The need to encourage more pension savings

In two weeks’ time all the speculation should be over (or, knowing the pensions world, just starting!) as we expect the Chancellor to stand up in the Budget and outline his plans for pension tax relief, with some kind of reform expected to cut the availability of higher rate tax relief.

Since the leak to the FT several weeks ago the industry wheels have certainly started to spin.

Well, one thing we can be sure of is that the Government wants to save money on pensions and the cost of tax relief would be easy picking. They could go as far as stealing the Labour party’s clothes by reducing the amount of money given to the more well-off and redistributing it to the less well-off, and one way to achieve this would be to change the effective rates of tax relief.

Rumours have been to cap pension tax relief at basic rate, or introduce a flat rate of relief of somewhere between 25% and 33%.

We can argue what we want, but something looks sure to happen.

I am all for reform if we achieve the desired result, but I am not sure we have looked hard enough to see what the desired result is!

Let’s look forward twenty years to a time of a flat rate of state pension, (increased by the Triple Lock?) probably payable from a state pension age of near 70. There are likely to be fewer tax payers funding the retired, and fewer mechanisms to change the benefits payable from the State. In such circumstances surely it makes better sense to encourage more pension funding leading to higher levels of consumption in the economy and a higher tax take for The Exchequer.

The thing that irks me most is the strap line from the Treasury that such a move will “encourage” more people to save. I cannot see this happening as it misses the fundamental point that those at the lower end of the earnings spectrum have not got the extra income to save more!

We have, as an industry, worked hard at this and we have got to the best situation we have had for years via auto enrolment. Would an increase in tax relief from 20% to 25% really incentivise more saving from this group? I would respectfully suggest that it may not even be noticed. A rate of 30% or 35% would look better, but again without some form of compulsion, I cannot see how this would encourage people to save any more.

At the other end of the spectrum will be the higher earners who will have significant earnings and other assets - they will save, take tax and investment advice and plan for themselves and their families.

The real problem for me comes with the so called ‘squeezed middle.’ Higher rate tax kicks in (all things being equal) at £42,385 p.a. and many earning modestly above this amount would not necessarily see themselves as ‘high earners.’ Indeed, statistics show that this is the group facing the biggest savings shortfall. Over the last 30 years the number of people paying higher rate tax has risen by 400%, up from 930,000 in 1984 to 4.4million in 2014.

A saver earning over the threshold may well have reluctantly put money into pensions in the past because they could reclaim their tax – if they cannot reclaim it all, what pressure will there be to find an alternative?

For a pension geek it has been like dying and going to heaven with the amount of research and comment that has been published.

A selection of headlines from:

  • the IEA - “Flat rate tax relief would be devoid of any economic rationale” “misguided” “arbitrary”
  • the IFS - “If higher rate relief were less than 30% … higher rate taxpayers … would be actively discouraged”
  • Hymans Robertson - “Millions face retirement crisis if Osborne moves to a flat rate of pensions.” “A flat rate will hit middle class savers …”

I could add in the comments made by the previous Pensions Minister and a whole variety of other headlines. There are indications that many employers are already limiting contributions to £10,000 p.a. due to the complexities of contributing more.

For the sake of balance I should also mention the Centre for Policy Studies and their continued support for a Pensions ISA, a move to TEE and/or other forms of significant cost cutting reform, plus research from the ABI that was in favour of some form of matching system.

As well as the central reform question regarding tax relief, there are other issues to consider, such as the future of the tax-free lump sum, and the problem of administering the difference between tax rates payable and tax relief to be given (particularly for DB schemes, as well as the future of the LTA and even salary sacrifice and NICs.

I can see the need to encourage more pension saving, but cannot see that the reforms mooted will achieve this aim.

Head of Platform Technical

Mike Morrison has worked in financial services for far too many years. In 1990 he joined Winterthur (now AXAWealth) as Technical Manager, playing an instrumental role in the development of their SIPP product and later their pioneering work on income drawdown.

Mike is an ex Chairman of AMPS (the Association of Member Directed Pension Schemes) and is on the Financial Planning Committee of the ICAEW. He is also an Associate of the Pensions Management Institute and the Chartered Insurance Institute, and he holds both an LLB and an LLM in European Law.

An accomplished speaker and writer on financial services matters, Mike is passionate about retirement and savings issues, and how we can better communicate these to a wider audience.