In search of a better way

The Government are in the middle of the consultation on how the tax system can be amended, if at all, to encourage people to save more for their retirement.  It has raised the question whether tax relief would be better placed on benefits, rather than contributions.

Some may feel that this may be driven in part by a desire to remove tax relief on pension contributions

In an earlier blog I have already considered the position for high earners, but what about the less well paid?  What drives them to save for their retirement, and is there a better way of doing things?

Clearly, the less someone is paid, the less they are able to save.  At this level saving is done either because it is compulsory, or because the terms on offer to savers are highly favourable.  The largest part of the retirement benefit will probably be the state pension, and membership of the state scheme is compulsory.  The vast majority of those who are employed will also be in a company scheme – where, from 2018, they will get an immediate bonus of at least £3 for each £5 they contribute, and many companies contribute more than this.  Consequently, very few employees are expected to opt out of this scheme.  But why should they save more?

Where the incentive is not sufficient (e.g. the self-employed will not benefit from any employer contribution), there is less reason to save.  In fact, there may be disincentives to save, including high interest costs as people borrow to live, and the expectation of continuing state benefits in retirement.

Would the removal of tax relief on contributions in return for tax free benefits be appealing at all to this group?  And what would happen to the tax-free lump sum if such a switch was made? 

In fact, for many, pension benefits in payment will already be effectively tax-free.  The personal tax allowance is currently £10,600.  If a couple carefully constructed their retirement income they could have a combined pension close to £25,000 a year before they started to pay tax.  Currently, they do not pay tax on contributions made to finance this benefit. 

The challenges faced by restructuring the tax system need to be thoroughly considered and solved, but should not in themselves halt any future reforms. At the heart of the debate and reform, the Government and industry need to keep savers front of mind and design a system which people will understand, value, trust, and take part in.


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