The Association of British Insurers (ABI) has calculated that the pension ISA tax relief reform currently being considered by the UK government could lower savings by around a sixth.
The ABI’s response follows a consultation on pensions tax relief launched by UK’s Chancellor George Osborne in July 2015.
With increased longevity and the changing nature of pension provision, the consultation paper said the UK government needs to make sure that the system incentivises more people to take responsibility for their pension saving so that they are able to meet their aspirations in retirement.
The UK Treasury’s July 2015 consultation paper noted it has been suggested that a fundamental reform of the system so that pension contributions are taxed upfront (a "Taxed-Exempt-Exempt" system like ISAs), and then topped up by the government, may allow individuals to better understand the benefits of contributing to their pension as the government’s contribution might be more transparent, and they would no longer need to consider the future tax implications of their pension choices or work out how much their pension pot is worth given their expected tax rate in retirement.
However, based on research by the National Institute of Economic and Social Research (NIESR), the ABI said it has found that, even if the Government added up front 30% to contributions, over 20 years a move to a pension ISA could:
- Lower savings by a sixth – resulting in an average annual reduction in contributions of £383 ($583)
- Cut average wages by £1,284 per year
- Increase the typical annual mortgage bill by £466.
- Reduce the size of the economy by around 6%
The ABI argues that a move to a Pension ISA in the UK would also create a fiscal deficit of over £5bn a year for future generations, according to Pensions Policy Institute research it commissioned.
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Instead, the ABI is proposing an alternative reform, a ‘Savers’ Bonus’, or flat rate of pension tax relief. It says this would produce a simpler, fairer and more sustainable system for pension savings, and would encourage people to save more for retirement.
Yvonne Braun, director of Long Term Savings at the ABI, said: "The Pension ISA would hit today’s savers and could create a fiscal time bomb for future generations. Many savers would be worse off and it would also damage the economy more widely because of its impact on saving and investment.
Yvonne Braun, director of Long Term Savings at the ABI
"It’s superficially attractive because of the savings it can deliver in the short term – but as the IFS have said, this is no more than a ‘temporary windfall’.
"We do favour reform but a Savers’ Bonus will benefit 4 out of 5 workers without the wider impacts on the economy, wages and savings."
The ABI cites independent research by the NIESR estimates that introducing a TEE style pension ISA with a Government matching contribution of 30% would result in a decrease in investment (savings) of 16.8%.
If applied directly to an average taxpayers’ annual pension contribution of £2,280 per year (for occupational and personal pensions, calculated from HMRC table 3.8) he ABI said this could result in an average annual reduction in contributions of £383.
The ABI’s response comes after Aviva has said its research has shown that public support for using an ISA-style saving system for pensions almost halves when the tax implications are explained.
In September 2015, Aviva said a survey was carried out asking working people which system of tax incentive for pension contributions they would prefer. 41% of people opted for an ISA style system where contributions are paid from taxed income, but withdrawals in retirement are tax free.
However, Aviva said when it was explained that using the ISA system most people would end up paying more tax that figure fell to just 23%.
In contrast, Aviva said the number of people in favour of the current system of tax relief (pension contributions are tax free but withdrawals in retirement are taxed) rose from 20% to 34% once the tax implications of pension-ISAs were explained.
In the July 2015 consultation paper, the UK government has said it was interested in views on whether an alternative system that is simple and transparent, in which savers can better understand the benefits and risks, is likely to result in greater engagement with pension saving and therefore increase the overall level of saving, or whether it would be better to keep with the current system.
Commenting on Aviva’s research at the time, Andy Briggs, CEO UK & Ireland Life at Aviva, said Aviva’s research showed that people are confused.
Briggs said: "The figures show that two thirds of people didn’t realise that at least £20 out of every £100 in their pension comes from the Government. This is why at Aviva we are calling for the tax relief system to be made fairer and simpler. We need to remove different rates of relief for different incomes and offer everyone a flat rate of 33%.
Andy Briggs, CEO UK & Ireland Life at Aviva
"Once that is in place we need to make it easier for people to understand. Just call it "Buy 2 get 1 free" so everyone knows that each time they pay £2 into their pension the Government will add £1. It’s a simple, clear and fair incentive for all savers."