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Head to head: Relief roads

Does tax relief work as an incentive to save in a pension?

Mark Stopard head of marketing Sun Life Financial of Canada

It is a common misconception that offering tax breaks to the mass affluent, or at least those with bigger pension pots, benefits the wrong end of the spectrum. For example, although £200,000 is a large sum of money, it will only provide an annual retirement income of around £12,000 for a conventional male annuity.

Saving has become even harder over the past decade. The Institute of Actuaries calculated that, since Gordon Brown brought in the pension “stealth tax” in 1997, UK pension pots have been devalued by around £100bn. Further, the Pensions Policy Institute concluded that ill health and disability can add between £50 and £250 a week to expenditure needs. This can add up to £13,000 a year.

Given the dramatic drop in income that high earners are likely to experience at retirement, the chances of them becoming to some degree reliant on the state becomes more likely if no incentives are provided. Proposals such as limiting tax-free annual contributions at £40,000 do not send a positive message to consumers and are representative of a rather regresThe Government wants to reduce tax relief and increase tax on death benefits. This will hardly give people the push they need to save sive approach.

The Government wants to reduce tax relief and increase tax on death benefits. This will hardly give people the push they need to save

The former proposals of targeting those earning more than £130,000 with tax cuts affected a far smaller group of people, whereas the new recommendations will impact on a far bigger proportion of the population.

Indeed, tax breaks could be the respite that will make the difference needed by many and could be seen by the Government as a way of demonstrating its appreciation of people’s pension contributions during their working life. This has surely got to be a more preferable option than witnessing this group becoming an additional burden on the state in retirement.

Maintaining tax breaks can, crucially, also act as an incentive to save, especially in the context of the current economic climate. Our “Unretirement Index” showed three out of five consumers in the UK are already preparing to work longer than the current state retirement age.

Any benefits the Government could give to help people prepare for their old age is vitally important and beneficial to the country’s economy and recovery.

Recent documents issued by the Government show that it wants to reduce tax relief on contributions and increase tax on death benefits. This will hardly give people the push they need to save.

To date, the debate in the media and in Whitehall has predominantly focused on those with smaller pension pots, ignoring those who should be saving a bigger fund for their retirement. As a result, many middle and high earners have been lulled into a false sense of security, mistakenly believing they have or are doing enough to prepare for their financial future.

Ian Naismith head of pensions market development Scottish Widows

Tax relief on pensions is a huge incentive for high earners but has very little impact on the decisions made by lower earners. In the survey for the 2010 Scottish Widows UK Pensions Report, 60 per cent of those earning under £30,000 with no pension arrangements said that was because they could not afford it. Only 14 per cent of those surveyed said that tax-efficiency was a main reason for starting a pension.Tax relief might be more of an incentive if it was presented better – if consumers were told that for every £4 you pay in, the Government adds £1. That would make more sense to them than 20 per cent tax relief.

However, the overall tax position of pensions gives little incentive to basic-rate taxpayers. Ignoring any investment growth, £100 invested in a pension costs £80 after tax relief, £25 is available at retirement as a tax-free lump sum, and the remaining £75 buys taxed income. Assuming 20 per cent tax on that, it is worth £60. So the total returned is worth £85, One way to increase savings might be to paint a graphic picture of what it means to be dependent on the state for your incomean increase of £5 or 6 per cent.

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

In return, your money is tied up potentially for 30 years or more, with most of it only available as income in retirement.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 a pension is either simply a deduction on a payslip or paid direct under relief at source, with no impact on the tax they pay. So what does incentivise lower earners to save in a pension? There are two dominant reasons, both cited by around a third of those in our survey. The first is fear of not having enough income in retirement and the second is qualifying to join a company pension scheme.

People worry about their old age and have low expectations about what the Government will provide. So 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.

Much more positively, 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.

So tax relief does matter but the maintenance of higher-rate relief for bosses arguably does much more to improve pension provision than basic-rate relief for workers.

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