The government’s consultation on pensions’ tax relief, which ends this month, could be the last opportunity for us to create a robust, yet simple, pensions framework, that encourages saving for retirement without bankrupting the Treasury.
There are already suggestions that Isas and pensions savings should be linked together. Though simplistic in theory, I believe this could create a nightmare of increased complexity as the years progress and, while Isas are tax-efficient, they do nothing to incentivise or encourage long-term savings. Pension funds, on the other hand, can only be accessed from the age of 55 and, as this early-access option is just months old, it is too premature to predict the impact it will have on the long-term living standards of the elderly. As it stands, my hunch is that the long-term result of early access to pension funds will be negative.
To simplify pension savings, I believe we need to continue the government’s radical approach. We must get rid of all the complex rules surrounding contributions and eliminate all references to tax relief, as they confuse rather than incentivise most consumers. Tax relief should be replaced by a simple ‘government bonus’ on pension contributions and, as nobody expects higher-rate tax relief to continue, the review presents the ideal opportunity to make this fundamental change.
Every pension contribution should qualify for a straightforward 25 per cent government bonus. To simplify it further, the maximum permitted contribution in any year to qualify for the bonus should be 25 per cent of income with a limit in any year of £25,000 – that is, 25 per cent of £100,000. This simple and effective control would enable all the current, complex rules surrounding maximum funding to be scrapped. Sticking with the concept ‘25’, everyone should be able to contribute up to £2,500 regardless of income and, when the benefits are drawn at 55 or later, 25 per cent should remain the maximum tax-free lump sum.
In addition, as all prudent long-term savers should have some portion of their assets in bonds or government stocks, I believe the government bonus should be paid for directly in the form of long-dated gilt stock. This simple and logical step would have a transformational impact on government finances and match the liabilities to the future benefits.
To summarise, with ‘25 + 25 + 25’ as the simple retirement planning concept, everyone could save up to 25 per cent of their income up to £25,000 in any year, receive a 25 per cent government bonus payable in long-term gilts and, upon encashment, enjoy 25 per cent of their total pension fund tax-free.
If we are in the last chance saloon, I believe this is a solution which would meet the needs of both government and savers for the foreseeable future. Simple.
Ken Davy is chairman of SimplyBiz Group