Advisers and providers are wary about whether the latest proposed overhaul to pension tax relief will do anything to encourage more people to save.
It emerged last week the Treasury is considering a policy which would see the Government offer different top-ups to pension contributions based on an individual’s age.
Under the proposals, which are the brainchild of Hargreaves Lansdown, the Government would offer £1, minus a person’s age, for every £1 they pay into a pension plan.
A 25-year-old would get a £75 top-up for every £100 they invest while a person aged 60 would get a £40 bonus for saving the same amount.
The Treasury is also said to be looking at cutting the annual allowance from £40,000 to £20,000, as part of efforts to keep down the costs of the new system.
Hargreaves Lansdown head of retirement policy Tom McPhail says: “In terms of pension tax relief, we want to break the link between income altogether.”
But will such a move meet the Government’s original stated aim of pension tax relief reform – strengthening the incentive to save?
Will the Government move this time?
The Government has been floating various methods of reforming tax relief over the last year, but has so far stopped short of following through on overhauling the way pensions are taxed.
Cicero Group executive chairman Iain Anderson believes the Government is considering major pensions changes ahead of the Autumn Statement on 23 November.
He says: “I am expecting it to be a blockbuster. Any changes that bolster and incentivise lower- to middle-income savers are very likely, as well as incentives to get millennials saving. This idea fits into that space and is being seriously looked at.
“There is of course the risk this move alienates older voters. There is a very strong lobby. But there is also a growing appreciation in Whitehall of the need to finally address the ‘pinch’ issues.”
In theory giving younger people a bigger bonus for saving will incentivise them to pay more in. But AJ Bell senior analyst Tom Selby argues behavioural economics tells us people do not always respond in a logical way to such sweeteners.
He says: “Lack of understanding is a big barrier to pension saving, and an age-related solution is arguably even more complicated than what we have today. If it were to be introduced, the reform would need to be accompanied by a serious, sustained consumer awareness campaign.
“Even then, for a young person deciding whether or not to save in a pension – or boost their auto-enrolment contributions above the def-ault rate – tax relief is just one of a number of factors. Many will want to prioritise saving for a house or paying off debts, for example, while others simply won’t have the spare cash to pay any more into their pension.”
Selby adds the new system, when combined with a lower annual allowance, would hit the self-employed – “an already underpensioned dem-ographic who are more likely to make big contributions later in life”.
He adds: “For them, a significantly reduced annual allowance could have a huge impact on their ability to make up for those years when they didn’t pay into a pension.”
Aviva head of financial research John Lawson agrees past experience suggests tweaking incentives to save will not necessarily boost pensions take-up. He says: “We have seen through automatic enrolment that the best way to encourage people of all ages and incomes to pay into pensions is through behavioural techniques rather than by varying incentives.
“From a practical point of view, varying rates of relief are likely to be difficult to administer and reconcile, particularly given that the rate of relief received will change every year. I would anticipate a large number of errors arising where the date of payment is unclear or disputed by HM Revenue & Customs.”
Lawson suggests moving to an age-based tax relief system may create unintended consequences, particularly where the rate of relief is much higher than a saver’s marginal rate of tax.
He says: “Employers will be encouraged to stop employer contributions (which are effectively taxed at marginal rate of income tax) and increase pay to employees so that pension tax relief can be achieved on total contributions at the higher employee age-based rate.”
He believes the other danger with the age-based model is for higher rate taxpayers, pensions become less tax-efficient when compared with Isas. He says: “We prefer the simplicity of a flat rate of relief at a rate of 33 per cent. This would allow pension schemes, employers, providers and the Government to more clearly articulate the value of tax relief as ‘you pay £2, get £1 free’. This is a much simpler message than that proposed under an age-based system of tax relief.
“A flat rate at 33 per cent would also offer a valuable extra incentive to lower earners while still being sufficient to encourage higher-rate taxpayers to pay into a pension.”
Informed Choice managing director Martin Bamford says he has “mixed feelings” about whether an age-based system should be introduced.
He says: “Younger people clearly need bigger incentives to save for the long term, due to their competing financial priorities and the reluctance to address long-term issues at the expense of more urgent financial priorities. However, when you start saving for retirement early, you benefit from compound investment returns, so the tax relief offered on contributions is less important compared with its importance for someone already close to retirement, who does not have that time on their side.”
Instead, Bamford would prefer to see a simplified system, with existing tax relief levels maintained, alongside the annual allowance, but the abolition of the lifetime allowance.
He says: “A guarantee from the Government that no changes would be made to pension tax relief for the foreseeable future would also give younger people far more incentive to save for retirement than a slightly higher tax relief.”
Expert view: Tom McPhail
All the reasons why former chancellor George Osborne looked at pension taxation in the first place are still relevant. The current system is complicated, inefficient and unfair.
We want to make it easier and simpler for investors to do the right thing and to save and invest for the long term. This means simplifying the Isa landscape back down to one simple “super Isa”, which could offer a Help to Buy top-up for the under-40s but which would be simple and engaging.
We also want to incentivise individuals to take responsibility for their retirement saving, to reward them for doing so, and to target Government money both fairly and effectively. By weighting the top-up incentive in favour of the young, while also still giving middle-aged savers generous allowances and incentives, we can achieve higher levels of engagement and commitment and use Government money more effectively.
We want to eliminate the anomalies which penalise the very low and very high earners in the pension system. We want to ensure those with money, in their 40s and 50s, can still save adequately and enjoy an attractive Government top-up.
We also want to put the individual in control by overturning the current auto-enrolment restrictions which force individuals to join a scheme of their employer’s choice. Our proposals would achieve all these things.
Every investor would have a £20,000 a year pension and Isa allowance, irrespective of income, giving individuals and couples scope to make substantial short, medium and long-term savings every year.
The pension top-up we propose, applicable to individual defined contribution pension savings of £100 minus your age would be more generous than basic rate relief for almost everyone and, even for a 50-year-old, would be the equivalent of 33 per cent tax relief in
We estimate our overall package of measures would be fiscally neutral.
For advisers this system would mean less complexity and more scope for efficient financial planning for their clients. In the long-term, this system will be more sustainable than the current set of Isa and pension tax rules.
Tom McPhail is head of retirement policy at Hargreaves Lansdown