Pension contributions can receive tax relief on worth up to 100 percent of annual earnings. This tax relief is given automatically if the employer takes workplace pension contributions out of the employees pay before deducting Income Tax and their rate of income tax is 20 percent.
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However, research conducted by the Pensions Policy Institute (and commissioned by the Association of British Insurers) revealed that those on low incomes are missing out on the vital tax relief, despite actually saving more for retirement.
Their research, which examined figures from HMRC, the ONS and DWP among others, looked at defined contributions (DC) specifically.
DC pensions are the kinds that get tax relief and they now likely make up the largest proportion of private pensions among the UKs workforce as defined benefit schemes are no longer (or rarely) offered.
According to the Pensions Policy Institute (PPI), basic rate taxpayers make up 83.4 percent of total taxpayers but they only receive 26 percent of the pensions tax relief related to DC pension contributions.
Their research also found that the system in place favours higher earners, with the number of people earning less than £30,000 who now qualify for tax relief increasing from 52 percent to 62 percent due to automatic enrolment. However, only 24 percent of tax relief goes to them.
Worrying statistics on age and gender gaps were also unearthed.
Younger workers are struggling with their pensions when compared to their elders.
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Of total DC pension contributors, 42 percent of them are under 40 but they only receive 27 percent of the available tax relief.
PPI detailed that people in their 40s and 50s receive two and half times as much tax relief from the government.
Also in news that will sadly not surprise many, men are receiving a disproportionately higher amount of support.
Men contribute the most to DC pensions (69 percent) and as such, they receive 71 percent of the tax relief.
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While these findings are worrying, PPI detailed that there could be a relatively simple solution.
They went on to detail that changing the current system to a single rate would increase the amount of pension tax relief for the basic rate taxpayer from 26 percent to a more equal 42 percent.
The findings from PPI will go on to inform the Association of British Insurers wider policy work on simplifying pension’s tax relief.
The research conducted found that generally, the current pension’s tax relief system is too complex and it has made it difficult for savers to plan for the long term.
Both institutions involved in the research have called for changes to be made to the system to make it simpler, fairer to all earners and encourages saving for retirement.
Yvonne Braun, a Director of Long-Term Savings and Protection at the Association of British Insurers, commented on the findings: “Pensions tax relief plays a vital role in encouraging people to save, but also in supporting the adequacy of that saving.
“However, the distribution of pension’s tax relief under the current system exacerbates existing inequalities, particularly between men and women.
“We hope the research will provide food for thought on how to make the system simpler and fairer.”
Tim Pike, the Head of Modelling at PPI, concurred with this: “While automatic enrolment has significantly increased the number of low earners benefiting from tax relief on DC pension contributions, half of the value of this relief goes to people earning £60,000 or more.
“A change to the system of tax relief on DC pensions could offer an opportunity to address the philosophy of the current system although implementation would present challenges.”
In response to the findings, some detailed that the potential introduction of flat rate pension tax reliefs should be considered very carefully.
Jon Greer, the head of retirement policy at Quilter, commented on the reports findings: “Moving to a flat rate of pension tax relief is a radical proposal and one that must be carefully considered. Pensions are for the long-term and so any policy making needs to be made with that in mind. We cannot have an overhaul of the pension tax system only to find it flawed and altered when challenges present themselves. Consultation on how it could be implemented, and to which schemes, is important as on the surface it sounds like an easy thing to do, but in practice it is not necessarily the case.
“While a flat rate of 30-33% would be re-distributive and benefit basic rate taxpayers, it would be broadly revenue neutral for the government. And this begs the question, what will they do next? Once pension tax relief is decoupled from marginal income tax rates it is a slippery slope and there would be little to prevent future governments then cutting tax relief to 25 percent or even 20 percent to save money.
“It is also important to remember that income tax relief on pension contributions is not truly a relief in the conventional sense, but a tax deferral mechanism. Pensions are liable for income tax, but this is applied on the way out, not on the way in. This tax deferral system creates an incentive to save for the future and ensures people are contributing some income tax later in life, helping to smooth fluctuations of demography and the pressures of an ageing society.
“While a universal flat rate might be simpler to understand for some of the public, it is unlikely to make a dramatic difference on public comprehension of the benefit of pension saving. We need more than tweaks to policy to change the perception of pensions and their perceived complexity and open up pensions so that information is accessible, timely and is framed in a way that is easily understood. Financial education is a key part of that and can be greatly helped by pensions dashboards.”
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