Relief route to saving
The threat to higher-rate tax relief runs the risk of turning individuals and employers off pensions
Once again higher-rate tax rate relief is coming under fire as an easy target in a time of fiscal belt tightening and public sector cuts.
Currently, pension savers receive income tax relief at their highest marginal rate on their pension contributions, providing they do not exceed the annual allowance of £50,000. Contributions to personal pensions automatically receive tax relief at the 20 per cent basic rate.
Higher-rate taxpayers can claim marginal tax relief of 40 per cent or 50 per cent from HM Revenue and Customs. It is these higher-rate tax reliefs which may be under attack.
Last April saw a radical change in pension tax relief with the annual allowance reduced from £255,000 to £50,000 a year. Although higher-rate tax relief was thought to be under pressure, the Government decided to keep it, instead opting for a much reduced annual allowance. The concern raised by many commentators at the time was that constant tinkering and moving the goalposts can create mistrust, confusion, uncertainty and put people off saving. We run the risk that people, including employers, become less engaged with pensions.
Saving is important. People are living longer and need to build up bigger pension pots to achieve adequate incomes in retirement and employers can play a significant role in this. Cutting higher-rate tax relief sends out the wrong message to employers, many of whom fall into that bracket. Employers need to see pension saving as worthwhile. If they don’t, they won’t help their employees to save.
Automatic enrolment from 2012 will encourage more people to start pension saving. However, the statutory minimum contribution of 8 per cent of qualifying earnings will not be enough to give most people an adequate income in retirement. People need to be encouraged to pay more than this.
Furthermore, the 40 per cent tax rate is becoming increasingly regressive. The lower tax threshold is gradually increasing, so fewer people at the lower end of the income scale are paying income tax. But, as the policy has been designed to be fiscally neutral, the higher rate tax threshold is gradually being reduced, meaning more people are becoming 40 per cent tax payers and potentially affected by any change in policy.
Arguably this group should be saving for retirement but their income is further squeezed by the recent 1 per cent hike in National Insurance contributions, on income over £42,484 a year, and by the general increase in the cost of living.
Incentives can play an important part in encouraging people to save, providing they understand and make the most of them, for example, by reclaiming higher-rate tax relief through their tax return.
But many people do not really understand the tax advantages of different savings vehicles, as we discovered from some independent research we commissioned last year into consumers’ attitudes into saving. To help people make more informed decisions on how and when to save, we need to raise awareness and understanding of the tax advantages of different savings products.
Another important message coming out of our research was a strong sense of cynicism about the sustainability of savings policy. People were aware of successive Governments moving the goalposts around retirement.
To restore confidence in saving we need to end the piecemeal approach to savings incentives and look again at what actually encourages people to save. Constant change just is not the right way to go.
Kate Smith is regulatory strategy manager at Aegon