By now, we’ve all heard of the new Health & Social Care levy – but what does it really mean in practical terms? I’m not going to talk about the politics, or whether the levy is actually fit for purpose to improve the NHS and social care – I’m mostly keeping this blog apolitical.
However, I think it’s worth a quick look at what the levy is and what it means for us – by “us”, I mean people saving and investing for retirement in the UK.
What is the Health & Social Care Levy?
In short, a new/increased tax from April 2022 and an increase in the dividends tax (all the gory details are in the government’s paper). For the first year starting in April 2022, it’ll show up on your payslip as an increase to your National Insurance tax, before splitting out as a separate line from April 2023 (IT changes take time!) For most employees, National Insurance is in three bands for the employee portion (your employer also pays as an employer contribution):
- Less than about £9,568 a year: 0% – not changing
- £9,569 to £50,270 a year: 12% – now increasing to 13.25%
- Above £50,270 a year: 2% – now increasing to 3.25%
The increase also applies to higher income (>£9,568 a year) self-employed (Class 4) National Insurance, but not to Class 2 (lower income self-employed people) or Class 3 (voluntary contributions to fill in gaps). So it pretty much hits everyone working with income above about £9,568 a year. It also expands, from April 2023, to cover people above State Pension age who are still working – today, they don’t pay any National Insurance, but will start paying this 1.25% levy.
Since the new tax is a flat 1.25% on everything above £9,568 a year, if you want to know how much you’ll pay, just take your taxable income (after any salary sacrifice pension contributions, etc.), subtract £9,568, and multiply by 1.25%. Example: £60,000 taxable income – £9,568 = £50,724 * 1.25% = £634 extra a year.
And for dividends, the tax rate is aligned to your overall income tax rate, with a 1.25% increase on each rate:
- Basic Rate (20%): dividend tax of 7.5%, now increasing to 8.75%
- Higher Rate (40%): dividend tax of 32.5%, now increasing to 33.75%
- Additional Rate (45%): dividend tax of 38.1%, now increasing to 39.35%
Dividend tax only applies above the Dividend Allowance (£2,000 a year), and of course doesn’t apply within an ISA, Pension, SIPP, IRA, 401k, etc. So very roughly, at a 2% dividend yield you’d need £100,000 of taxable dividend-paying investments before paying dividend tax, but now at a higher rate. There’s plenty of people on a FIRE (or normal retirement) path with that level of taxable investment, of course.
The other group that’s substantially affected are limited company directors who pay themselves via dividends rather than income – I won’t speak to this group in any detail, because limited companies in the UK are something I haven’t studied at all, beyond knowing that US tax law makes this a complicated area!
What do we get for our money?
Some of the extra money goes to the NHS – no actual change to anybody’s entitlement for NHS care, just try to cut down the backlog. Enough said – the proof will be in the pudding how much difference this really makes.
The bigger systematic change is in social care. Under the current system, everybody (in England at least – slightly different in the other countries) who has assets over £23,250 has to pay for their care in full. In some cases, this means selling family homes, and obviously severely impacts the ability to support children, grandchildren, charity, etc. Not passing judgment on whether that’s right or wrong, there’s a fair debate to be had as to whether end of life care is the responsibility of the individual or the state. The new system shifts the balance – it was already mixed between the individual and the state, but now the state takes more of the responsibility (although far from all!).
Huge caveat: the cap and subsidies only apply to the “social care” part of the cost of care. It doesn’t include the “hotel” or “residential” part of the cost, which can be substantial – often around 1/3 of the weekly cost of care.
To that end, the new system splits into three buckets:
- If your assets are less than £20,000, you pay nothing towards your care from your assets, although may still pay from your income (pensions, etc.)
- If your assets are between £20,000 and £100,000, there’s a sliding scale of means-tested support – you contribute no more than 20% of your assets a year, plus a contribution from income.
- If your assets are over £100,000, you pay the full cost of care up to a cap of £86,000. After that, you pay nothing from your assets towards your care, although you’re still paying for the “hotel” costs.
- If you start out a bit over £100k but the cost of care pushes you below £100k, you get some of that means-tested support from the bucket above.
I expect the vast majority of my readers plan to have more than £186,000 in assets by the time most people expect to need social care (hopefully well after State Pension age!), so will fall into the third bucket.
Is it a good deal for us?
Again setting aside any moral arguments about the need to take care of the less fortunate in life – is this plan good value for money for those of us who invest carefully over many years in the hope of a comfortable retirement?
One way to think of this plan is as a forced purchase of long term care insurance. Since long term care insurance hasn’t been sold in the UK for a while, it gets tough to compare – I tried looking at the US as an illustration, but the cost of care is too different (much higher on average in the US). So we’ll just try to think it through with UK numbers. The government paper on social care says it typically costs £700 a week – let’s round up to £40,000 for a typical year of care. That’s just the “care” costs, not the “hotel” bit.
On average, somebody who needs care needs about two years of it, and about 70% of people need care. So that makes our expected spend £56,000, with massive variations. There’s a good chunk of people who won’t spend anything at all, but also a long tail – the people who might spend decades in care. We can look at the value in three broad buckets:
- Those who never need care: these people now pay an extra 1.25% and get nothing for it (aside from whatever part goes towards improving the NHS rather than social care – impossible to measure right now).
- Those who only need a typical amount of care: these people, assuming they have assets over £100k, will cover their entire cost of care from their assets and/or income, because the total cost is less than £86k before they die, plus the hotel costs. They also pay an extra 1.25% and get nothing for it.
- Those who need a lot of care: these people spend their £86k in care costs and then the government picks it up from there, plus a contribution from their income and they still need to cover the hotel costs. But it’s a significant reduction from the uncapped cost of care until your overall assets fall below £23,250.
This is a pretty classic case for insurance – when you think about home or car insurance, you put money in every year hoping that you don’t get anything back. On average, you will spend more than you ever get back, but there’s a small group of people who have very high expenses due to some kind of disaster, and they get more out than they put in. Effectively, for people with assets over £100k, the new levy is “catastrophic long term care insurance” – it won’t cover “routine” or “expected” care, but for the tail of people that need a lot of care, it puts a partial cap on your costs.
Of course, you don’t get to choose how whether or not you buy the insurance, and the price is indexed to your income rather than your risk, but that’s what we get. Given the lack of any comparable commercial insurance options, it’s really tough to say whether this is good or bad value for money, for the benefits offered by the “insurance.” There’s a case to be made that nobody besides the government could insure the long tail of protracted care needs – it might not be commercially viable.
What to do about the remainder of the cost? Realistically, unless a new “care gap insurance” springs up, our only choice is to self-insure. In most cases, people who are investing for retirement, especially early retirement, will be able to absorb an £86k cost at the end of life. Really, it becomes an estate planning problem more than a drawdown/cashflow problem.
What’s a bit more challenging to handle are the hotel costs, but hopefully those can be absorbed by your remaining cashflow, since the rest of your expenses are probably minimal once you’re in care. At something like £500 a week or £26,000 a year, you’d need £650k at a 4% withdrawal rate to cover the hotel costs indefinitely. Add in any state pension, social security, etc., and that number falls even more. So except in the leanest of FIREs, or in a case where both partners need extended care (rare but possible) we’re probably ok, even after taking an £86k hit to assets. The new plan reduces the risk of a very long care stay reducing our assets to practically nothing, albeit at a substantial cost during our working lives.
How do we minimize the cost?
There’s no major new strategies here – good tax management that worked on the “old” system works just as well or even better on the new one:
- Salary sacrifice pension contributions are even more valuable, since they completely avoid the new 1.25% tax.
- Keeping high-dividend investments in tax-advantaged accounts is now slightly more important. Dividend rates are still lower than income rates (which apply to bond interest) though, so the overall prioritization of tax-efficiency probably doesn’t change.
- You could argue that currently low bond yields might push some people to put high dividend investments in a tax-advantaged account over a bond (e.g. 3% dividend taxed at 39.35% = 1.82% after-tax return, vs 1.5% bond taxed at 45% = 0.825% return), although the 1.25% dividend tax increase doesn’t change that math much.
- There may be some nuances in drawdown and estate planning, depending on how the asset calculations work. That level of detail isn’t clear yet, but maybe you want to prioritize gifts earlier in retirement, or maybe annuities start to look more attractive if they’re not an “asset” but a pension in drawdown is? Just really don’t know yet.
It will be interesting to see what happens to wages – do employers increase them to offset the higher tax? Or do they pass on the higher NI tax that they’re paying, reducing wages (or at least reducing raises to below inflation). And if they do increase wages, whether because of the new tax or due to the tight labor market, what does that do to inflation? We’ll have to see.
What do you think? Does the new system change your approach to planning for late retirement, or your estate planning?