Government efforts to encourage families to save are being undermined by its own Universal Credit rules

Long-neglected rules governing capital means-testing in Universal Credit (UC) are undermining other Government policies aimed at encouraging lower-income households to accrue savings, according to new research from the Resolution Foundation published today (Thursday).

The report Saving penalties – part of a partnership with abrdn Financial Fairness Trust – notes that the current capital thresholds, which have been frozen in cash terms since 2006, mean that a claimant’s UC entitlement is tapered away if they have savings above £6,000, with entitlement ended completely if savings go a penny over £16,000.

The authors estimate that in 2020-22 around two million families were eligible for UC based on income (with an average household income of just £15,700) but had their entitlement reduced due to the capital rules. Of these, 830,000 families faced a partial reduction, while 1.2 million families saw their entitlement wiped out entirely.

These capital rules are designed to ensure that claimants use their own resources before calling on the state. However, the report highlights three ways in which they are creating wider problems.

First, the rules are undermining flagship Government saving schemes like Help to Save, which aims to boost the financial resilience of UC recipients, and Lifetime ISAs, which promote long-term saving by applying strict penalties to early withdrawals. Keeping savings accrued under these schemes within the scope of the capital rules weakens their impact and penalises families trying to build meaningful savings.

Second, a near 20-year freeze in capital thresholds means more and more low-income families are having their entitlement reduced by them. In 2006-08, only one-in-three families in the UK (35 per cent) had savings greater than £6,000, but by 2020-22 that had risen to nearly half (45 per cent). Had the capital rules instead been uprated in line with prices, they would be £10,000 and £27,000 this year.

Third, the capital thresholds entrench the kind of cliff-edges that UC was designed to phase out. For example, a family entitled to £750 a month in UC (based on income alone) would see their entitlement reduced to £576 if they had £16,000 in savings – but it would drop to zero if they saved a penny more.

The rules risk disincentivising saving and weakening financial resilience among low-income families as a result, say the authors. Nearly one-in-eight (12 per cent) UC recipients who can afford to save refrain from doing so to retain their benefit entitlement.

The report identifies several simple policy changes to improve the system.

First, money saved through Help to Save and Lifetime ISAs should be exempted from the capital rules. This would empower low-to-middle income families to build more meaningful financial resilience and to achieve long-term financial goals, such as buying a home.

Second, uprating the current capital limits with prices from 2026-27 onwards (costing £135 million in 2029-30) would prevent the system from becoming increasingly punitive over time.

Finally, removing the cliff edge at £16,000 (costing £900 million in 2029-30) should be considered as part of the upcoming review of UC. While not an immediate priority, this reform would remove cliff edges, poverty traps, and perverse incentives.

With the Government currently reviewing UC, this is an opportune time to implement reforms that encourage low-income families to save, says the Foundation.

Molly Broome, Senior Economist at the Resolution Foundation, said:

“Benefits are means-tested on both income and capital. But the long-term neglect of the capital rules in Universal Credit means they are now undermining wider Government efforts to encourage low-income families to save.

“Important schemes such as Help to Save and Lifetime ISAs should be exempted from these capital rules so that families doing the right thing by saving into them aren’t penalised for doing so.

“And with the Government currently reviewing Universal Credit, it should take the opportunity to index the capital thresholds to inflation, to prevent the system from penalising more families every year. Fortunately, this can be done at limited cost to the Exchequer.”

Mubin Haq, CEO at abrdn Financial Fairness Trust, said:

“Given limited government resources it is right that those claiming means-tested benefits who have significant savings use these first before claiming support from the state. However, the capital limits for savings have failed to keep pace with inflation for nearly twenty years and this is leading to over a million low-income families being locked out of Universal Credit support. This particularly affects couples, the self-employed and those retiring early. Small changes to the capital limits and what counts as savings could improve the living standards of many struggling to make ends meet.”