New tax solutions to incentivise private pensions

• Current system redeems tax relief at the individual’s margin rate of tax.

• Higher earners can get 40/50% tax relief on contributions up to £50,000; lower earners only get 20% relief.

• Low earners, the group likely to insufficiently save, could be incentivised by a tax relief credit which brings the same relief as for higher earners e.g. A 20% tax relief credit.

• High earners are not benefitted, but are likely to have sufficient pension plans anyway.

• The treasury would potentially face a costly rebate if adopted, depending on the reactions of individuals.

• The current system is centred around tax relief corresponding to individual’s marginal tax rates.

• The system appears most beneficial to the highest earners (the marginal rebate is higher), despite these being most likely to make pension provision.

• The system could be modified so tax relief level is unrelated to individual’s marginal tax rate. This means all have the same reward to pension savings.

• Research could determine a tax receipt neutral solution, balancing increased rebates to lower earners with decreased rebates to higher earners.

• The scheme potentially endangers defined benefit schemes reliant on the 40% rebate for revenue, and is politically unpopular with ‘Middle England’.

• Tax relief is directly linked to the level of marginal tax rates.

• The measure would also be a boost to the treasury, as long as the optimal point of the Laffer Curve is not surpassed.

• A Swedish study has shown a tax-price elasticity of -0.51; If marginal rates rise 1%, an individual will increase pension contributions by 0.51%.

• An increase in tax rates means less income for individuals. Those on low incomes would be forced to think even more short-term, with disposable income for savings depleted.

• The move would be largely unpopular with the voting population, and is unlikely to increase pension contributions in the target population.

• A significant incentive for individuals to develop a pension provision is for their employers to offer a partly or fully matched contribution themselves.

• Evidence from stakeholder pensions demonstrated that an employer contribution would increase employee contributions by up to 80%.

• One potential strategy is a tax credit to offset tax costs to the business. This could relate to NICs or corporation tax.

• The scheme relies on the behaviour of individuals to respond to employers. It is also likely to punish employers who already contribute and have large existing employee members.

• If the scheme is successful, the tax revenue loss to the government may be significant.

• Most investment income in pension schemes are tax-free.

• The exception are dividend returns. Prior to 1997 they were tax free, as theory believed firms performance was taxed via corporation tax, so dividends were effectively post-tax.

• The move raised £5bn for the treasury, but is believed to have compromised pension schemes far more significantly.

• Pension funds suffered large finance shortfalls, forcing a switch to less attractive pension schemes, and deterring private saving.

• The re-introduction is unlikely due to the cost at a time when the government pursues an austerity programme.

Key allowances:-

1) Lump Sum Allowance – 25% pension can be withdrawn tax-free on retirement.2) Annual Allowance – Individual allowed tax relief on first £50,000 of contributions.3) Lifetime Allowance – Individual allowed tax relief up to £1.8m pension

contributions.

• Changing these measures could encourage significant additional absolute levels of savings.

• The second and third options are exclusively related to the wealthiest. These will have significant pension plans already.

• A change in the first option may encourage savings amongst all levels of wealth.

• It would need a significant pension increase, which would be costly to the treasury.