A flat rate will hit ‘middle class’ savers, who face the biggest savings shortfalls, hard says Hymans Robertson.

Research from Hymans Robertson, the leading independent pensions and benefits consultancy, shows that those who currently face the biggest savings shortfalls in retirement are the ‘squeezed middle’ of 40% tax payers (see table 1 below). This is based on an analysis of over half a million people saving into Defined Contribution (DC) pension schemes through Hymans Robertson’s Guided Outcomes™ platform. A move to a flat rate of pensions tax relief, a move being considered by the Chancellor, will penalise these middle class savers discouraging them from putting aside sufficient money for retirement.

Commenting, Chris Noon, Partner at Hymans Robertson, said: “A move to a flat rate of tax relief redistributes tax relief away from additional rate tax payers, which is justifiable as they tend to save enough. But, it also takes tax relief away from higher rate tax payers, which is a problem as this is the group facing the biggest savings shortfalls in retirement*. Discussing why the Chancellor should consider a capped rate over a flat rate, Patrick Bloomfield, Partner, added: “The easiest and fairest way for the Chancellor to reduce the cost of tax relief on pensions and boost Government finances quickly is to move to a capped rate of tax relief. Flat rate tax relief would fit with existing payroll and pension systems; whereas the implementation of flat rate tax relief would be horrendously complicated. The added complications of implementing flat rate tax relief could mean it is takes a few years before George Osbourne starts to see the benefits.

“In theory flat rate tax relief could be effective at targeting tax relief at those who are currently under-saving for retirement. But the reality is, given the Treasury’s budget, it won’t make a meaningful difference.Our consumer research has shown that the number one disincentive to save is changes to legislation. So what is planned as a small benefit could end up being a major deterrent to savings. The case for flat rate tax relief just doesn’t stack up. Of all the options on the table for Government, modifying the current system to bring in a capped rate of tax relief will represent the smallest disruption for the greatest policy benefit. It would also enable the removal or at least a simplification of the complex system of annual and lifetime limits. It’s a simpler and fairer policy than introducing a flat rate.” 

Explaining how a capped rate of relief would work, Chris Noon said: “We recommend Mr Osborne limits the highest level of tax relief on pension contributions to 33%. This would mean that basic rate tax payers would get the full 20% relief but higher and additional rate tax payers would only get 33%. Clearly any system has to be sustainable, both now and in the future. A capped rate of relief gives the Government fiscal control, introducing a controllable cap on pension tax relief which can be changed independently of income tax bands to help balance the books. It will also provide stable long-term costs as a percentage of GDP.”

Commenting on why a capped rate of relief would be better for employers and the pensions industry, he concluded: “A capped rate would be a less disruptive change for employers and the pensions industry than a flat rate. A capped rate would provide a better approach for employers in managing retirement provision. Both they and the pensions industry are still adjusting to the changes heralded by the pension freedoms less than a year ago. The infrastructure is largely in place to implement a capped rate of relief. Introducing a flat rate, on the other hand, would create considerable upheaval and cost.”

“At the moment basic rate tax payers receive a £20 top-up from the Government for every £80 they pay into a pension. Higher rate tax payers receive £40 for every £60, while top-rate taxpayers receive £45 for every £55. If the Government implemented a flat rate of relief at 25%, everyone would receive £25 for every £75 they contribute. “By limiting the highest level of tax relief on pension contributions to 33%, basic rate taxpayers would continue to receive £20 for £80 they contribute. Higher rate tax payers would receive £33 for every £67, as would additional rate tax payers. The task of communicating pension changes should not be underestimated and the benefit of leaving millions of basic rate tax payers unaffected should not be overlooked.”

Table 1:

The DWP examined what constituted ‘adequate’ incomes in retirement. It concluded this could be measured by comparing people’s retirement income with their income in work. These are known as income replacement rates and form the basis of Hymans Robertson’s Guided Outcomes analysis. See the DWP’s ‘Framework for the analysis of future pension incomes 2013

Hymans Robertson’s Guided Outcomes™ research looks at the savings behaviors of over half a million private sector employees who participate in company pension schemes. Our Guided Outcomes research shows that less than 1/3rd of earners in the 20% and 40% tax bands are likely to achieve acceptable levels of pension incomes through the defined contribution (DC) schemes they participate in. However, a higher proportion of lower earners are likely to achieve acceptable levels of pension income; largely because state pensions provide a lot of their income needs. And a higher proportion of higher earners are likely to achieve acceptable levels of pension income, largely because they are more able to save into pensions.