The proposal forms part of the ABI’s submission into the Government’s consultation on pensions tax reform The comprehensive report draws on detailed work with pension providers, analysis from the respected Pensions Policy Institute, the National Institute of Economic and Social Research (NIESR), Populus consumer research and a review of academic research, to consider the options.
It concludes that reform is essential. As the ABI has argued, the current system is too complex and benefits the wealthiest savers the most.
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A new ‘Savers’ Bonus’ system would best meet the Government’s reform objectives because:
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It would create a simple and transparent system that could be more easily understood by savers and employers than the current system.
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Depending on where the rate was set (25% or 33%) for every £3 or £2 paid in, an additional savers’ bonus of £1 would be paid.
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It would encourage personal responsibility by targeting savings incentives to lower and middle income earners. Currently basic rate taxpayers only get £1 of relief for every £4 put in, while higher rate payers get £2 of relief for every £3 put in.
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It would be sustainable over the long-term and can be implemented quickly to deliver savings in the short-term. Based on a government contribution set at 25%, savings of roughly £1.3 billion a year could be expected from defined contribution pensions alone.
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Transitional risks would be minimal and economic investment protected.
The ABI has also analysed the proposal to switch to a pension ISA, where contributions would be taxable and retirement income tax-free. This is known as Tax/Exempt/Exempt (TEE) as opposed to the current system of Exempt/Exempt/Taxed (EET).
While this may appear superficially attractive due to its potential for short-term savings for the exchequer and its simplicity, it would carry a number of risks that considerably outweigh this:
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A costly, over fifty year transition period that would be confusing for savers and complex to manage.
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It would put at risk employer contributions (which account for around 75% of all pension contribution tax relief) and the success of auto enrolment – evidence indicates that employer contributions are likely to fall.
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Removing tax paid on pension payments at the same time as society ages and care costs increase would put a disproportionate financial burden on the working age population.
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Estimates by independent economists at NIESR suggest that under TEE, GDP could be between 1.4% and 9% lower when transition to the new TEE regime is complete (assuming some kind of matching contribution of between 20% and 30%).
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It would reduce savings incentives because savers may not trust future governments not to reintroduce tax on pension income. A Populus survey1. for the ABI revealed that less than 1 in 5 people think that future governments would stick to not taxing pensions in retirement.
Dr Yvonne Braun, the ABI’s Director of Long Term Savings Policy, said:
"We believe that the new savers’ bonus is easy for savers to understand, keeps the upfront incentives to save for individuals and employers, targets help more fairly between low and high earners and saves money. While there is no ‘silver bullet’ solution to replacing the current complex pensions tax relief system, it is clear that no change is not an option, and a savers’ bonus, based on a single rate of tax relief meets the Government’s reform principles.“In contrast, our forensic analysis of the options concludes that introducing pension IS. As risks dissuading people from saving for their retirement, would be costly and complex to implement, and hit economic growth.”
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