The government’s proposed ‘pensions Isa’ would see workplace savers miss out on thousands they would have otherwise gained through the impact of compound interest, according to Towry’s head of retirement planning.
Andy James argued that during the consultation period for the recent green paper on alternative ways to tax pensions, the government should “seriously consider” that savers investing taxed income will miss out on the benefits of compound interest.
During the summer Budget in July, the chancellor suggested that pensions could be “taxed like Isas” – meaning taxed income can be put into retirement savings and never be taxed again.
This move from ‘exempt-exempt-taxed’ – with pension money currently not taxed until the point of withdrawal – to ‘taxed-exempt-exempt’ may encourage younger savers, but will ultimately lead to much smaller retirement funds, pointed out Mr James, unless the government provides “substantial” bonuses from an early stage.
Towry gave the example of a 40-year-old who earns £50,000 a year and is putting 5 per cent net of their wage (£2,500) into a pension fund.
Currently, as a higher rate tax payer, they benefit from 40 per cent pensions tax relief and so their contribution is in fact worth £4,167.
Assuming the investments themselves grow at a rate of 5 per cent each year, by the time they reach their intended retirement age of 65 they would have a pension fund of £208,822 – assuming no further wage increases/additions to pension contribution.
Mr James noted that if former pension minister Steve Webb’s suggestion of a 33 per cent flat rate on pension tax relief came to fruition under the current system, it would mean that the employee was making contributions of £3,731 a year and their pot at 65 would total £186,973 – a loss of more than £20,000.
“Moreover, if the government is to carry out this suggested new policy and only income which has already been taxed can be added into retirement funds, and the employee maintains a £2,500 contribution into their pension fund, at 65 this would total just £125,284 – a fall of over £80,000.
“Even if, at age 65, the chancellor’s promised ‘top-up from the government’ is then delivered (at the suggested 33 per cent rate), the fund would only total £166,627 – still leaving the worker with a £40,000 shortfall in their retirement funding.”
Mr James told FTAdviser that there has been little as yet to incentivise younger people to take saving for their own retirements more seriously.
“The phasing in of auto-enrolment may be good to help people divert more of their own money – and that of their employer – straight into their pension fund, making tax savings as they do so, but this still does not represent an incentive scheme to rival that of the recent pensioner bonds, for example.
“The government may wish to consider other sweeteners to help people to save more, perhaps in the form of greater tax relief for basic-rate tax payers or a percentage bonus paid on top of any contributions the individual makes.”
Towry’s warning follows a number of pension specialists telling FTAdviser that the outcome on the green paper focused on pensions tax relief has already been decided by the government.
peter.walker@ft.com
