The Government’s consultation on pension tax relief has now closed and the industry waits with baited breath to find out what the Chancellor will do next. It seems almost inevitable we will see some changes as the spend is just too big to go untouched in the current climate.
What is clear is the decision is far from straightforward. Recent research we conducted to support our consultation response looked to understand how advisers and their clients might deal with any changes.
Most advisers told us, unsurprisingly, that the main driver for their clients saving into a pension is a desire to maintain their standard of living in retirement. However, over half also said tax relief was a significant factor. This contrasts with our consumer research, which showed tax relief generally affects where people save but has a lot less influence on how much they save.
Both our adviser and consumer research points to a very low level of public understanding around the details of pensions. With this in mind, it seems logical those clients who have the benefit of expert advice will place greater value on tax relief than the general population. Advised clients are, of course, also more likely to be higher rate taxpayers for whom the benefits of the current system are greatest.
Another interesting contrast between our adviser and consumer research is the issue of complexity. Advisers feel complexity is a significant barrier to their clients’ retirement saving, with 70 per cent of them rating this highly.
Consumers tend to put this lower down the list after lack of access to pension savings or having other saving priorities. However, both advisers and consumers are agreed on the main barrier to retirement saving: a lack of trust of the pensions system. It seems the constant change to rules and previous pension disasters have left a very dim view of them as a savings vehicle.
This is salutary for policymakers and has to raise serious questions about the effectiveness of the taxed-exempt-exempt model that has been mooted as an alternative approach. Under such a system, contributions are made from taxed income but with the resulting benefits being tax-free.
It seems the Government has a credibility problem persuading people tax-free would remain tax-free. However, putting aside any subjective biases, TEE would generate a significant pool of tax-free savings and the pressure on the government of the day to tap into this in the event of a crisis would be pretty overwhelming.
Getting people to save more for retirement has to be the greatest priority for the pensions industry and society in general. Whatever the Government chooses to do with tax relief, over three-quarters of our adviser audience believe keeping rules consistent over the long term is an important factor in encouraging more saving. Consistency would not only help restore confidence but would also reduce complexity as a barrier to saving.
Our research showed moving to TEE would have a significant impact on savings levels – at least among advised clients. Only a fifth of advisers state such a system would be simpler to explain, while only a third of clients agreed it would make things clearer to understand. Furthermore, three-quarters felt the lack of any tax at retirement would make it more likely people would spend their savings too quickly.
Even if TEE is not introduced, changing the existing system could reduce pension savings for advised clients. Nearly two-fifths of advisers said a move to a flat rate of 30 per cent would make them likely to recommend alternative solutions to clients while the complete removal of higher rate relief would push this up to three-fifths.
Of course, most recognised the benefit of employer contributions but just under a half of them said they would recommend their clients reduce workplace savings to the minimum needed to qualify for the employer contribution if tax relief was reduced.
In summary, then, while it seems consumers have only a slim grasp on the detail of tax relief, its existence is important to long-term pension saving. Advisers will provide an objective assessment of benefits and will no doubt vote with their feet if the numbers do not stack up.
Getting to a workable solution will not be easy but the clear message is that whatever the Government does, it must be durable. Constant meddling with the system is the biggest barrier to consumer trust and this must be recognised if we are to solve the UK’s looming retirement crisis.
Richard Parkin is head of retirement at Fidelity Worldwide Investment