Simpler solution needed for pension tax relief
Would a buy-two-get-one-free style approach to pension tax relief gain greatest traction among consumers? Steven Levin, managing director of distribution at Old Mutual Wealth, comments
The huge sum of money we spend on pension tax relief is probably not working hard enough to get people to save because they don’t understand how it works. It feels like now is the time to capitalise on the heightened awareness of pensions created by the new pension freedoms so the Chancellor is sensible to launch this consultation on pension tax relief now.
The consultation addresses four principles. The first of these is simplicity and transparency. Focusing on this, we believe there is a once in a generation opportunity to do away with pension tax relief in favour of a simpler system of Government funded matching contributions.
The first of the eight questions in the consultation document asks to what extent the complexity of the current system undermines the incentive for individuals to save into a pension. The current system of pension tax relief is complicated and the majority (57%)* of people do not understand how it works.
It is set to become even more complicated with the new restriction on pension tax relief available to those with income over £150,000 coming into effect from the start of the next tax year.
The second question asks whether a simpler system could result in greater engagement with pension savings. In our view, matching contributions based on the well-recognised concept of buy two get one free would be simpler, easier for people to understand and therefore more likely to encourage people to save more for their later life. This approach of repositioning tax relief as Government matching contributions into an individual’s pension was also proposed by TISA’s The Savings and Investments Policy project (‘TSIP’) in March of this year.
The consultation should therefore include consideration of a new format of matching contributions whereby everyone, regardless of the level of income tax they pay, receives a £1 Government contribution for every £2 that they or their employer contribute, subject to the annual allowance. This would be significantly simpler and easy for people to understand and the behavioural impact of such changes on saving levels should be tested as part of the consultation.
In today’s terminology this solution would equate to a 33% flat rate of pension tax relief, which increases the incentive for basic rate tax payers but is still an attractive incentive for higher rate tax payers. The vast majority of people will be basic rate taxpayers in retirement, even if they are currently higher rate tax payers. So pensions would remain a very attractive savings vehicle, regardless of the tax paid on income.
The consultation will also need to consider the impact of such changes on auto-enrolment company schemes and salary sacrifice arrangements. It should also consider the removal of the lifetime allowance to further simplify the pension system and test the behavioural impact of such changes on saving levels. The annual contribution allowance already caps how much people can save tax efficiently in pensions and so the lifetime allowance seems an unnecessary control. It simply penalises good investment growth and is a further complication.
A consistent incentive for everyone, based on a simple concept of buy-two-get-one-free, could significantly change the way people engage with pensions and increase savings levels.
[*YouGov/Old Mutual Wealth research – 43% of respondents understood that higher rate tax payers receive a greater incentive from the Government to save via pensions than basic rate taxpayers. Total sample size was 1023 adults. Fieldwork was undertaken between 11/03/2015 – 17/03/2015. The survey was carried out online.]