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Scenarios for saving

A Pensions Policy Institute report has cast a critical light on the potential economic and behavioural impact of the Government’s pension reforms.

The Aegon-sponsored report, which draws on an “intensive” behavioural study of 25 basic and higher-rate taxpayers by independent consultant Jackie Wells, models the effect that three different policy scenarios could have on Government spending and saving levels.

The cost of radical pension reform modelled in the radical scenario would rise from 5 per cent of GDP to 8.5 per cent of GDP by 2055, although this includes the introduction of a £140 a week basic state pension for all existing and future pensioners from 2015.

The Government has so far suggested introducing a flat-rate benefit for future retirees only, a policy the National Association of Pension Funds suggests would cost the Treasury an extra £1bn per year. The timing and structure of any reform remains uncertain, with Barnett Waddingham partner Malcolm McLean warning the paper could propose a timescale beyond the end of this Parliament.

Even under current state pension reform proposals, which include the introduction of a triple lock for increases in the basic state pension and a rise in state pension age to 66 by 2020, the PPI says Government spending on state pensions will rise from 5 per cent of GDP to 7.3 per cent of GDP by 2055.

The introduction of automatic enrolment will result in a “step-change” increase in pension contributions, says the PPI, although the stock of money held in pension funds will decline as a result of the continuing shift from defined-benefit to defined-contribution provision.

This decline would be exacerbated if the private pension tax system switches from exempt, exempt, taxed (EET) to TEE, as modelled by the PPI under its radical scenario. Head of research Chris Curry says the switch would result in a “a one-off charge” on pension funds of £270bn. However, the report says this would not necessarily lower the amount of money paid out to individuals in retirement as payments would be made tax-free.

The PPI’s alternative scenario considers how moving to a single 30 per cent rate of contrib-ution tax relief for pensions and introducing early access via a single withdrawal of up to 25 per cent of the fund would affect saving. It indicates a single-rate tax relief would be more progressive than the current system, with higher-earners receiving less and basic-rate taxpayers getting more.

Well’s behavioural research suggests people’s responses to big policy changes are less dramatic than policymakers believe, according to Curry. The research also found people struggle to grasp the concept of tax relief, prompting Aegon to call on the Government and Nest to use the word “matching” in communications to improve the link between incentives and behaviour.

Aegon head of corporate affairs Francis McGee says employers will have a critical role in promoting pensions to employees. He says: “The behavioural research gives the sense of the numerous factors that stand between incentives and the behaviour it is supposed to influence. Active employers enjoy a level of trust and appreciation of pension contributions that the Government and the tax system should be envious of.”

Worryingly for policymakers, under every policy scenario, including when the behavioural impact of Government changes is “strong”, combined state and private pension income fall significantly below an adequate retirement earnings level of around £235 per week.

Aegon UK chief executive Otto Thoresen says: “The research clearly shows the potential of the workplace in boosting saving. Auto-enrolment will go some way to harnessing that but it alone will not result in higher retirement income if employers cut contributions to existing pension schemes. We need to show employers the value in good pension provision to make sure that does not happen.”

THE PPI’S THREE SCENARIOS

  • The central scenario is based on the current system, including the triple lock for the basic state pension, increasing the state pension age to 66 from 2020 and the introduction of automatic enrolment and Nest.
  • The alternative scenario introduces a single 30 per cent tax relief on pension saving and allows people one-off early access to up to 25 per cent of their pension pot.
  • The radical scenario includes the introduction of a flat-rate state pension of £140 A week for existing and future pensioners, shifting tax relief to a TEE basis and allowing early access to any employee pension contribution.

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  1. Were the government genuinely committed to “reigniting the UK savings culture”, it’d do away with all these punitive tax charges and the shackle of annuity rates to levels of retirement income. What are they waiting for?

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