Julian Knight is MP for Solihull and a former BBC News personal finance and consumer affairs reporter.
It is the biggest tax break available; worth as much as £40 billion a year. But it is comparatively unloved and unacknowledged by the general public. I am referring to the tax relief available on pensions and its future is currently being debated in the Treasury and Department of Work and Pensions.
The problem, at present, is a simple one: the tax break goes to those who least need it. Three quarters of all the money given in relief goes to the small fraction of the working population who earn above the forty percent income tax band. Meanwhile, we still have millions of working people who are heading towards a retirement based solely on what they will receive from the state, with perhaps a little bit of private saving on the side. The Turner Report on pensions a decade ago recognised that 12 million people are not saving enough for their retirement and, despite the welcome advent of auto-enrolment, this cohort hasn’t got any smaller.
The Government, having reformed annuities to give people greater flexibility at retirement – a key reason why people don’t use pensions has been because they had felt railroaded into an inflexible annuity – is now rightly turning to tax relief.
Potentially, this is a multi-billion pound tool which could be used more effectively to get people to save more, so that in old age they don’t rely on the state and remain active higher value consumers. By using tax relief reform to broaden retirement savings, the Government can ensure that it gets more money through consumer taxes in the future (and it would help our balance of payments, since the wealthier a pensioner is the more services they buy – something we have a competitive advantage in) and pays out less in benefits. And it can do this without expending an extra penny today, just recalibrating what is clearly an unjust pensions tax relief regime.
The options being considered are no change; doing away with tax relief when paying into a pension altogether in favour of allowing people to enjoy tax free status when then eventually get to use their pension pot – the so called pensions ISA – and the final option a new single rate of relief.
Now, as a financial journalist I have been arguing for the new single rate option (dispensing with the current situation whereby if you are a 40 per cent taxpayer you get 40p relief, but 20 per cent taxpayers get just 20p relief) in print for nearly a decade.
Some would like to see everyone levelled down to 20p relief, and this would provide a huge boost to Treasury coffers but it would not leave the vast majority of working people any more likely to save. Indeed, the narrative that tax relief was being cut – even if it didn’t impact the 20p taxpayer – would be enough to damage pension saving still further.
A far better route would be to have a single rate of tax relief between the 20p and 40p ranges. This would still keep the higher rate taxpayers interested in pensions – not least because, since a small fraction of 40p taxpayers in work will still be 40p taxpayers in retirement, they ostensibly would still gain from a rate of relief set between 20p and 40p. There would be some at the very top end who might think that seeing pensions tax relief cut will make pension saving a game not worth the candle, but they could be assuaged by a loosening of the – frankly – over-restrictive lifetime pension allowance regime.
But it is the effect on the 20p taxpayers – the overwhelming majority of the workforce, remember – which is the real prize here. The Government would be doing the equivalent of supermarket BOGOF offer, but with pensions. Setting pensions tax relief at a single level – say 25 or 28p in the pound – would mean millions of Britons effectively seeing their pensions supercharged. With auto-enrolment nearing completion, just think what a huge fill-up to public perceptions of pensions receiving such a tax boost would be.
The insurer Aviva is keen on the idea – as a mass market brand they no doubt believe that will capture this extra tax relief in higher pensions contributions – but they are proposing a single rate of 33p, as are others. I think this is unnecessarily high. The same uplift in our savings culture could be achieved at a lower level – above 25p single rate tax relief is a sweet spot – and we have to be mindful that if the extra incentive of higher pensions tax relief for ordinary working people does the trick (married with auto enrolment) more will be saved and the tax relief bill will rise.
In my view, a single 33p rate might not be sustainable for the Treasury in the medium term, and if the rate has to be cut that could damage perceptions of pensions once again. And, of course, in the short term the exchequer would make a not inconsiderable saving on its tax relief bill were a 25-28p range favoured: the idea would be that as more people save the move would become revenue neutral.
Now opponents of a single rate of pensions tax relief – a few of the pension scheme bodies in the main – point to difficulty of administration and the fact that top bosses, seeing their own tax relief cut, will effectively stop investment in company schemes. Effectively, the argument is that if they can’t feast on rich pickings why should they allow their employees to partake of the crumbs?
That last reason was put to me when I was reporting on the closure of all but a handful of private sector final salary schemes a decade ago – and it didn’t make a blind bit of difference back then. Final salary schemes are an anachronism, and we can’t predicate the setting of pensions policy for decades to come on this sort of sentiment nor on propping up schemes that have had their day. And as for administration issues, that is forever the cry, is it not? Having spoken to bodies involved in payroll and several of the leading thinkers in this space, I believe that administration of a single rate of relief is a challenge but far from an impossible one to meet.
Ultimately, the government needs to ask itself whether the huge sum that it expends on pensions tax relief is being put to best use. I believe it is not – and that it is time that we got the public to benefit more widely.