Incentive to save or tax relief saving?
Claire Trott, head of Pensions Technical, Talbot and Muir considers the implications and what might be hoped for from the Government’s consultation on strengthening the incentive to save
The consultation “Strengthening the incentive to save” came off the back of a statement by the Chancellor where he implied the Government was considering removing upfront tax relief on pensions savings. It is safe to say that this filled a lot of the pensions industry with horror, because of the knock on implications this would have to all aspects of pensions as we know it.
The complexity of the current pensions system does not lie in the way in which tax relief is given nor in the way tax is paid on retirement benefits. Rather, it is the layers of legislation that have built up over the years that cause confusion and serve as a disincentive to save. Confidence in and an understanding of the system are the key pillars of a robust, popular and well run retirement benefits system. If people are unable to understand the system and are not confident that it will not change significantly between the time they save and the time they can access their benefits, then this is a barrier to entry which may have a damaging long- term impact on the cost of State Benefits. Constantly changing the amount that someone can contribute and the tax reliefs thereon, combined with changes to the level of benefits they can receive is unnerving even for those that are unlikely to breach these levels.
The recent changes to the pensions landscape have been virtually all positive for both individuals and pension providers giving greater freedom to both. However the amount of change over the years has caused complexities that if left unchecked could discourage saving, the complete opposite to the apparent reason for the consultation in the first place.
Up front tax relief
Currently, there is little trust that the regime people contribute to will still be in force when they actually retire because of all the tinkering that has occurred over the years, including the introduction of the annual and lifetime allowances and the way they have varied so dramatically over the last few years. Upfront marginal rate tax relief has however been constant. Moreover once received, is more difficult to take back, although that is currently up for discussion too. A boost to contributions by way of tax relief gives people considerable incentive to make provision in their working lives for their retirement. It has always been said ‘tax deferred is tax saved’ and I think people actually believe this and understand they will need to pay tax on the money eventually. By removing this you are also removing the compounding effect of the growth on the fund so people will see their pension grow at a slower rate, which again will discourage some.
Even a move to something that sounds simple such as flat rate relief would add to the complexities of pensions, there would clearly need to be a removal of salary sacrifice and additional ways to monitor employer contributions to ensure that they are not used as another form of remuneration, receiving employer contributions instead of salary is akin to marginal rate relief as it is.
Annual and lifetime allowances
The annual allowance and lifetime allowance are added complexities that the industry understands but the average individual struggles to see how they interact with tax relief and benefits at retirement. Testing funds on the way in and on the way out perpetuated the worst aspects of both personal and occupational regimes from pre A-day, meaning those that do save diligently and see good investment growth are then penalised unfairly.
There doesn’t seem to be an easier way to monitor the level of contributions paid to money purchase and final salary schemes, and the introduction of the annual allowance taper has made it virtually impossible for higher earners to work out with any accuracy what their annual allowance is before the end of the tax year in which they may want to pay contributions.
Should the annual allowance need to remain in place to restrict tax relief on contributions, then the lifetime allowance should be removed. The tax free lump sum payable at retirement could be capped at, say, £375,000 or 25% of the fund, whichever is the lower. This would mean that the majority of people would actually be in a similar position to the current regime but there would be no need to monitor fixed protection, fixed protection 2014, individual protection 2014 nor to bring in fixed and individual protection 2016. The time, effort and cost associated with the administration and enforcement of these protections by provider, adviser, individuals and HM Revenue & Customs is disproportionate to any benefit and, further, only serves to add complication to an already complex regime.
Layer upon layer of complexities
The biggest and best change we can hope for, although I don’t hold my breath, is a full review of the legislation in force today. There are clearly areas that could be simplified, from the new annual allowance taper and money purchase annual allowance rules all the way back to the block transfer rules and the legislation that prevents open market option to drawdown. Many issues we have to deal with day in day out have no rhyme or reason behind them today, even if they once did. We now wait to see the outcome of the consultation and I hope that it brings with it some relief from all this tinkering.