The coronavirus pandemic has opened up a substantial hole in the budget as the government has provided vital support for businesses, public services and individuals. There has been much speculation in recent weeks about how this will be paid for and pensions tax relief is reportedly under review by chancellor Rishi Sunak.
Speaking from a pensions’ perspective, we would prefer that government find some other way to find the funds. But if the government does choose to raise them from pensions, we would like to emphasise the amounts available are less than often quoted and the consequences less appealing.
Under the current rules, which are designed to incentivise people to lock money away for their retirement, most savers pay no income tax on any earnings they contribute towards a pension. However, apart from a 25 per cent tax free lump sum, they do pay income tax when they come to draw it. So, the figures quoted are not all that they seem.
The real cost of pensions tax relief
It’s often said that pensions tax relief “costs” the government about £40 billion a year. The implication is that if the government changed the rules on pensions tax relief, they could save a significant proportion of this sum of money. The reality is far from this.
About 40 per cent of the amount is allocated to public sector pension schemes so, if the government did reduce fiscal support, it is more likely than not that the employers involved might make up some or all of the resulting fall in take-home pay for the senior nurses, doctors and head teachers affected, especially if we are still battling COVID-19. Obviously, any additional funding would have to come from the public purse.
Around 20 per cent of the sum is tax not levied on employers who are making up the pension deficits in traditional final salary schemes. These contributions are generally used to make sure pension promises, to former and current employees for work done in the past, are honoured. Amending this part of the regime would simply add a tax on business and make the pensions of millions of people less secure.
The remainder goes to the minority of people in the private sector that are contributing to a final salary pension and the many millions of others, nearly all in the private sector, who have a money purchase or defined contribution pension. We estimate the total savings to government available from this part of pension saving is under half of the £40 billion so often quoted and, of course, the government would not want to remove all support from people saving for retirement. So, the total “savings” for the public purse will be far, far lower.
UK citizens not saving enough for retirement
Reducing fiscal support might be a reasonable approach if people in the UK are already saving enough for retirement. However, this is not the case.
In 2016, the Pensions and Lifetime Savings Association (PLSA) undertook a research project that examined the likelihood that current workers would have a pension equivalent to the pension targets identified by the 2006 Pensions Commission.
Using their targets, the PLSA’s research found that just over 50 per cent of the working population, or 13.6 million people, were at high risk of failing to meet their target replacement rate. Moreover, it is the middle-aged savers of Generation X, today aged around 40 to 55, and the young millennials, aged around 25 to 39, who are most likely to be not saving enough.
So the government should think very carefully before reducing the amount of support it provides for pension saving.
However, if the government is determined to alter pensions tax relief, then we would urge them to ensure that any change is primarily designed to help people save enough for retirement. Ideally, any change would also be simple to adopt and administer and should be sustainable over the long term. Everyone knows that the current system is not perfect, so the pensions sector is open to consider how it can be improved. But let’s keep our eyes on the prize: everyone having an adequate income in retirement.
