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  • July 2013
07

PPI criticises 'ineffective' pension tax relief system

Open-access content Monday 15th July 2013 — updated 5.13pm, Wednesday 29th April 2020

The current regime of pension tax reliefs is ‘not very effective’ at incentivising people to save for their retirement, a report examining the reliefs by the Pensions Policy Institute has found

2

The current regime of pension tax reliefs is 'not very effective' at incentivising people to save for their retirement, a report examining the reliefs by the Pensions Policy Institute has found.

Today's Tax relief for pension saving in the UK found there was 'limited evidence' that the £23.7bn paid in reliefs in the 2010/11 tax year had encouraged people to save.

Among the reasons for this, the report said that understanding of the tax treatment of pension contributions is low. 

However, it found that, as reliefs are based on the tax rates paid by individuals, the current system of reliefs had disadvantaged the lower paid. Although people who pay the basic rate of tax - earning up to £34,371 - make around half of total pension contributions, they only receive around 30% of the total spending on reliefs. By contrast, higher rate taxpayers, who account for 40% of total contributions, actually receive around half of the total spending on tax reliefs. Additional rate taxpayers, who earn at least £150,000 and pay the top 45 pence rate of tax, receive 17% of all tax relief but make only 95 of total contributions.

PPI director Chris Curry said the current system is 'poorly understood and there is little evidence that it encourages pension saving among low and medium earners'.

He added: 'Even with pension saving boosted for lower earners by automatic enrolment, basic rate taxpayers are estimated to make 50% of pension contributions, but receive only 30% of pension tax relief on contributions.

Curry said that 'radical alternatives' to the current regime, such as a single rate of relief applied to all pension contributions, could spread the advantages more evenly. 

'A tax relief rate of 30% could have a cost similar to the current system. If presented clearly, a 30% rate could give a larger incentive to basic rate taxpayers to save, while still leaving pension saving at least tax neutral for higher rate taxpayers.'

However, he warned that implementation of such a system 'would be far from straightforward', with significant changes in the administration of pension contributions required.

The Institute and Faculty of Actuaries, which sponsored the report, said the existing system was extremely complex and confusing for many people.

IFoA president David Hare said it highlighted that higher rate tax payers do best out of the present system. 'That may not be surprising, given the higher tax rates that would otherwise be paid on the money involved. However, the PPI's research presents alternatives that would channel the current cost of tax relief more towards those on lower incomes, to the extent that, in addition to the tax relief already provided on their contributions, the government will, in effect, also contribute on their behalf.

'While this may be one possible policy option, it is also important to consider how employers can be incentivised to provide pension saving. Most pension saving is already made via employer sponsored provision and this will increase under auto-enrolment. It would be interesting to examine how removing complexity and using tax incentives to reduce costs could encourage employers to wholeheartedly embrace pension provision.' 

The Trades Union Congress, which also supported the research, said it 'cannot be right that basic rate taxpayers make the majority of all pension contributions but receive less than a third of the total tax relief budget'.

General secretary Frances O'Grady said: 'The PPI report also highlights a serious flaw in the current tax relief system, with many people receiving relief at the higher or additional rate, but then becoming basic rate taxpayers in retirement.

'Hundreds of thousands of wealthy pensioners are likely to be benefiting from this anomaly, having effectively avoided income tax on a portion of their earnings during their working life. With the cost of pensions tax relief set to rise to £35bn a year, the case for a simpler, fairer system is stronger than ever.'

The TUC would back a flat rate for tax relief, set at 30% of contributions, she added. 'This would transfer some of the benefits from the very wealthy to lower and middle income earners without any additional cost to the Exchequer.'

This article appeared in our July 2013 issue of The Actuary.
Click here to view this issue
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