It seems that whoever forms the next government intends to fund manifesto commitments in other areas by reducing pension tax relief. We have already seen the first move, with a proposed cut in the allowances for people earning in excess of £150,000.
This generated a warning from the Institute for Fiscal Studies that the reform proposals run a real risk of creating ‘chaos’ in the pension tax system. The IFS acknowledged that high earners would not be pushed into penury by the changes, but many commentators voiced concerns that people will be put off saving if the system becomes more complex.
That in itself is a worry as we all need to be saving more in the short term to ensure that our longer-term needs will be met. Any change that reduces the attractiveness of long-term retirement saving will not be helpful.
But are we also missing out on an opportunity? Given that we know we need to significantly elevate pension contributions, should we not reinvest any savings from pension tax reforms back into the system? Surely the money could be better used by boosting the retirement savings for low to middle income families, with the objective of reducing future demands on the taxpayer?
This is certainly the view of the Savings and Investments Policy project – an unprecedented coalition of more than 50 financial services entities – initiated by Tisa to consider how to re-establish a savings culture in the UK. In a recently published report entitled Saving our Financial Future, TSIP identified four recommendations linked to pension tax reform.
Core to the recommendations is that the government should consider using any savings arising from changes to the tax regime to introduce an additional incentivised annual flat rate contribution paid directly into a pension. To qualify for the payment, the individual would be required to meet a target level of savings. This is intended to encourage people to save more than the auto-enrolment minimum and move them closer to the preferred savings rate advocated by the DWP.
The level of the contribution would be dependent on the cost reductions for the Treasury as a result of government changes to the current regime. The hope is that it could help low and middle income families reach annual retirement contribution levels that, if sustained over the longer term, could deliver a meaningful income in retirement.
As the concept of pension tax relief is generally poorly understood by the general public, TSIP is also recommending that it be re-positioned instead as government-matching contributions. This approach has already been successfully adopted with auto-enrolment for both government- and employer-matching contributions. Extending across all pension arrangements would be a natural progression. Studies looking at matching of individual contributions in employer pension schemes point to increases in the rate of participation in the plan, which again bodes well.
Tisa fully supports these recommendations, but we do need to face up to the fact that there are still many individuals who feel that a pension is not right for them. We therefore propose a further initiative – the Workplace Isa – as a credible supplement to the traditional pension scheme provision, but with access for other purposes.
A Workplace Isa scheme would allow contributions from both employee and employer (separate from the individual contribution limit). Contributions would be net of personal or corporation tax but would attract NI relief, and would be locked in for a certain period to encourage longer-term savings.
The pension freedoms have made saving for retirement and funding our later life years topical once again. We need to seize this opportunity and encourage people to take the necessary steps to improve their financial well-being. The industry has a role to play by developing innovative services and products, but we also need government to take the politics out of the pensions system.
David Dalton-Brown is director general of Tisa
