from human judgements. In that sense it is more physics than investment and uses the assumption that we occupy no special place or time. What was true will be true. At least that is the safest assumption.

Data from the BEGS confirms that the period 1995 to 2015 is not that different from the whole period from 1899 to 2015. For example, over the long run there is a significant percentage of investment periods when cash outperforms shares. The proportion identified is clearly less than the present study due to the overstatement of share returns and the understatement of cash returns. But for example from 1899 to 2015 30% of three year investment periods showed a higher return for cash. From 1995 to 2015 that percentage was 33%. Similarly cash won in 25% of investment periods of five years from 1899-2015 compared with 29% from 1995 to 2015. Those figures do not imply that the period 1995 to 2015 is anything special. Taking the available data from the table below cash outperforms shares in 21% of periods 1899-2015 and 23% 1995-2015.

	Over n years
	2	3	4	5	10	18
1899-20151	32%	30%	27%	25%	9%	1%
1995-20152	24%	33%	38%	29%	14%	0%
1995-20153	39%	42%	50%	57%	50%	19%

Sources:

1. BEGS figure 8.1 p.61 cash = 4x3 month Treasury Bills; shares = own total return index

2. BEGS email to me 9 June 2016;

3. Paul Lewis research. Cash = Active Cash. shares = HSBC FTSE100 tracker.

Read the original Press Release

Paul Lewis

15 June 2016

2 October 2025 See update at the top

  

GOVERNMENT ABANDONS CARERS STUCK IN EARNINGS TRAP

Some carers have lost £62.10 a week because the new National Living Wage put their earnings up by £8 a week in April. 

The people affected claim Carer’s Allowance – which means they already work unpaid looking after a disabled person for at least 35 hours a week. And they supplement that with part-time work of 16 hours a week on the minimum wage. Most of them will be parents – many single parents; some may be over 60 without a state pension; others may be disabled themselves.

Before 1 April 2016 National Minimum Wage for an adult was £6.70 an hour. For 16 hours work that is £107.20. On 1 April the new National Living Wage rate of £7.20 an hour began for those aged 25 or more, as most carers are. So 16 hours’ work comes to £115.20 a week. One of the conditions for getting Carer’s Allowance is that you do not earn more than £110 a week in a paid job. So before the change in minimum wage carers could work 16 hours and stay below the threshold. From 1 April sixteen hours’ work will put them above the threshold. Once that line is crossed the whole £62.10 a week benefit disappears completely. So an extra £8 a week costs them £62.10 in lost benefit. That is a tax rate of 776.25%. 

The simple answer of working fewer hours creates another problem. People on low pay can claim a benefit called Working Tax Credit. This group of people (single parents, some other parents, over 60s under pension age, and those who are disabled) must work at least 16 hours a week to get Working Tax Credit. So if they cut their hours below 16 to bring their pay under the threshold for Carer’s Allowance they stop being entitled to Working Tax Credit. It is worth up to £76 a week for some.

So this small rise in the National Minimum Wage faces this group of carers with the choice of losing a benefit of £62.10 a week or one of up to £76 a week.

Benefit complexities

Nothing in benefits is quite that simple. If they give up Carer’s Allowance they would not lose the full £62.10 a week. That is because their income is lower and Working Tax Credit might therefore rise – though never by more than £25 a week.

And two things might stop Working Tax Credit increasing. First there is a maximum amount payable and if they are close to or at that level already a further cut in income may not result in a significant rise in Working Tax Credit. Second, the Credit is worked out on annual income in the previous tax year. So it is insensitive to changes in the current tax year. You can apply for it to be changed if income has fallen significantly if your income in the current tax year falls by more than £2500 a year compared to the previous tax year. Losing £62.10 a week for a tax year will pass that test. Assuming of course you ask and HMRC, which administers it, gets the sums right. It often doesn’t.

If the carer also pays rent and council tax they will probably already get help with those expenses through Housing Benefit and local Council Tax Support. Again, a reduced income from losing Carer’s Allowance could mean those benefits rise, though always by far less than the amount they have lost. They will have to apply (remember they are already working at least 51 hours a week plus travelling time doing their caring and part-time job) and hope that the local council works it out correctly and swiftly. Almost all councils in England now have impose a minimum payment of council tax on even the poorest. So those who are paying that will not see it cut further. 

But even at the very, very best these carers are going to lose many tens of pounds for a pay rise of £8. Earn £8, lose £40 is not a slogan to encourage work.

Employers say no

Even those who do not claim Working Tax Credit may find cutting their difficult. Employers often structure part time work round standard hours. And because Working Tax Credit needs 16 hours work they may like their part-timers to work that many hours. They are under no obligation to agree to a cut of even one hour to allow someone to claim Carer's Allowance.

Government refuses to help

When this problem has happened before the Government of the day has often stepped in to raise the earnings threshold so that 16 hours work did not preclude getting Carer's Allowance. For example, in October 2014 when a rise in minimum wage put people in a similar position the Coalition Government announced a rise in the earnings threshold to £110 a week from the following April. That left the problem for six months but at least it was resolved then. 

The obvious answer, which CarersUK would like to see, is to link the earnings threshold for Carer’s Allowance to the minimum wage. It could fixed for example at 16 times the National Living Wage rounded up to the nearest pound. So when the National Living Wage of £7.20 an hour began on 1 April the the threshold would automatically have gone up to £116. Problem sorted.

But the Government has refused to act. It was raised in Parliament on 9 May 2016 by South Shields MP Emma Lewell-Buck 

"One of my constituents who works 16 hours a week and is a carer for a disabled relative has discovered that because of the living wage she no longer qualifies for carer’s allowance, leaving her with a substantial shortfall. Why on earth have this Government forced her and thousands of others into this desperate situation?"

But the Parliamentary Under-Secretary of State for Disabled Justin Tomlinson gave no hope of change when he simply replied “The impact of the national living wage will always be reviewed”. 

When Radio 4's Money Box programme asked if there were any plans to change the threshold it was told 

“There are no current plans to do so, but we do keep the earnings limit under review and adjust it when it is warranted.”

One barrier may be the cost. Around 80,000 people who claim Carer's Allowance also work part-time. If even half of them are affected by this rule it will save saves the Government £129 million in 2016/17. And that saving will grow. The Government plans to raise the minimum wage itself to £9 an hour by 2020. That would mean a threshold of at least £144 a week to keep those on 16 hours work entitled to Carer's Allowance.The National Living Wage may be even higher than that. 

Postscript

Buried deep in the rules is one small glimmer of hope. The income which counts for the Carer’s Allowance earnings threshold is earnings minus half the contributions paid into a pension scheme. So a carer who earns £115.20 a week but then pays £10.40 a week or more into a personal pension (or a pension at work) would bring their weekly income down to £110 and just scrape below the threshold.

Even though these carers earn far too little to pay tax the Treasury would still boost this £10.40 contribution by another £2.60 making a total of £13 going into the fund. Under the rules for stakeholder pensions contributions of as little as £20 have to be accepted. So a fortnightly or monthly contribution into a stakeholder pension would be accepted by any insurance company which offered the product. Stakeholder charges are capped at 1.5% a year. The small fund they build up could be cashed in at any time once they reach 55. If their circumstance remained the same no tax would probably be due on it. 

PS A benefit geek writes: when they cash in their pension it may reduce any working tax credit, housing benefit, council tax support, or other means-tested benefit they receive.

This blogpost is an updated version of Carers Stuck in Earnings Trap written in October 2014.

15 May 2016
version 1.00

THE EQUATION THAT SANK IAIN DUNCAN SMITH

The Secretary of State for Work and Pensions Iain Duncan Smith resigned on 18 March, two days after the Chancellor delivered his Budget which included another major cut in the benefits paid to disabled people.

In his resignation letter Duncan Smith said

"I have for some time and rather reluctantly come to believe that the latest changes to benefits to the disabled and the context in which they've been made are, a compromise too far. While they are defensible in narrow terms, given the continuing deficit, they are not defensible in the way they were placed within a Budget that benefits higher earning taxpayers."

The cut in the Budget was specifically set out in para. 2.76

• "changing the way that entitlement to Personal Independence Payment is determined – a reduction in the number of assessment points awarded for needing to use an aid or appliance to carry out two of the ‘daily living’ activities assessed. This will take effect for new cases and re-assessments from January 2017."

And the Prime Minister's reply to Iain Duncan Smith's letter of resignation says that the change was agreed by all.

"That is why we collectively agreed – you, No 10 and the Treasury – proposals which you and your Department then announced a week ago."

The equation
The savings from this change were around £1.3 billion a year. They were matched almost pound for pound by two items of spending. 1. raising the threshold at which higher rate tax began from April 2017 by £2000 to £45,000. 2. Cutting the rate of tax on capital gains made from selling shares, businesses and other items.

In 2019/20 the savings from cutting PIP were given as £1.3 billion and the cost of cutting those two taxes was estimated to be £1.235 billion. It was this use of the PIP savings to which Iain Duncan Smith objected. The table below sets out the annual costs and savings and the total over the five year period 2016/17 to 2020/21. They match closely.

	2016/17	2017/18	2018/19	2019/20	2020/21	2016/17 to 2020/21
SAVINGS
Cuts to PIP	£15m	£590m	£1,190m	£1,300m	£1,280m	£4,375m
SPENDING
Raise higher rate threshold	£0	£365m	£595m	£565m	£600m	£2,125m
Cut Capital Gains Tax rates	£105m	£630m	£605m	£670m	£735m	£2,745
Total SPEND	£105m	£995m	£1,600m	£1,235m	£1,335m	£4,870m

Source: Budget March 2016 Red Book Table 2.1, lines 5, 28, 73. pp.84-85.

The cancellation of the cut in the Personal Independence Payment leaves the Budget with this tax cut spend of nearly £4.9 billion but no offsetting saving of £nearly £4.4 billion. How this gap will be filled remains to be seen. Iain Duncan Smith's successor as Secretary of State, Stephen Crabb, will be asked to find a way. 

Higher rate threshold

Raising the income at which higher rate tax is paid will benefit people with a taxable income of more than £43,000 from 2017/18. That is about one in seven income taxpayers. The gain from the Budget change will be £200 in the year. The total gain from changes to the threshold between 2015/16 and 2017/18 will be £441.50. About 4.7 million people will benefit. Additional rate taxpayers, with an income of more than £150,000, will also gain, paying £80 less tax as a result of the Budget change and paying £81.50 less tax in 2017/18 than in 2015/16. About 335,000 people will benefit from that.

These figures assume that the limit for paying the lower 2% rate of NICs will also rise with the higher rate threshold. The lower earnings limit where NICs begin has not been announced for 2017/18 or beyond and it is assumed it stays the same. It will rise with inflation but that will make very little difference to the totals.

Capital Gains Tax

The rate of tax charged on gains from Budget day is cut from 28% to 20% for higher and additional rate taxpayers and from 18% to 10% for basic rate taxpayers. Sales of residential property are exempt so the gains will mainly be made from the sales of shares and businesses. The number of people who pay CGT is in the region of 200,000. Not all of them will benefit. 

The total gains on which CGT is charged were £30 billion in 2013/14. About a fifth of that (18%) is from residential property which the new rates will not apply to. If the new rates apply to the whole of the rest then the tax loss would be about £1.9 billion. But the Treasury says it will be only £630 million implying that it will only apply to around £8 billion of gains. At the moment I cannot reconcile those numbers. Perhaps you can do better with these latest CGT figures.

Personal Independence Payment

This benefit replaces what was called Disability Living Allowance. It pays between £21.80 and £139.75 a week depending on the degree of disability. The qualifying conditions for Personal Independence Payment (PIP) are much tougher than those for Disability Living Allowance (DLA). As people are reassessed many of them lose their payment or get a lower one. 

The planned change was announced on 11 March and would tighten the conditions further by halving the number of points allocated for needing aids for cooking, eating, and using the toilet. Halving the points would reduce the PIP paid, in some cases to nothing. Around 640,000 people would be affected. The Institute for Fiscal Studies estimates that 370,000 would get less money, costing them on average £3500 a year each. It would affect new claimants, existing claimants of DLA as they are moved to PIP, and existing PIP claimants who are reassessed or whose circumstances change. 

The change was due to start on 1 January 2017 but now will not do so. 

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19 March 2016

FLEXIBLE STATE PENSION

Should women born in the 1950s who face a steep rise in state pension age be allowed to draw a reduced pension early?

State pension age was raised from 60 for women born 6 April 1950 or later first to 65 to equalise it with men and then in parallel with men rising to 66 for anyone born 6 October 1954 or later. Many of these women say they were given no notice or too little notice of two changes to their state pension age. A strong campaign has been mounted by the group Women Against State Pension Inequality (WASPI). It wants what it calls 'fair transitional protection'.

The House of Commons Work and Pension Committee considered the women's case and in a report published on 15 March 2016 ruled out undoing the state pension age rises or revising the timetable for them because of the cost. (Though it left the door open to those "if the Government is subsequently able to allocate further funding" - p.22 para.5).

Instead it will consider further allowing these women to draw their state pension early but at a reduced rate. The reduced rate would last for life (paras.40-48).

It suggests that the reduction should be at an actuarially fair rate. In other words a woman who chose the reduced pension would get the same in total over he lifetime as if she drew her full pension at the new higher state pension age.

The rate it suggests is a reduction of 5.2% for each year early the pension was drawn. That is the rate used when MPs want to take their parliamentary pension early and is, the Committee says, common among similar work pension schemes. Note that the reduction applies for life so the pension is less from the date it is drawn until it ends on the death of the recipient.

There is already a provision in the new state pension for people to defer drawing it. In that case it is increased for life when they do finally take it. That increase is 5.8% for each year of deferral. The increase is paid as a supplement to the pension rather than as a part of it. That distinction is important because the main pension rises each April with the so-called triple lock of prices, earnings, or 2.5% whichever is the higher. But the extra pension earned by deferring only rises with inflation as measured by the Consumer Prices Index. This April the triple lock gave a rise of 2.9%; the CPI was zero so no rise was paid in the extra pension earned for deferring. The 5.8% increase for deferring is also supposed to be actuarially fair. In other words over the average life the total pension paid would be the same.

Some idea of what the reduction for drawing the pension early would mean is shown in the table. It uses a reduction of 5.5% for each year the pension is drawn early. That is between the 5.2% suggested by the Committee and the 5.8% given for deferring the new state pension.

REDUCED STATE PENSION IF DRAWN BEFORE STATE PENSION AGE
		Full state pension per week
		£120	£125	£130	£135	£140	£145	£150	£155.65
Reduction per year		5.50%	5.50%	5.50%	5.50%	5.50%	5.50%	5.50%	5.50%
Years early	Reduction
0.5	2.75%	£116.70	£121.56	£126.43	£131.29	£136.15	£141.01	£145.88	£151.37
1.0	5.50%	£113.40	£118.13	£122.85	£127.58	£132.30	£137.03	£141.75	£147.09
1.5	8.25%	£110.10	£114.69	£119.28	£123.86	£128.45	£133.04	£137.63	£142.81
2.0	11.00%	£106.80	£111.25	£115.70	£120.15	£124.60	£129.05	£133.50	£138.53
2.5	13.75%	£103.50	£107.81	£112.13	£116.44	£120.75	£125.06	£129.38	£134.25
3.0	16.50%	£100.20	£104.38	£108.55	£112.73	£116.90	£121.08	£125.25	£129.97
3.5	19.25%	£96.90	£100.94	£104.98	£109.01	£113.05	£117.09	£121.13	£125.69
4.0	22.00%	£93.60	£97.50	£101.40	£105.30	£109.20	£113.10	£117.00	£121.41
4.5	24.75%	£90.30	£94.06	£97.83	£101.59	£105.35	£109.11	£112.88	£117.13
5.0	27.50%	£87.00	£90.63	£94.25	£97.88	£101.50	£105.13	£108.75	£112.85
5.5	30.25%	£83.70	£87.19	£90.68	£94.16	£97.65	£101.14	£104.63	£108.57
6.0	33.00%	£80.40	£83.75	£87.10	£90.45	£93.80	£97.15	£100.50	£104.29

The Committee points out that calculating the exact reduction to make the exercise cost neutral is difficult. First, some women - mainly those who were single with few other resources - may be eligible for the means-tested pension credit if their weekly income was below £155.60. Under present rules they would only be eligible for that at women's full state pension age. In the longer term the cost of Pension credit may rise. Second, if women chose to draw their pension rather than work then tax and National Insurance receipts would fall. There would though be some savings if fewer women claimed Jobseeker's Allowance or other benefits. And the scheme would require some administration costs.

The Committee recommends that the Government explores this option and says it will take evidence on it in the near future.

Issues

• Even if the scheme was cost neutral in the long term it would bring cost forward as women claimed their reduced pension earlier. The costs would be felt in the first few years and the savings would only be made over the long term after they reached state pension age but drew their smaller pensions over another 25 years or so.
• Although the Committee says the scheme would apply "from a specified age and for a defined cohort of women" it may be very difficult to impose such restrictions. Equality laws mean that the change could not only apply to women. Even restricting it to those with a certain number of years' delay could be challenged by men as indirect discrimination if women were the clear majority of those affected. So the reduced pension for drawing it before state pension age would almost certainly have to become a part of the new State Pension rules and allow anyone to claim their pension early - perhaps from 60 or even 55 - if they were willing to have a smaller pension for life. That would parallel the existing rule allowing the pension to be deferred in exchange for an enhanced pension for each year of deferral.
• Although the change is a fairly fundamental one, could it be implemented quickly - perhaps by October and certainly by April 2017?
• Women who were already on a means-tested benefit such as Jobseeker's Allowance, Universal Credit, Employment and Support Allowance, Housing Benefit, Council Tax Support would find that benefit was reduced if they got the state pension. So the very women who need the support could find they get the least from it.

Government response

The Government is obliged to give a formal response to a Select Committee report. But the DWP has already said  

“The government has already listened to concerns expressed by those affected by the 2011 changes, and took action to limit the maximum change to state pension age to 18 months, a concession worth over £1bn.

“Women retiring today can still expect to receive the state pension for 26 years on average – four years longer than men.”

Your thoughts

Many WASPI women have already expressed their opposition to this plan in their very active twitter presence. 

Please let me know your response to the Select Committee plans and the issues raised in this blogpost. Email paul@paullewis.co.uk.

I will update this blog to reflect different views and changes.

Background
My earlier blogpost Women Given just Two Years' Notice of State Pension Age Rise

Version 1.10

15 March 2016

CHANGING STATE PENSION AGE

1908 - age 70

The first state pension in the UK was the Old Age Pension. The law was passed in August 1908 and the first pensions paid on 1 January 1909 to around 500,000 people aged 70 or more. It was 5/= (five shillings or 25p) a week and was paid in full to individuals aged 70 or more with an annual income of £21 a year or less reducing to nothing at an annual income of £31 a year.  A higher pension of 7/6 (37.5p) was paid to a married man. At the time only one in four people reached the age of 70 and life expectancy at that age was about 9 years.

1925 - age 65

In 1925 a new kind of pension was introduced based on contributions paid at work by both the employer and the employee. It was paid from age 65 without a means-test. A married couple's rate of pension was paid if both spouses were aged 65 or more. That meant men whose wives were younger than they were had to wait for some time after they reached 65 to get the higher rate for their wives.

1940 - men age 65, women age 60

In 1940 pension age for women was cut to 60 to try to ensure for most couples that the married rate would be paid as soon as the husband reached 65. 

1948 - retirement condition added

From 1948, men had to retire as well as reach 65 to claim the new Retirement Pension paid under the National Insurance scheme. If their wife was still under 60 when they reached 65 and retired they could now claim a dependant's addition for her. When she reached 60 she could claim a married woman's pension of around 60% of the full rate. 

1995 - women's state pension age to be equalised

Following pressure from Europe, the Conservative Government under John Major was forced to announce plans to equalise state pension age for men and women. The decision was put off at least once for fear of adverse public reaction. The timetable for change was the most relaxed possible and would raise pension age for women from 60 to 65 over a ten year period from 6 April 2010 to 6 April 2020.

2007 - rises for men and women to 66, 67, 68 planned

Rising life expectancy led the Blair Labour Government to pass a law to raise state pension age to 66 between April 2024 and April 2026, then to 67 between April 2034 and April 2036 and to 68 between April 2044 and April 2046.

6 April 2010 - women's state pension age begins to rise

The first women are affected by the equalisation changes. Women born 6 April 1950 to 5 May 1950 have to wait until 6 May 2010 to reach state pension age, a delay of up to one month.

Entitlement to Pension Credit for men and women became linked to women's state pension age rather than the age of 60. A similar change restricts entitlement in England only to free bus travel. Entitlement to Winter Fuel Payment is also linked to women's state pension age and the qualifying date for the payment in winter 2010/11 moves to 5 July 2010. It would then rise by six months each year.

May 2010 - further change promised

In opposition the Conservative Party had announced it would raise pension age for men and women more quickly than existing plans. After it came to power in the Coalition government with the Liberal Democrats in May 2010 this pledge was repeated in the programme for government set out in the Coalition Agreement.

"We will...hold a review to set the date at which the state pension age starts to rise to 66, although it will not be sooner than 2016 for men and 2020 for women."

October 2010 - revised changes

The commitment in the Coalition Agreement fell foul of EU equality laws which allowed the government to equalise state pension ages as late as April 2020 but would not allow further discrimination between men and women during that process. So in the Spending Review of October 2010 the plans were revised. Women's state pension age would now be raised more quickly to reach 65 in 2018 and then both men and women's pension age would rise to 66 by 2020. Critics pointed out that plan breached the Coalition Agreement promise of 'no sooner than...2020 for women'.

2011 - Pensions Bill sets out the planned changes

In February 2011 the detailed timetable for change was announced in the Pensions Bill 2011. Women's state pension age would rise to 65 by November 2018 and then men and women's pension age would rise together to reach 66 by 5 April 2020. Five million men and women would face a later state pension date. But while men would have to wait at most another year, 500,000 women would have to wait longer than a year. The wait for 300,000 would be 18 months or more and 33,000 would have to wait for two years.

Widespread protests and rebellions in Parliament - which the Government defeated - led to promises by the Secretary of State Iain Duncan-Smith to introduce some 'transitional' changes to help the most severely affected women. But the Pensions Bill went through almost all its stages in Parliament with no details of what the Government would actually do.

On Thursday 13 October 2011, the last possible date, the Government announced its plans. It would cap the delay for women at 18 months. It kept the rise to 65 by November 2018. But would then stretch out the transition from age 65 to 66 for both men and women by an extra six months. It will now be completed in October 2020. The concession will cost £1.1 billion (at 2010/11 prices), half of which will be spent on stretching the timetable for men, none of whom had complained.

On Tuesday 18 October 2011 the House of Commons accepted these changes and despite a further attempt in the Lords to make further amendments the Pensions Act 2011 became law on 3 November 2011.

April 2011

In April 2011 the Government began a consultation on how it should bring forward the change in state pension age to 67 and then 68. That consultation closed on 24 June 2011.

29 November 2011

In the 2011 Autumn Statement the Chancellor George Osborne announced that the rise in the State Pension Age to 67 would be brought forward eight years to run from April 2026 to April 2028 instead of April 2034 to April 2036. That change will save £60 billion.

5 December 2013

Two years later, the 2013 Autumn Statement announced the principle "that people should expect to spend, on average, up to one third of their adult life in receipt of the State Pension."

It warned that would bring forward the rise to 68 which was announced in the 2007 Pensions Act. 

"This principle implies that the increase in the State Pension age to 68 is likely to come forward from the current date of 2046 to the mid 2030s, and that the State Pension age is likely to increase further to 69 by the late 2040s." (1.122-1.123)

And admitted that one purpose of this change was to save money

"Along with action this government has already taken on the State Pension age, [this change] could save around £500 billion from pension expenditure over the next 50 years."

A paper setting out the principles also said that in future people should have at least ten year's warning of any change in their state pension age.

The changes were set out in the Pensions Act 2014 and the Government set out the timetable of the 2011 and 2014 changes.

A review of state pension age was promised by spring 2017.

March 2016

On 1 March 2016 the Government set out the Review's terms of reference and John Cridland, ex-Director General of the Confederation of British Industry, was appointed as its chair.

It is clear from these terms of reference that the principle of people spending a set proportion of their adult lives on state pension had been abandoned. Para 2.2 says the Review will consider "Whether the current system of a universal State Pension age rising in line with life expectancy best supports affordability, fairness, and fuller working lives objectives."

It was also clear that cost was a major consideration "These recommendations should be affordable in the long term" (para 1.1).

And the principle that there should be one state pension age for all was being abandoned "the review is to have regard to: Variations between different groups" (para 2.3). That leaves the way open for pension age to vary with postcode as life expectancy does; with occupation; or even with education - should someone who starts contributing at 16 reach state pension age earlier than someone who does not start until 21?

The Review will report to Government by January 2017 and a decision will be made by the Chancellor George Osborne before 7 May 2017 (para 3.1). Perhaps in the 2017 Budget.

14 April 2016

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