The pension system is broken. Over the years there has been plenty of tinkering around the edges and changing of rules and regulations but the long-term problems of the pension industry remain. It is time for radical action.
The Liberal Democrats have argued that higher-rate tax relief should be abolished on pension contributions. All this will do is discourage higher earners from investing in pensions. With the restrictions in higher-rate tax relief already announced, anyone earning more than £130,000 a year will need seriously consider making any further pension contributions from April 2011. Is it really sensible for high earners to invest in an inflexible product where they get initial 20 per cent tax relief but face a 40 or 50 per cent tax when taking benefits?
However, the real challenge we face is in encouraging low earners to save. Put simply, too many people are not saving for their retirement and are on course to becoming a burden on the state. With an ageing population and comparatively less people working, this is a burden we cannot afford.
The Government is trying to address these issues with Nest. Similarly, it tried with stakeholder pensions and pension simplification. To date, all attempts have failed.
People do not invest in pensions because they are faced with rules they are not able to understand, an industry they mistrust and the risk of losing meanstested benefits if they do make any pensions savings. We need to make pensions attractive.
Initial tax relief of 20 per cent does not engage people. What if tax relief was increased to 100 per cent, so every pound invested is worth £2? Clearly, we cannot afford to do this without limit and so we need to see what is affordable.
We could cap contributions that benefit from 100 per cent tax relief to, say, £1,000- £5,000 a year. Even if the cap is just £1,200, it means people could invest £100 a month and get real tax incentives for doing so.
Beyond this limit, people should still get tax relief at their marginal rate. This will also make it attractive for higher earners to invest. However, to help pay for the 100 per cent tax relief, the annual pension limit will need to be reduced dramatically from the current £255,000 a year to a £30,000, £20,000 or even £10,200 a year. Every individual could have an annual pension allowance, as with Isas.
To further encourage lower earners to invest, pension savings up to a certain level must not be taken into account when determining means-tested benefits. It is ludicrous that those who save something get no benefit over those who save nothing at all. We need to encourage a savings culture.
For too long, politicians have played politics with pensions. The result is a generation of people who are disengaged from the industry and a state pension that will not be able to cope with the burden of an ever-ageing population ill-prepared for retirement. This is why we need to take action now.
Martyn Laverick is marketing director at AWD Chase de Vere