How tax relief tinkering will harm younger savers

So it is odd that the government almost appears to contradict itself with rumours swirling that it could look to cut higher rate tax relief on pensions in order to pay off some of its Covid debts.

Steven Cameron, pensions director at Aegon, has previously warned these proposals, while also keeping the state pension triple lock, would hurt younger generations the most and create intergenerational unfairness.

But why is this?

Disincentivising the younger generation

Tax relief is paid on pension contributions at the highest rate of income tax a person pays. 

So basic rate taxpayers get 20 per cent pension tax relief, higher rate taxpayers can claim 40 per cent and additional rate taxpayers get 45 per cent. 

Toby Bentley, a financial adviser at Lathe & Co, says if young, higher rate taxpayers were to lose out on this 40 per cent, not only do they lose out on additional contributions, but also the investment growth that would go along with it. 

“This massively disincentivises younger higher rate taxpayers who would pay higher rate tax or additional rate tax their whole working life, without receiving that tax back via a pension contribution, only to then have to potentially pay higher rate tax or additional rate tax again when they draw an income from the pension itself,” Bentley explains.

The triple lock, which guarantees the state pension will go up by the highest out of inflation, wage growth or 2.5 per cent, adds to the unfairness felt by young people, Cameron argued.

This is because retaining the triple lock without adjustment is likely to grant state pensioners a windfall increase next April, which will be paid for by the working age population.

This would not go down well if these people were to see their own pensions cut via a drop in tax relief.

Holly Mackay, chief executive of Boring Money, says tax relief is the main bribe for asking people to save for retirement and if you take this away then the government will just be exacerbating an already substantial problem.

“Pensions remain unloved and poorly understood; 81 per cent of under 40s say they wouldn’t feel confident opening a new personal pension, illustrating that young people are not at home picking a retirement product," Mackay adds.

“There are difficult trade-offs to be made but the chancellor is going to have to decide whether to rob younger Peters to pay older Pauls, and I find that an unjustifiable prospect.”

But Rebecca Aldridge, managing director of Balance Wealth Planning, argued that younger savers will most likely be basic rate taxpayers who will not be as adversely affected, although it could put people off of saving.

She says: “The loss of higher rate tax relief, as well as the miserly lifetime allowance will put people off. I’d like to think people will save into Isas instead, although as a nation of property lovers, my fear is that this will drive more people to buy rental properties, which causes a whole lot of issues for us as a country. 

“And it pushes people further in the direction of alternatives including cryptocurrency as a place to put their money.”

Advisers step in

This is why advisers have a place to help people understand their options and separate fact from fiction and fear, Aldridge says.

Bentley agrees, saying one of the most important things advisers can do is educate their clients on what allowances are available.

“This could be alerting them to the existence of lifetime Isas, helping them understand their ‘carry forward’ opportunities to make the most of previous years' unused pension contributions, or illustrating the importance of compound interest by encouraging them to set up junior pensions for children to take advantage of their stakeholder allowance from an early age,” he says.

But the role of an adviser is changing. Where they used to educate clients on topics they did not have exposure to, they now need to make sure clients have the correct information.

Bentley adds: “With so much information (and disinformation) available online, financial advisers need to be able to cut through the noise to show people what is most relevant to them, and by doing so will attract younger clients. 

“The upcoming generational wealth shift will be the largest ever, so advisers need to position themselves as receptive to younger clients’ expectations.”

This is especially important as younger generations are becoming more financially aware, says Ben Sherwood, director and chartered financial planner at Satis Wealth Management.

He says: “While many will find Isas and pensions rather boring, many more with whom we interact have a good understanding of pensions and Isas. They realise that the short-term tax benefits of a pension contribution are significantly greater than those available for an Isa contribution.

“Very few successful advisers can afford to deal with youngsters with limited resources. However, through websites and social media advisers can publish articles and raise awareness of the key issues.”

Past generations vs today

Sherwood says younger people nowadays face a harder time to build up a sufficient income for retirement due to “low interest rates and low nominal investment returns coupled with increased life expectancy and the demise of the defined benefit scheme”.

But Aldridge disagrees, saying the issue is not regulation, government policy or tax reliefs but instead a change of attitude.

She says: “Generally speaking, most people retiring now were brought up to be frugal and to save their money carefully, which is what they’ve done. 

“As a broad statement it’s fair to say that most people in their 30s and 40s have more of a ‘live for today’ approach, being more comfortable with debt, and maximising experiences today over saving. Neither attitude is wrong, but they give different outcomes.”

Amy Austin is a senior reporter at FTAdviser