The Government’s pension tax relief consultation closes at the end of September. While, at first glance, the outcome appears relatively open, there is a danger the Government has favoured a move to an Isa-style system, which will bring in significant tax revenues over the next few years.
Using these savings to help reduce the UK deficit has its attractions but the Government should not play fast and loose with future retirement provision. It may be stating the obvious but any changes to pension tax relief need to be driven by the aim of helping more people save more for their later life.
Some believe an Isa-style system will be simpler for people to understand and remove the anomaly of tax-free cash, which gets tax relief on the way in and the way out. However, we need to recognise that this anomaly is hugely attractive to people. Having no upfront tax relief means it is highly debatable this move would encourage more saving.
Another major complication with an Isa-style system is the impact on defined benefit schemes. Pulling DB schemes – and, in particular, the significant deficit recovery payments that many employers are making – into a taxed-exempt-exempt system is not straightforward and could mean we end up with a two-tier system, with different tax relief for DB and defined contribution arrangements.
That would seem hugely unfair. What is more, as significant tax relief goes towards DB schemes, it would also limit the tax savings the Government would make.
However, it can easily be argued that the current system of tax relief is not understood by enough people and does not sufficiently incentivise younger and less well-off savers. Add in the complexity of continuous changes to limits, such as the lifetime allowance, and the system is ripe for change.
The third main option is an improvement to the current system: for example, a flat-rate of tax relief for all, particularly if it can be presented simply, along the lines of “you save £2, we add £1”.
We need tax relief that gives a clear incentive to save (especially for those who do not currently save enough) and is easily understood. Combine this with the abolition of the current, unnecessary, lifetime allowance and we have the beginnings of some simplification.
The shift towards DC pensions in recent years has highlighted the importance of people paying enough to their pensions. Of even more importance is ensuring employers pay as much as possible: it is by building on payments from their employer that people really accrue decent retirement savings.
So it is vital that, as well as simplifying tax relief for individuals, we encourage and incentivise employer payments. Removing as much red tape as possible will also help. Setting up and paying into a pension scheme for employees should be a simple straightforward task, not a herculean effort.
With this in mind, it is crucial any change to pension tax relief is made in a measured and considered way and not rushed onto the statute book. It needs cross-party consensus and – forgive me for living in dreamland for a moment – a commitment to make no further changes for a generation.
The Government’s consultation paper says “it has been over a decade since the government last reviewed the support on offer through the tax system for those saving into a pension”. That may be true but it ignores the continuous change we have seen over the last decade. Change that has no consistency, no well thought through end game; just change, year upon year.
That needs to stop. Pensions are a long-term savings plan and need a long-term commitment from politicians.
So there you have it: my views on how we should change pension tax relief. Accept the current system has not worked perfectly, ignore the short-term lucrativeness of an Isa-style approach and focus on how best we can help more people save more. We need simple, easily understood tax relief, as well as help for employers to encourage them to pay as much as possible and a commitment to limit future political interference.
Whether you agree or not, I would urge you to respond to the consultation. This is as big as it gets for pensions.
Andrew Tully is pensions technical director at Retirement Advantage