Michael Johnson: Replace pensions tax relief with bonuses

Savers can currently obtain tax relief on private pension contributions worth up to 100 per cent of annual earnings.

Tax relief is earned automatically if an employer takes pension contributions from an individual’s pay before deducting income tax, and that person’s rate of income tax is 20 per cent.

For the majority of people the pension tax rules are not complicated

Jon Greer, Quilter

According to CPS research fellow Michael Johnson, existing tax relief arrangements are inadequate in the face of costly, complex and inflexible pension products.

Britain’s household savings ratio has fallen to its lowest level since records began in 1963, at just 4.9 per cent, the thinktank said.

The CPS has also proposed dropping the £10,000 minimum earnings threshold for auto-enrolment eligibility and the introduction of a workplace Isa for employer contributions.

Tax relief favours the rich

In 2016-2017, the combined cost of tax relief and national insurance rebates on pension contributions stood at £47bn. Forty per cent of that sum was received by the top 10 per cent of earners, according to the CPS.

The CPS recommends replacing national insurance contribution rebates with bonuses paid on employees’ contributions.

Johnson argued that the current system “motivates the wealthy, who will save anyway”.

“From a Treasury perspective, it’s spending vast sums of money and it’s not a very effective way of spending if we assume that the purpose of incentives is to encourage more people to save more,” he said.

Johnson pointed to a lack of understanding of tax relief across lower earners, arguing that the introduction of a bonus system would lead to a higher savings ratio.

The CPS paper suggests a £2,500 cap on the bonus that an individual would receive in a year.

“One of the objectives is to reframe the incentives language, and to move away from tax relief to the language of bonuses, which is far more readily communicated to people who are not financially astute, which is most people,” Johnson said.

The rules are not that complex for most

The CPS is far from the first body to call for sweeping reforms to pensions tax relief. In April, the Royal Society of Arts called for a flat rate of tax relief on pension contributions for the self-employed.

Jon Greer, head of retirement policy at Quilter, recognised the regressive nature of pensions tax relief, but was unconvinced by the proposals set out by the CPS.

“For the majority of people the pension tax rules are not complicated,” he said.

Greer supported the idea that adopting a bonus culture in place of tax relief would be more accessible for savers.

He expressed concern, however, at the sheer scale of the CPS’s proposed changes, and the potentially destabilising effect that they might have on auto-enrolment, which has helped millions of savers save into a pension.

“I can’t see that any employer as well would be that happy in having to change their workplace pension scheme over to an entirely new sort of vehicle and explain that to their members, and for what benefit?” he asked.

This government cannot afford to pick fights

Such grand revisions to the pensions system would require ample space in the government’s agenda, something that Tom McPhail, head of retirement policy at Hargreaves Lansdown, said it does not currently have.

In 2015, former chancellor George Osborne oversaw a review of pensions tax relief, that was eventuallyscrapped to the industry’s chagrin.

“There was widespread disappointment when Osborne subsequently shelved those plans and instead introduced the lifetime ISA. Many felt that that was a fudge and that he’d ducked an opportunity to make bold reforms that were necessary,” he said.

In McPhail’s view, Osborne ducked this fight due to his inability to achieve consensus on pensions tax reform, along with his willingness to expend much-needed political capital. This, he says, remains applicable today.

“You can only really drive through these fundamental changes to the pensions system, either in times of great emergency… or when you’ve got enough political capital that you can ride over the speed bumps of some opposition,” he said.

“I don’t think either of those sets of circumstances particularly pertain today.”