Is the pension system in need of reform?
"Incomprehensible! Baffling! Convoluted!"
These are just a few of the adjectives bandied about when the subject of Britain's pension system is brought up. And certainly, few could argue that it isn't without its complexities - specifically with regard to pension tax relief.
The latest contribution to the chorus championing reform is a study by the Centre for Policy Studies (CPS), which found that half of our adult population do not fully understand what pension tax relief is; consequently drawing the conclusion that such confusion in itself dis-incentivises savers.
This would seem to be substantiated by the fact that UK workers paid a collective total of £9.4bn into their pension pots in 2016-17, which represents an 8 per cent drop compared with the corresponding figure a decade earlier.
Furthermore, the research found that pension tax relief puts considerable strain on the Treasury's finances, costing £47bn each year (including National Insurance rebates). And this outlay appears to be largely going into the pockets of wealthier individuals, with some 40 per cent of it being received by the top 10 per cent of Britain's earners.
Would a bonus system be a better alternative?
The resulting suggestion from CPS's paper was that pension tax relief should be scrapped, and that a replacement Government-backed bonus scheme - somewhat similar to that associated with Lifetime and Help-to-Buy ISAs - would be a simpler, more-effective solution.
Capped at £2,500 per year, such bonuses would apply to individual and employer pension contributions, and CPS recommends substituting rebates on NI contributions with bonuses paid on contributions made by workers.
At present, tax relief is applicable at the highest rate of income tax that the individual pays (provided that total gross contributions do not exceed annual earnings and the annual allowance), so it is true that higher earners have the most to gain.
And while wealthier individuals are rightly taking advantage of this tax relief, Britain's overall household savings ratio has slumped to less than 5 per cent - the lowest level since records began 55 years ago. The inference being that uptake among lower earners has been poor, and the CPS paper submits that this is indicative of a lack of understanding of the tax relief system among those who are less au fait with savings and investments.
They argue that a bonus system, rather than pension tax relief, would not only be easier to comprehend, but also more relatable as an incentive for saving. The former terminology carries universally-understood appeal, while the latter more resembles technical jargon.
CPS therefore predicts that this revamped system would encourage a greater number of people to save more, with the added perk of lowering the cost to the Exchequer.
Would such upheaval be justified?
It's difficult to remember a sustained period in recent times where the pension system hasn't been tinkered with. Indeed, former Chancellor George Osborne was responsible for a seismic change as he introduced the pension freedoms in 2015. That said, he also proposed the introduction of a flat rate of pension tax relief later that year, which was later axed following a mixed response.
Rumours are rife that Osborne's successor, Philip Hammond, is considering cutting relief available to the UK's top earners - potentially by reducing the annual allowance. Given the considerable cost to the Treasury, it is understandable that pension tax relief would be in the crosshairs.
However, caution must surely be urged as calls for an overhaul grow louder. Cutting relief, even for higher earners, would open the door to cuts for all workers in the future, and thus be a disconcerting portent. Additionally, it would undermine the levels of certainty which are so vital to long-term retirement planning.
Fighting the pension’s corner
Perhaps the most pivotal aspect is the fact that the pension, in its current form, still remains a hugely-lucrative vehicle for long-term saving. Employer contributions essentially amount to free money - something not widely available in any other walk of life - and the advent of auto-enrolment has ensured that a greater number of people are reaping the benefits. The added gain of tax relief only compounds the power of the pension in building up a substantial savings pot.
Many people have grown concerned that the collapse of high-profile firms in recent years has put workers' pensions at risk. However, this is something of a misconception, given that final salary pensions are protected to the tune of at least 90 per cent by the Pension Protection Fund, while those on defined contribution schemes will have a pension portfolio that sits separate to the books of their employer. As such, performance and/or longevity of that particular company will not affect pension pot value (unless they hold shares in the company itself).
In summary, pensions are safe, flexible, and, most importantly, hugely rewarding for diligent savers. Even the CPS study hints to the fact that the problem with pensions isn't the product itself - just the way it is marketed. Furthermore, the successful implementation of auto-enrolment is helping to turn the tide, and ensuring more people are putting long-term financial planning at the forefront of their minds.
The status quo may be imperfect, but there is still much to cheer. So, respectfully, we'd urge the Chancellor to add stability to the pension system, rather than roll out hasty, ill-planned reform in a bid to make a quick buck.
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