The chancellor Rishi Sunak delivered his autumn 2021 budget speech on 27 October 2021. Here’s my thoughts on what the budget means for financial independence planning.
Why the autumn 2021 budget was interesting…
The country is still reeling from the effects of the coronavirus pandemic. No-one knows for sure if they’re meant to go to work or work from home. UK national debt is 103% of Gross Domestic Product as of March 2021, which means the country officially owes more than it can make in a year. Scary numbers, scary stuff.
Amidst this whole panic has been the question: how is the country going to pay for this?
Where I work, the bets were that capital gains tax would be increased dramatically. That was Joe Biden’s proposal for the USA. It’s a move that seems to be popular among people who don’t invest their money into capital assets; with exemptions on Capital Gains Tax for homes and assets in an ISA wrapper, and a further c.£12k-a-year allowance, most people avoid paying tax on capital gains.
I’ve never paid it, that’s for sure.
The consensus in my workplace was that CGT was going to increase, or that the allowance was going to be dropped in this budget. It was a contentious point, because of course you buy capital assets using income that has already been taxed, and much of the “gains” on a lot of things are just from inflation – you’re not necessarily wealthier; everyone else is just poorer.
Yet it didn’t happen. Interesting times indeed.
…and why it was boring
Very few changes were announced in the end. There was a big fuss about shipping taxes, a new tax for property developers, some standard rhetoric about “levelling up” and some seemingly minor changes to terms of different taxes or the tapering of universal credit.
Don’t get me wrong: if you’re gaining this alleged extra £1,000-per-year from the tax rate and universal credit changes, this is big news for you. It’s welcome. However, in terms of “we’re all going to pay for COVID, let’s see how bad it is”, it was quite a boring speech.
Which I’m generally thankful for!
Things that might impact on financial independence planning
Boring as it might be, the autumn 2021 budget and its speech did come with a few things that you should consider as part of financial independence planning.
- Inflation is predicted at 4% average over the next year.
- The Chancellor has written to the Bank of England to “reaffirm its remit” to keep inflation low.
- A new Residential Property Developers Tax of 4% on profits over £25m.
- A new 1.25% Health and Social Care levy – i.e. a tax on your income – from April 2022.
- Increase in dividend tax rates of 1.25% per bracket.
- A downgrading of the “triple lock” on State pensions – “temporarily” – to a double lock.
I don’t think any of these things will be a big shock to you. Most of them will be pretty obvious, but they’re considerations nonetheless.
Inflation predictions
The main report that Mr Sunak relies upon is from the Office of Budget Responsibility (OBR). The chart below is from their October 2021 report, and shows the current inflation predictions up to 2024 and beyond.
You’ll notice that the squiggly lined flattens to a perfect 2% CPI inflation at 2025. That’s probably not going to happen, it’s just to show that the OBR can’t forecast that far out and has gone to the default 2% CPI target.
If you’d like a primer on inflation and what CPI means, why not check out my post on how money is made? That ought to set you up nicely!
This graph isn’t the best, and even the OBR can’t predict the future. If it could, this whole public financing issue would never happen. However, it seems to me that we can expect 3% or greater CPI inflation for the next two years.
What this means for financial independence
A couple of things come to mind.
Firstly, stuff’s going to get more expensive. Unless your income grows faster than 4% per year, you’re going to be putting less away in real terms into your investments. This means that it might be worth negotiating for that pay rise, or investing in yourself to get a bigger income.
Alternatively, you could try saving 4% from your current budget. A penny saved is better than a penny earned. There’s a limit to this, though; don’t start regressing to eating Rice Krispies for dinner to shave 4% off your budget. That way lies sadness and health problems.
Secondly, in a high-inflation environment, capital assets ought to preserve your wealth. Things like real estate, gold and (to some extent) shares are good assets for inflation environments.
Debt instruments like bonds go the other way: their real terms value drops, as their income is generally fixed from the time of purchase. You can get inflation-linked bonds and gilts, but they tend to lag slightly behind inflation or meekly keep up with it.
For my planning, I barely touch debt instruments anyway, so I guess I’ll carry on regardless. I will keep a very low cash allocation though, as interest rates from savings at 0.5% are now going to mean that cash savings will shrink in buying power by 3.5% over the next year or two.
This brings me nicely to the second item.
The Bank of England’s remit to keep inflation low
Mr Sunak publicly declared that he’d written to the Bank of England to reaffirm its remit to keep inflation low. What does that mean?
As readers of the how money is made post will already know, the Bank of England’s Monetary Policy Committee (MPC) is meant to control CPI inflation. The MPC pretty much does this by working out what the current CPI is, how likely the big picture events are to influence this, and therefore what interest rate the Bank should set as the central bank interest rate.
This isn’t the same as the interest rate that you get for borrowing and lending. Your bank sets that. However, your bank will consider this rate, then add their premium on top. This is basically a cost to them, and it’s one that they pass onto customers like you and me.
Raising interest rates is meant to encourage saving (hoarding), taking cash out of the money supply and putting the brakes on inflation. Conversely, lowering interest rates is meant to make borrowing cheaper, discourage saving and reward borrowing to invest. That’s important, because while you or I wouldn’t normally borrow to invest, companies definitely do, which should grow the economy. Unfortunately, the borrowing creates money, so inflation rises.
What this means for financial independence
The Bank and the Chancellor are in a bind.
The Chancellor will want rates to be low, to keep economic growth going. Theoretically, most Tory supporters are home owners, so a rise in interest rates will transfer to mortgages too, and the Chancellor won’t want to upset them too much.
On the other hand, the Bank doesn’t have other options to influence inflation, and 4% is a pretty big rate of inflation when the target is 2% CPI. Will the Bank suppress rates to boost growth, failing its task; or will it increase rates, controlling inflation in line with its duties but risking a limit on the economic recovery?
My prediction is that interest rates will slowly increase as the inflation begins to bite. I’m thinking, wet-finger-in-the-air, as a completely non-scientific prediction that 1% interest rate is politically and economically palatable.
If I’m right, that will mean that we can expect mortgage deals to be a big higher. Assuming that you have no other debts, don’t expect your mortgage to be any cheaper on renewal in the next couple of years. You may even have to pay more, and if you’re a landlord with an interest-only mortgage this could eat into your profits a bit.
I don’t think that interest rates will rise enough to make cash savings attractive for financial independence, however. That 4% inflation rate is a bit punishing.
Residential Property Developers Tax
4% added to £25m of profits isn’t chump change.
Adding costs to residential property developers likely won’t prevent houses being built. There are other government incentives being announced to improve that situation.
However, £25m in profits is quite easy for a residential property developer to amass, and there is already a shortage of housing in the UK. I suspect that this will contribute to rising house prices in the near future, as another cost to be passed on to new developments.
Interestingly. the Centre for Cities points out that there isn’t a housing shortage across the UK. Instead, they say that there are areas where supply maintains pace with demand and localised crises, focussed on “most economically successful cities and towns”. The Centre for Cities points out that house building tends to be unrelated to house prices in an area.
What this means for financial independence
Presumably, where there are already enough places to live, the 4% tax will have the least amount of impact on the prices in the area, whereas in places where there’s already a shortage, developers can easily pass the tax on to buyers, further adding pressure on raising prices.
If you plan to live in one of these “most economically successful cities and towns”, you’re probably going to keep seeing prices rising on average. That’s going to mean very little to you if you already own the property you want to live in. However, if you don’t own such a property yet, the barrier to entry is likely to keep on rising with growing prices.
On the other hand, if the Centre for Cities is correct, geoarbitrage should be increasingly achievable… provided that you don’t want to live in one of these cities or towns. You could sell your in-demand property at an increasing price growth to buy something significantly more extravagant in a lower demand area.
This could also be good news if you have a buy-to-let property in one of these in-demand areas and plan to use the capital growth to re-mortgage and buy other properties.
Health and social care levy
This wasn’t actually in the budget, it was made law on 20 October 2021. However, it’s effectively a 1.25% top-up on Class 1 (employee) and Class 4 (one of the self-employed bands) National Insurance contributions until 2023, to be replaced by a separate 1.25% extra tax from 2023.
What this means for financial independence
This isn’t something you can really avoid if you’re still en route to financial independence, but it’s something else that’s going to reduce your investment income.
Increase in dividend tax rates of 1.25% per bracket
Yup, you read that right. If it’s not in an ISA, tax is increasing on dividends to 8.5%, 33.75% or 39.35% for basic, higher or additional rate taxpayers.
Technically, this isn’t law yet, but it’s almost certainly going to get through parliament with the current majority held by the government.
What this means for financial independence
For most of us (me included!), our dividends will come from shares in an ISA. That means they’ll be exempt from this tax raise anyway.
If you’re self-employed through owning your company though, this will be another tax on your earnings.
Finally, if you’re in the fortunate position that your investment money overflows your ISA, any dividends being paid will be taxed just that little bit more. This won’t affect capital gains, just dividends,
A downgrading of the “triple lock” on State Pensions
The State Pension had been under a famous “triple lock”. Under that arrangement, the payout of the pension increases by the higher of 2.5%, CPI or average wage growth.
COVID-19 has artificially boosted the “wage growth”, largely as a result of furlough schemes and suchlike. As a response, the government has “temporarily” removed this third lock.
What this means for financial independence
If you treat the State Pension as bonus, this will have very little meaning.
However, if you factor in the State Pension to your financial independence planning, my suspicion is that this “temporary” arrangement will be a small step towards a more permanent state of affairs.
That might not matter, for now, but the State Pension is a significant financial commitment. I’m betting that it won’t exist, at least in its present form, by the time I qualify for it. The latest announcement does nothing to improve my confidence in this situation!
Final thoughts on the autumn 2021 budget
Overall, the autumn 2021 budget seems to be largely irrelevant to my planning. I’m fortunate that we already own a house (albeit mortgaged), which neutralises some of the downsides.
However, it’s clear that the country is expecting higher official rates of inflation for the next two years. This reinforces that saving cash isn’t going to cut it while I’m accumulating for financial independence. I’m going to need assets that will grow in value at or faster than that 4% inflation!
There are some relatively minor taxes that are likely to eat into the amount of cash that many people on the financial independence campaign can put away, but ultimately the budget could have been a lot worse.
