Michael Johnson, Advisor, Cushon
With pensions tax relief forecasted to cost £38 billion it is not surprising that the Public Accounts Committee (PAC) is concerned about value for money. In a report issued this week, it has called for a 12 month review of the pension tax relief system.
The review will be welcomed by many in the pensions industry who recognise that the current system is overly complicated and arguably does nothing to encourage saving for retirement or reduce dependencies on the state.
Separate to the PAC report, there have been recent calls from Sajid Javid MP to replace pensions tax relief with a simpler bonus scheme, which is disconnected from tax-paying status. This makes perfect sense particularly for those at the lower end of the pay scale. Not only would this greatly simplify the savings landscape, but it would also significantly increase the incentive for many individuals to save.
As it stands, the current tax relief system is far too complicated and therefore ineffective in motivating people to save for retirement. It also means that some higher earners find themselves limited in the amount they can contribute to a pension scheme unless they want to pay a tax charge.
In his new report, Javid proposes shifting to an ISA-style pension system, replacing tax relief with a simple flat rate bonus paid independent of tax-paying status, perhaps set at 25%. Simplicity to the fore.
Steve Watson, head of proposition at Cushon believes that simplicity is definitely the way forward “We know from our own research that one of the biggest reasons for low pension engagement rates is that they are far too complicated, with 66% of individuals stating this as a key factor”.
A bonus-based incentive would instantly remedy today’s injustice that employees in ‘net pay’ schemes and earning between the auto enrolment trigger of £10,000 and the Personal Allowance, miss out on tax relief. Bonuses would be paid solely on the basis of the amounts contributed, with major advantages for those on the lower end of the pay scale, because, unlike tax relief, they would be paid even if total earnings (from one or multiple jobs) were below the Personal Allowance.
Today, people with multiple low-paid jobs are essentially shut out of auto enrolment (AE). The inability to aggregate multiple incomes to surpass AE’s £10,000 minimum earnings threshold for contribution purposes, and the use of band earnings for determining contributions, conspire against the low paid. Consequently, many miss out on employer contributions, as well as tax relief on their own contributions.
Replacing tax relief with bonuses would render tax considerations irrelevant, providing an opportunity to bring many more people into AE’s embrace, widening the participation. Band earnings could be replaced by total aggregate earning for determining AE contributions, thereby addressing the multiple small incomes problem, as well as simplifying the process for determining contributions.
In addition, a bonus-based incentive would put an end to the Annual Allowance (and potentially the Lifetime Allowance too), and the ludicrously complicated taper that demoralises high earners.
Steve Watson agrees. “Auto enrolment has done a great job of ensuring more workers have a pension, but over the years other rules and regulations have deeply affected the level of engagement. The Government’s interventions in the market in recent years – such as reducing annual allowances and loosening the rules on accessing funds at retirement – has done very little and if anything, has simply made the current pensions system more complicated”.
Furthermore, a significant enhancement would be to redeploy employer National Insurance rebates as bonuses paid on employer contributions, paid directly into employees’ personal savings accounts. This would make the contributions more visible, with enhanced personalisation helping to solve the age-old problem of employee disengagement.
The overall effect would be to significantly increase the incentive to save, particularly for low earners and the self-employed, while also potentially making substantial savings for the Exchequer.
There is a growing sense that pensions tax relief has had its day. Introducing a bonus system would put an end to all the confusion associated with the ‘pensions’ language, it would greatly simplify the savings landscape, and provide a much-needed boost to the effectiveness of the Treasury-funded incentive to save.
Michael is an Adviser at Cushon and a Research Fellow for the Centre for Policy Studies (CPS).
 After the Virus; Rt Hon Sajid Javid MP, Centre for Policy Studies, June 2020.
 Cushon Pension Research: A need for real change – November 2019.