The report highlights the extent to which pensions tax relief is concentrated on higher earners, with basic rate taxpayers paying 50 per cent of all contributions but only receiving 30 per cent of tax relief.
The report points out that 77 per cent of pension savers have a lump sum of under £40,000, between them receiving just 24 per cent of all tax relief on lump sums.
The report says reducing tax-free cash to 20 per cent would reduce the cost of this tax relief from £4bn to £3.5bn. But an alternative approach of capping the amount of lump sum that could be taken tax-free at £36,000 would mean 75 per cent of current lump sums would be unaffected, with only the largest 25 per cent of lump sums would be capped.
The PPI report also looks at the effects of changing the tax on contributions. The PPI says the cost of tax relief on pension contributions from employers, employees and individuals, allowing for the full introduction of auto-enrolment, is £35bn under the current system.
A single rate of tax relief at the basic rate of income tax on employers’, employees’ and individuals would cost £22bn, while 30 per cent tax relief for all would cost £35bn.
The PPI says a single rate of 30 per cent might lead higher rate taxpayers to divert their savings from pensions, while incentivising lower and middle earners to make more pension saving, although the report concludes there is little evidence as to how individuals and employers might react to broader changes in tax relief on pension contributions.
But it also identifies complexities in implementing a 30 per cent rate of relief across the board, particularly in relation to net pay arrangements. It also predicts problems for payroll systems.
A single 30 per cent rate would also mean employers running defined benefit schemes would have to make calculations of deemed contributions in respect of the lifetime and annual allowance for a greater number of employees.
The report has been sponsored by Age UK, The Institute and Faculty of Actuaries, Partnership and the TUC. It has received a positive welcome from some pension providers and the Association of British Insurers, while the Treasury is reported to have called for a public debate on the rising cost of tax relief on pensions.
PPI director Chris Curry says: “Despite tax relief on contributions costing up to £35bn a year after allowing for the introduction of automatic enrolment, tax relief is poorly understood and there is little evidence that it encourages pension saving among low and medium earners.
“The current system of pension tax relief favours higher and additional rate taxpayers. While recent reforms have reduced the cost of tax relief, they have not increased the value of saving for any individuals. More radical alternatives, such as a single rate of tax relief applied to all pension contributions, could spread the advantages of tax relief more evenly.
“A tax relief rate of 30 per cent could have a cost similar to the current system. If presented clearly, a 30 per cent rate could give a larger incentive to basic rate taxpayers to save, while still leaving pension saving at least tax neutral for higher rate taxpayers.”
“But implementation of a single rate of tax relief would be far from straightforward, with significant changes in the administration of pension contributions required. The resulting tax charges could be very difficult to understand and lead to changes in behaviour by employees and employers.”
Cicero Consulting chief corporate counsel Iain Anderson says: “What this report sets in train is a debate that should run up to the autumn statement. It is now up to the industry to enjoin that debate with policies that can work for all income groups.”
TUC general secretary Frances O’Grady says: “Tax relief is an important way to encourage pension saving but the benefits are currently far too skewed towards the very wealthy. It cannot be right that basic rate taxpayers make the majority of all pension contributions but receive less than a third of the total tax relief budget. Additional rate taxpayers, who earn at least £150,000 and represent the top one per cent of earners, receive 17 per cent of all tax relief.
“With the cost of pensions tax relief set to rise to £35bn a year, the case for a simpler, fairer system is stronger than ever.”
Hargreaves Lansdown head of pensions research Tom McPhail says: “The PPI report looks at the possibility of capping the tax free lump sum at £36,000. This may sound a lot, three-quarters of lump sum payouts are for less than this amount. However, a tax free lump sum of £36,000 would mean an investor being left with a fund of £108,000 with which to secure a retirement income. For someone aged 65 today, this would deliver a secure inflation-linked income of just £3,571. This is not fat-cat territory, in fact this is a relatively modest level of income even for someone retiring on average earnings.”
Royal London chief executive Phil Loney says: “Today’s proposal by the Pensions Policy Institute is an encouraging suggestion and such a move would go a long way to rectifying the public scepticism regarding the viability of pensions as a source of retirement income. Our research indicates that the majority of the population – 54 per cent – would be in favour of a move to a flat rate for everyone.
“Almost half – 46 per cent – of basic rate tax payers say that this will encourage them to increase their contributions which would be a significant shift in savings terms. There aren’t too many tax changes that would cause such a material change in behaviour, so this should be welcomed with open arms.”
Partnership CEO Steve Groves says: “The 30 per cent single rate option analysed by the PPI alongside other reform options – which is a seemingly simple intervention, albeit with implementation challenges – can really make pension savings more effective and attractive for the majority, at a limited cost to the Government.