It is time to introduce a flat rate of tax relief
Imagine shopping in the January sales, where items are discounted but you are not told which ones or by how much. Would you not buy more if you could see the discounts from which you were benefitting?
You then get to the till and discover you have got 20 per cent off, but the person next to you gets a bigger discount simply because they earn more.
Would you be happy with that as a customer? Of course not. So why do we accept a pensions tax relief system that essentially works in this way?
The argument for reform of tax relief is clear; it will make the current system much fairer, encourage people to save more, and put tax relief on a sustainable and long-term footing
Along with employer contributions, tax relief is one of the best benefits of saving for a pension, but the current system disadvantages lower earners.
Out with the old
There are arguments that tax relief is simply deferred income and it should be taxed at the marginal rate, but we have now moved on from that system. In a world dominated by auto-enrolment, relief should be viewed instead as a reward for saving into a pension.
Currently, the system is so obscure that most people are simply not aware of the benefit they are getting. How can that really be an effective incentive to save?
With 14m people unlikely to have enough money to live on when they retire, it is time for the government to level the playing field and make tax relief fairer and more sustainable.
Let us refocus relief on getting everyone up to a decent standard of living in retirement – let us have a debate about the outcome we are aiming for and where support is most needed.
Setting a flat rate of between 25 and 30 per cent would address some of the unfairness in the current system, reward basic-rate payers for saving more, and continue to reward higher-tax earners for contributing to their pension.
Levelling the playing field
The Pensions Policy Institute has warned that despite the effect of auto-enrolment, 83 per cent of all taxpayers who are basic rate payers will only receive 35 per cent of UK total tax relief in 2018.
Further PPI research shows that if a flat rate of 25 per cent was introduced, the amount of tax relief spent on basic rate payers would increase to 55 per cent – and it would not cost the government any more than the current system.
Even when minimum contributions increase to 8 per cent, most people will still not be putting away enough for retirement, so we need to do all we can to support people to save more for their future.
Rebranding tax relief
Recent research found that half of the UK working population, around 16m people, are unaware that the government boosts pensions saving with tax relief.
Yet a quarter of people would save more into their pension pot if they knew that the government topped up their pension contributions.
The current system is missing the perfect opportunity to encourage people to save more. Something as simple rebranding tax relief as a bonus or a top-up would be much simpler for people to understand, make them far more aware of the benefit of saving into a pension, and could incentivise them to save more.
On this latter point, at least there would be more chance of incentivising people to save if we had a system that did not confuse people.
Difficulty is no excuse
It is clear that the current system of tax relief is simply not fit for purpose. It does little to act as a real incentive to save for the majority of the population, it is poorly understood, and it is highly questionable whether the taxpayer is getting value for money.
The argument for reform of tax relief is clear; it will make the current system much fairer, encourage people to save more, and put tax relief on a sustainable and long-term footing.
Some will no doubt argue that now is not the time to consider reform, that the political situation is not right, that it is all too difficult.
But tax relief is one large area of our pension system that does not work effectively, and it needs looking at to deliver the stable framework that the industry craves.
Darren Philp is director of policy and market engagement at B&CE, provider of mastertrust The People's Pension