This move from ‘exempt-exempt-taxed’ (with pension money currently not taxed until the point of withdrawal) to ‘taxed-exempt-exempt’ may well succeed in encouraging younger savers to save into their pot, but will ultimately lead to much smaller retirement funds, unless the Government provides substantial bonuses from an early stage.
Take the below example of a 40 year old who earns £50,000 a year, and is putting five per cent net of their wage (£2,500) into a pension fund. Currently, as a higher rate tax payer, they are benefitting from 40% pensions tax relief and so their contribution is in fact worth £4,167. Assuming the investments themselves grow at a rate of five per cent each year, by the time they reach their intended retirement age of 65 they would have a pension fund of £208,822*.
If Steve Webb’s suggestion of a flat rate of 33% on pension tax relief bore fruition under the current system, it would mean that the employee was making contributions of £3,731 a year, and their pension fund at 65 would total £186,973 – a loss of over £20,000.
Moreover, if the Government is to carry out this suggested new policy and only income which has already been taxed can be added into retirement funds, and the employee maintains a £2,500 contribution into their pension fund, at 65 this would total just £125,284 – a fall of over £80,000. Even if, at age 65, the Chancellor’s promised ‘top-up from the Government’ is then delivered (at the suggested 33% rate), the fund would only total £166,627.72 – still leaving the worker with a £40,000 shortfall in their retirement funding.
Unless the Government chooses to help fund pension pots from an early stage, workers are going to miss out on vast amounts of money they would have otherwise gained through the impact of compound interest, and this is something that the consultation period will seriously need to consider. It is vital that savers receive every encouragement to put something into their retirement funds as early as possible.
* Assumes no further wage increases/additions to pension contribution.
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