Incentive themes

September Retirement Strategy | By Lee Jones

The pension industry recently breathed a sigh a relief as the coalition Government scrapped Labour’s plans to restrict higher-rate tax relief for pensions in favour of a reduced annual allowance.

But some experts are predicting this may not be the end of the road for the debate on tax relief and other are questioning whether the benefit of this relief is worth the cost.

Scottish Widows says its consumer research shows that 60 per cent of those earning under £30,000 with no pension arrangements blamed too little income for their lack of retirement provision. Only 14 per cent said tax-efficiency was a main reason for starting a pension.

Head of pensions market development Ian Naismith says: “Tax relief on pensions is a huge incentive for high earners but has very little impact on the decisions made by lower earners. The tax benefit is much greater for higher-rate taxpayers, especially those who pay basic rate tax in retirement. The gain is then 42 per cent, which is a huge incentive. Higher-rate taxpayers also use pensions to manage their tax liabilities, but basic rate taxpayers will never consider that because the pension is either simply a deduction on a payslip or paid direct under relief at source, with no impact on the tax they pay.”

Centre for Policy Studies senior research fellow Michael Johnson agrees that tax relief is a costly incentive that does not help most people to save for the long term. “There is a lack of up-front incentive to encourage people to put money away for a long time,” he says.

Johnson puts the chances of higher-rate relief surviving another two years at less than 50 per cent as the Government looks to win votes by increasing the state pension while encouraging the majority of the population to save more for longer.

National Association of Pension Funds chief executive Joanne Segars says tax relief does incentivise people to save but its benefits would be more profound if they were properly communicated by the Government.

She says: “Tax relief is an important incentive but good quality communications is key. If you tell people that for every 88p they put into their pension the Government will top it up to a pound then that is more enticing than talking about relief and contributions. If the facts are used in an innovative way it can be used to a powerful affect.”

Segars also notes that the existence of higher-rate tax relief helps the pension system exist. She says: “If you scrapped higher-rate relief, it would effectively take the higher earners out of pension savings altogether and that would have the rather unhelpful by-product of accelerating the closure of good quality pension schemes, which does not help anyone.

“We also talk a lot about tax relief but we do not look at the amount of tax people will pay in retirement and the amount that is paid at 40 per cent by pensioners, so in that sense it is just tax deferral, not tax relief.”

Zurich head of government affairs Matt Connell agrees that tax relief does play a role but says scrapping such an incentive would be an even bigger reason for people to shy away from pensions. He says: “If you cut back tax incentives, that psychologically says the Government does not want people to save and that is a big disincentive because the perceived direction of travel of the Government is maybe the most important aspect.

“Consistency is key - long-term savings rely on people believing the Government’s promises but when you change tax incentives there is a sense Naismith: ’One way to increase savings might be to paint a graphic picture of what it means to be dependent on the state for your income. However, such scare tactics might only increase nega-tive perceptions of pensions’

that there is less confidence in successive government’s honouring pension promises. Yes, there should be simplification but keep things consistent. You must have principles underpinning the system.”

B&M Harrison director Michelle Airey says debating incentives to save are irrelevant for most people as their pension knowledge is so low. She says: “The main crux of the problem is that people don’t even understand pensions. I think for most lower earners in this country who don’t understand how pensions work, offering tax relief makes no difference towards their attitude to saving.”

But if tax relief is not a big enough carrot for the masses to save, what is a more appropriate incentive? Naismith says the best way to encourage savings is to look to the employer, not the employee: “Employer contributions to pensions are a tremendous incentive to become involved and could be even more so if they were understood as ’free’ money that would not otherwise be available. Tax relief on employee contributions is then the icing on the cake.”

Both Naismith and Airey says a solution may be to simply scare younger people into saving.

Naismith says: “One way to increase savings might be to paint a graphic picture of what it means to be dependent on the state for your income.

However, such scare tactics might only serve to increase negative perceptions of pensions.”

Airey says: “Education is the only key - people need to be told the cold, hard truth because incentives will not help them. We hear all too often from clients who think the state will provide for them when they retire at 65. They have done no pension saving of their own so that is an illogical assumption.”

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