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Alan Higham: Osborne is missing the point on pensions reform

Alan Higham Annuit Direct 700

Do you know how much money is saved every year into a tax-approved pension scheme? No? Well, at least you are not alone. I do not know and it turns out nobody else does either.

I had a good chat with a friendly official at the Office for National Statistics, who explained why it was so difficult to even produce a reasonable estimate of the amount. It is so tricky that 2010 was the last time the ONS gave it a go. It has not even tried since.

It just shows how complicated we have made saving for retirement and how we now have a system so fragmented that we just do not know how much is being put away.

However, the taxman does know how much tax relief is being given to pension savings and everyone is interested in that number. This is especially true since the Budget’s green paper opened up the prospect of changes to the pension tax systems.

We should have a debate on the tax relief, even if my fears prove to be well founded that this is simply a process with a view to diverting money from pension savings to pay off the deficit now. But the debate should not be about the tax relief alone. It should be about the level of retirement saving.

Eighty per cent of all relief from income tax goes to occupational pension schemes, so that is where the bulk of pension savings must lie. In this area, we have a split system of defined benefit and defined contribution pensions, and the most recent ONS data shows the stark contrast in contribution rates (see table one).

According to the Pension Protection Fund’s latest estimates in June, there is also a huge deficit in the funded DB sector of £240bn, so expect much more money to go into DB schemes.

If you want secure income in retirement then you need to be saving eye-watering amounts as a percentage of pay (see table two). With this in mind, there are two big issues for the green paper’s tax proposals. First, will it raise retirement savings from, say, 9 per cent to at least 20 per cent? Second, will it encourage sensible investments?

If you do make pensions more like Isas then why would the average person want to lock it away until retirement age with the threat a future Government may decide to tax it again or, as the Aussies are considering, force you to buy an annuity?

The Isa has been a great success, with £57bn being saved alone in 2013. However, over two-thirds go into cash. With this in mind, there is a great danger retirement savings might increasingly divert to cash, which is likely to be ruinous both for the individual and for long-term business finance.

Moreover, the money might be spent well before minimum retirement age, let alone actual retirement age.

People will say the current pension tax rules are complex and unfair. However, people always find tax rules complicated so I attach little weight to that argument.

The other is a false dichotomy that ignores the fact millions of people who pay no net income tax (after working credits) receive tax relief on saving for retirement.

Anyone who thinks simplicity will automatically come from making the current tax system like that of an Isa-based one for retirement savings is kidding themselves. It will just make it even more fragmented, even harder to work out and there will be extra costs involved.

Of course, it could be simple in 40 years’ time once the huge amount of existing legacy pension systems work through the generations. We did have a go at pension tax simplification in 2006 and look how well that has worked in the nine years since.

It is clear billions could be raised to fund the deficit today, albeit at the expense of future tax revenues. It is less clear how these proposals can help people save more effectively for retirement. It may well test the ingenuity of today’s under-40s to break point as they will be faced with kicking an even larger can down the road when they reach retirement age.

The ONS’ estimate of the amount saved in a funded pension in the UK in 2010 was £76bn; not much more than the £57bn saved in flexi-access Isa savings in 2013. Therein lies the challenge ahead.

Alan Higham is retirement director at Fidelity Worldwide Investment

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