Tax relief overhaul could encourage saving

The pensions tax relief provided by the Treasury has largely failed to encourage people to save for retirement, according to a report by Michael Johnson, pensions analyst at the Centre for Policy Studies.

The report, Costly and ineffective: why pensions tax relief should be reformed, found relief on income tax and national insurance contributions has totalled £358.6 billion over the last decade.

The report found the Treasury’s cost of funding tax relief averages a real 3.9% per year, while the average annual return on all UK pension funds is 2.9%. According to the report, this means the return on the Treasury’s co-investment with people saving for retirement, through the medium of tax relief, has been negative £17.5 billion.

Johnson has proposed a radical overhaul to the savings incentives framework, including:

• Combining the annual contribution limits for individual savings accounts (Isas) and tax-relieved pension saving into a single limit of between £30,000 and £40,000.
• Scrapping higher-rate tax relief, which costs £7 billion a year, and reinstating the 10p tax rebate on pension assets’ dividends and interest income at a cost of £4 billion per year.
• Replacing the 25% tax-free lump-sum concession with a 5% top-up of the pension pot prior to annuitisation.

Tim Knox, director of the Centre for Policy Studies, said: “The Chancellor faces many difficult choices in the forthcoming Autumn Statement.

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“It is easy to say what he should not do: to dream up new punitive taxes which are inspired more by political signalling than by their financial contribution to the Treasury or by their impact on the economy.

“Rather, sensible reform of the financial incentives for savings could yield a double dividend of increasing long-term retirement savings, while also reducing the immediate cost to the Treasury.”