Age could impact pension tax relief, say new Government proposals
Whether the latest proposed changes to pension tax relief will actually encourage saving has led to varied opinions among numerous advisers and providers.
With details being recently released, the policy being considered by the Treasury would mean different levels of top-up being offered by the Government on an age-related basis.
Based on the original idea of Hargreaves Lansdown, the Government would offer £1 minus the individual’s age, for every £1 they would pay into the plan, should the proposals be implemented. Therefore, for every £100 a 25-year-old paid in, they would receive a £75 bonus, whereas someone aged 60 would receive a £40 top-up, despite saving the identical sum.
Cutting the annual allowance from £40,000 to £20,000 has also been suggested by the Treasury, as a means to minimise the costs of the fresh proposals.
Tom McPhail, Head of Retirement Policy at Hargreaves Lansdown stated: “In terms of pension tax relief, we want to break the link between income altogether.”
He also commented on wishing to simplify the complex nature of the current system as well as rewarding those who choose to save: “We also want to incentivise individuals to take responsibility for their retirement saving, to reward them for doing so, and to target Government money both fairly and effectively. By weighting the top-up incentive in favour of the young, while also still giving middle-aged savers generous allowances and incentives, we can achieve higher levels of engagement and commitment and use Government money more effectively.”
As well as wishing to accommodate savers across the generations, McPhail also expressed the proposal’s intentions to even out the system for different incomes: “We want to eliminate the anomalies which penalise the very low and very high earners in the pension system. We want to ensure those with money, in their 40s and 50s, can still save adequately and enjoy an attractive Government top-up.
“Every investor would have a £20,000 a year pension and Isa allowance, irrespective of income, giving individuals and couples scope to make substantial short, medium and long-term savings every year.”
McPhail concluded by highlighting the greater scope for advisers when advising their clients on financial planning as well as the proposal’s sustainable, especially in comparison to the current rules.
Strengthening the incentive to save?
Despite numerous tax relief reform suggestions being considered by the Government over the last year, an overhaul of the way pensions are taxed is yet to occur.
Considering the scale of the potential changes was Ian Anderson. The Cicerco Group Executive Chairman commented on the stances varying generations were likely to take: “I am expecting it to be a blockbuster. Any changes that bolster and incentivise lower- to middle-income savers are very likely, as well as incentives to get millennials saving. This idea fits into that space and is being seriously looked at.
“There is of course the risk this move alienates older voters. There is a very strong lobby. But there is also a growing appreciation in Whitehall of the need to finally address the ‘pinch’ issues.”
On a theoretical level, young people are likely to be attracted to saving more if they know they will receive a bonus for doing so. However, behavioural economics indicates that people may not always respond in a logical way, even if such incentives are offered, as argued by Tom Selby.
The AJ Bell Senior Analyst commented on the financial priorities of the younger generations not necessarily favouring pension saving: “Lack of understanding is a big barrier to pension saving, and an age-related solution is arguably even more complicated than what we have today. If it were to be introduced, the reform would need to be accompanied by a serious, sustained consumer awareness campaign.
“Even then, for a young person deciding whether or not to save in a pension – or boost their auto-enrolment contributions above the def-ault rate – tax relief is just one of a number of factors. Many will want to prioritise saving for a house or paying off debts, for example, while others simply won’t have the spare cash to pay any more into their pension.”
He also commented that the new scheme would be likely to impact the “already under pensioned” self-employed, especially when paired with the reduced annual allowance. This may, he states, have a “huge impact on their ability to make up for those years when they didn’t pay into a pension.”
Reflecting on past experience of adjusting pension incentives was John Lawson. The Head of Financial Research at Aviva commented on more effective means of encouraging saving in stating: “We have seen through automatic enrolment that the best way to encourage people of all ages and incomes to pay into pensions is through behavioural techniques rather than by varying incentives.
“From a practical point of view, varying rates of relief are likely to be difficult to administer and reconcile, particularly given that the rate of relief received will change every year. I would anticipate a large number of errors arising where the date of payment is unclear or disputed by HM Revenue & Customs.”
Where the relief rate is higher than the marginal rate for tax for savers, Lawson also suggested the possibility of unintended consequences being caused by the age-based pension scheme: “Employers will be encouraged to stop employer contributions (which are effectively taxed at marginal rate of income tax) and increase pay to employees so that pension tax relief can be achieved on total contributions at the higher employee age-based rate.”
The other potential danger he suggests, is the reduced level of tax efficiency in comparison with ISAs: “We prefer the simplicity of a flat rate of relief at a rate of 33 per cent. This would allow pension schemes, employers, providers and the Government to more clearly articulate the value of tax relief as ‘you pay £2, get £1 free’. This is a much simpler message than that proposed under an age-based system of tax relief.
“A flat rate at 33 per cent would also offer a valuable extra incentive to lower earners while still being sufficient to encourage higher-rate taxpayers to pay into a pension.”
Martin Bamford, Managing Director of Informed Choice expressed his mixed feelings towards the introduction of the new system and mentioned the competing interests of the numerous age-groups in stating: “Younger people clearly need bigger incentives to save for the long term, due to their competing financial priorities and the reluctance to address long-term issues at the expense of more urgent financial priorities. However, when you start saving for retirement early, you benefit from compound investment returns, so the tax relief offered on contributions is less important compared with its importance for someone already close to retirement, who does not have that time on their side.”
Instead, he expressed a simplified system such as “A guarantee from the Government that no changes would be made to pension tax relief for the foreseeable future” would provide much greater saving incentives for the younger generations.