How to incentivise pension saving
Jul 1, 2015 | BLOG
By: John Lawson, Aviva
A new Budget on 8 July and a triple lock that prevents the Government from raising VAT, Income Tax and National Insurance means that speculation has again focussed on restricting pension tax relief to fund pre-election pledges made by the Conservatives.
This speculation comes at a time when the average pension pot at retirement is £35,000 and 11 million people from the current workforce will retire with insufficient savings. We believe pension tax relief should be reformed as part of a strategy to resolve this significant problem.
It is widely accepted that people are not saving enough for their retirement, and this lack of saving will increase future health and welfare bills. Restrictions to pension tax relief, the incentive to save for retirement, do not address this fundamental concern.
The freedom and choice reforms have re-engaged savers with long-term savings and we believe now is the time to capitalise on this goodwill and reform pension tax relief so it works to incentivise savings more effectively. Further piecemeal restrictions in the 8 July Budget would miss this opportunity.
The tests for any new system are obvious: will it encourage greater savings? Is it fiscally sustainable? Is it easy to understand and fair?
The arguments over whether the current system is fair are well rehearsed; over 75% of tax relief goes to higher and additional rate taxpayers despite them only making 50% of contributions. 73% of people we asked said they had little or no understanding of the current system. An incentive can only work to encourage greater saving if it is first understood by all.
So how could it be improved?
We believe using a simple and familiar message would make it easy to understand; in particular “Buy 2 Get 1 Free”; so for every £2 an individual saves the Government would contribute £1. Matched contributions like this have been shown to encourage higher savings elsewhere. Rebranding tax relief as the Government contribution to pension saving and giving that contribution equally to all also addresses the fundamental challenge of fairness.
Such a system would need to prevent the use of salary sacrifice and avoidance to retain that fairness but this can be achieved. It should also retain what works from the current system. Nearly two thirds currently save at the level that will receive the highest matched contribution from their employer. The existing tax and National Insurance treatment of employer contributions should remain to preserve this crucial nudge effect.
The question the Government will rightly ask in such straightened times is whether the cost of such a system sustainable? The Pension Policy Institute has confirmed these changes would be broadly cost neutral. If the system has the intended behavioural effect and people save more, then the Government already have the perfect lever, in the annual allowance, to place a cap on the total cost.
So rather than continue to reduce it, the time has come for the government to use pension tax relief as an effective tool to improve the later lives of the majority. The risks of not doing so are already apparent.
Head of pensions policy, Aviva
John is a pensions spokesperson with experience in both print and broadcast media. He is an influencer of pensions policy in the UK.