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A Savers’ Bonus - personal responsibility and pension savings

Tiffany Tsang , Policy Adviser, ABI Tiffany Tsang , Policy Adviser, ABI

Recent government research shows a startling fact: almost 11 million people with incomes below £52,000 are under-saving.  Almost 60 percent of those people who are under-saving have incomes below £32,500. This means that when today’s savers retire, their incomes will not match those of today’s pensioners unless current savings rates increase.

Counterintuitively, although basic rate taxpayers account for the vast majority of taxpayers, as a group they receive less than 30% of government spending on tax incentives for pensions saving. Basic rate taxpayers only get £1 for every £4 put in, while higher rate payers get £2 for every £3 put in. Meanwhile, one in six pensioners currently live in poverty, with this figure set to rise with increasing life expectancy. What can be done to target this under-saving and the impending increase in pensioner poverty? As always in policy, there’s no easy answer.

The most important driver of an individual’s ability to take personal responsibility during retirement is the size of an individual’s pension pot. 

One of the four guiding principles identified in the Government’s Green Paper on pension tax relief reform in July 2015 includes personal responsibility. The most important driver of an individual’s ability to take personal responsibility during retirement is the size of an individual’s pension pot.  Many things can impact the pot’s final size. The level of wages and disposable income (after taking into account the often high costs of living – housing, food, and childcare) for instance are among the important factors, but so is the level of government incentives through tax policy.

In response to the Green Paper, the ABI is promoting a Savers’ Bonus that applies equally to all. Not only is this much simpler and more transparent (another guiding principle identified in the Green Paper) than the existing system, it encourages personal responsibility by targeting the current inequity in government spending on tax relief, which favours the highest earners.

  • The Savers’ Bonus encourages personal responsibility by directing incentives to lower and middle income earners. Depending on where the single rate of tax relief would be set (25% or 33%), for every £3 or £2 paid in, an additional savers’ bonus of £1 would be paid, allowing those more at risk for pensioner poverty to accumulate larger pots.
  •  Personal responsibility is also better encouraged in a single rate system than in a TEE system (one of the other reforms being considered). Tax acts as a natural brake to stop people from spending their pension fund too quickly, helping to facilitate personal responsibility in retirement, as it reduces reliance on welfare support. Under a TEE system, this natural “brake” would be missing at the point of withdrawal in retirement.
  • A single rate system is fairer than the current system for the majority of tax payers, as it increases the total amount of tax relief received by basic rate taxpayers as a group from 29% to nearly 50%.
  • In a single rate system, pensioners remain taxpayers, which would avoid the long-term unfairness of a TEE system that shifts the burden of funding for an ageing society entirely onto the working age population.
  • Finally, it will save the government money. If set at 25%, there would be savings of about £1.3 billion a year from defined contribution pensions alone.

It’s true that a single rate will be less generous to higher earners. However, this is arguably a result of the current system being particularly generous for these savers; six out of seven higher earners will only pay basic rate tax in retirement. A single rate system can also result in double taxation, which can discourage saving. But, the risk of this being a serious problem is low for the overwhelming majority of people, as even someone who is a higher rate taxpayer in retirement is very unlikely to have an average tax charge on their pension at a rate as high as the relief they receive while saving. For example, even someone with the maximum pension pot of £1,000,000 will only pay an average tax rate of under 19% on their pension. Even if they had other savings income of £20,000 per annum, their average tax rate on their pension would still be under 26% (see our consultation response - section 3.14).

Not only will the ABI’s promotion of a Savers’ Bonus provide an upfront and easy to understand incentive, it will encourage personal responsibility in retirement and help reduce pensioner poverty through an overall fairer system.

Tiffany Tsang is Policy Adviser at the Association of British Insurers (ABI).

The ABI Biennial Conference session on The Pensions Revolution – What’s Next? will discuss this issue and others in further detail.


Last updated 29/06/2016