Strengthening The Incentive To Save?

Are we on the brink of the biggest overhaul of retirement saving there has ever been? Very possibly. Chancellor George Osborne must be sorely tempted by the amounts of money he can wipe off the deficit by going for a root-and-branch reform of the retirement savings industry.

While the consultation on pensions tax relief is entitled ‘Strengthening the incentive to save’, few doubt its primary purpose is to see how the Treasury can save as much cash as possible without using up too much political collateral, and without destroying what remains of the nation’s retirement savings culture at the same time.

Without wishing to belittle the aims of the consultation, it is clear to most people in pensions that a switch from up front tax relief to Isa-like tax-free withdrawals plus some form of matched government contribution is unlikely to improve incentives to save. By its own admission, the government is already spending £50bn a year on incentives, yet we have had to resort to auto-enrolment to get millions of people into pension saving. Nudges, not new incentives, are doing a very good job of building a savings culture.

So what is the Chancellor really thinking about? The numbers on the table are massive – why pay out that £50bn a year foregone by the Treasury as a result of income tax and National Insurance relief on pensions at the beginning of the saving journey when you can shove the cost decades down the line by removing up front tax relief and, like Isas, make withdrawals tax-free?

That is one of the arguments put forward by supporters of a move to a pension-Isa model, where withdrawals, not contributions, are tax-relieved.

One of the arguments in favour of such a switch is that it would be clearer to people how much they would receive in retirement, as they would not have to try and guess their future marginal tax rate.

It would also be easier for providers to administer - and, the Treasury hopes - would lead to more competition in the savings industry as the barriers to entry would be lower.

But how would people respond to yet another fundamental overhaul of the pensions system, just a couple of years after the last one? The public like stability when it comes to savings structure, so more change could undermine trust in the system.

Would people trust future governments not to tax the income from their pension Isas? How would DB be untangled? Would it be fair to leave public sector pensions untouched? And what would the market impact be of so much money coming out of the industry in a short space of time?

Osborne has much to ponder. And if this fantasy world of a pensions Isa never does materialise, he can console himself that at least the debate has softened up the pensions industry to a point where they will be relieved at the thought of a flat-rate of tax-relief for all.

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