The savings crisis: Top-up v save more tomorrow

Last month, investment platform Hargreaves Lansdown came up with yet another suggestion as to how the tax relief system could be changed, and more recently there has been speculation that the Treasury is looking at the proposal. 

The Treasury has neither confirmed nor denied this. A spokesperson reiterated what the Treasury had said previously: “We conducted a consultation into pensions tax relief last year. Responses to this consultation clearly showed there was no consensus for reform. The government concluded that with the lack of consensus and the roll-out of automatic enrolment ongoing, now was not the right time to undertake fundamental reforms to the pension tax system.” 

Top-up minus your age

Under Hargreaves Lansdown’s proposal, tax relief would be framed as a ‘top-up’ from the government. All member contributions would be matched by the government less an amount equivalent to the pension saver's age – meaning the younger you are, the more you get. 

Tom McPhail, who heads up Hargreaves Lansdown's pensions research team, said people do not understand the current tax relief system. “As a mechanism to incentivise savings it’s very inefficient,” he said. 

Weighting the proposed government top-up towards younger ages and reducing it year by year would create a “motivational message to do it now… today is better than tomorrow”, he said. 

This would ultimately start to break down cultural barriers to engaging with long-term saving and investing, according to McPhail. 

Bleak outlook for UK households

The picture for UK saving is bleak: gross saving has halved in the past 40 years, while household debt has tripled. Three-quarters of UK workers will be unable to retire on an adequate income, according to consultancy Hymans Robertson.

However, Calum Cooper, partner at Hymans, criticised Hargreaves' proposal. “It will have a feel-good vibe of intergenerational fairness,” he said, but doubted that a redistribution of tax relief from old to young would encourage people to save, because of inertia. 

And once people are auto-enrolled, the majority are in the default contribution structure, he noted.

“The quantum of tax relief compared with the additional amount of saving that’s actually required to have a decent income in retirement is pretty small, so it feels a lot like shuffling chairs on the Titanic,” he said. 

Legislate for 'save more tomorrow'

Cooper said he favours a save more tomorrow system, where workers’ contributions are automatically increased when they receive pay rises, without the need for active decision-making. The idea goes back to a paper and the original programme Save More Tomorrow by academics Richard H. Thaler and Shlomo Benartzi.

“That helps you in two ways: one your replacement income you’re targeting is lower because you’ve given more up; and you’ve saved more,” said Cooper. 

He said employers have a role to play in bringing this about, but noted that the government could give a clear signal that employers will have to introduce auto-escalation: “I think the government could set the direction by sort of pointing, to flag to industry that this is what they’re doing before they do it.” 

Legislation is needed to get employers moving in the direction of auto-escalation, said Steve Webb, director of policy at insurer Royal London and former pensions minister. “Firms are not going to do it unless they’re told to,” he said.

Webb is also in favour of auto-escalation: “Just as auto-enrolment is a default, save more tomorrow should be the default.” 

Incentives or defaults?

As to changing pensions tax relief, he said: “It’s a creative, interesting idea in theory. It’s a terrible idea in practice.” 

He said the idea might be more plausible for defined contribution, but noted that most of the cost of tax relief is defined benefit.

“So either you exclude DB, in which case none of the sums add up; or you include DB and then it’s horribly complicated… You’d spend a fortune administering it, which is never a good idea.” 

He also questioned the psychological message the policy would give. “Guess what, it’s your birthday – your tax relief rate has just been cut. Happy birthday.” 

According to Webb, inertia trumps top-up promises. “Incentives don’t work; defaults work,” he said. 

Stability enables planning

The Department for Work and Pensions released new figures this week which estimate that 10m workers will be newly saving or saving more as a result of auto-enrolment by 2018. 

Webb recognised the level of saving is low at present, but said continual changes to tax relief would not alter this. 

“Yes they’re not saving enough, we know that, but we’ve just got 2m under-40s into pension saving for goodness’ sake. Faffing around with tax relief wasn’t what did it.”