Why are so many policymakers convinced that the relief should be cut? Pension relief is not a luxury tax break. Its purpose is to provide an income during retirement when we no longer work or have earnings. Why would any government wish to make this even more difficult to achieve? Yet the prevailing view in some circles is that tax relief is not an effective or well-targeted way of incentivising saving into pensions. I strongly disagree. I sit on a pensions committee and the one thing that gets people interested in increasing their contributions is understanding that when they pay in, two other parties (the government and their employer) pay in as well.
Pension tax relief isn’t free money: it’s earned income that is being locked away for the future. Without that crucial relief, the task of building up an adequate sum of money – something that is already an impossibility for millions of people – becomes even more unachievable.
I get that for some of those supporting a cut in the relief it’s more about levelling the field for low earners. They hope for a flat rate of 30 per cent, but we are more likely to end up with a flat rate of 20 per cent. A flat-rate relief is a great idea but why does it have to be downwards?
There is already plenty of tax barbed wire surrounding pensions. It’s only available on £40,000 each year and most people do not save anywhere near that level. If you earn too much that allowance falls to £10,000; and it can also fall to as little as £4,000 a year. If your pot does well you may have to pay lifetime allowance tax charges. Don’t forget that pension income is taxed too.
The financial damage caused by cutting relief is what policymakers need to focus on. AJ Bell points out that the impact of tax relief cuts would be most painful for the public sector, including frontline NHS staff. Other groups who would lose out badly are young people and women. Both of these groups account for a large proportion of low earners. Higher-rate relief in later life is one way they get to boost pots and this is often the time when people can finally afford to prioritise their pension.
We need to make pensions more not less enticing. We are asking people to lock money away for decades for a completely unknown future so any incentive must be generous.
Only 1.5 per cent of the UK’s 31m taxpayers are in the highest-rate tax bracket. Fury over high earners catching an additional 5 per cent break on their pension contributions does not undermine the principle that we should all get all the help we can to save for our futures. A future that’s full of risks and unknowns, such as job insecurity (terrible for your pension savings) and inflation (terrible for the value of your pot). Chris Dillow points out in this week's Portfolio Clinic how amazingly lucky investors have been with average annual returns for UK equities of 5.5 per cent since 1900 – we cannot assume that will be the case going forward.
Building up a worthwhile pension is vital, but difficult. Tax relief is a crucial part of the equation so let’s just bin the idea that pension tax relief is nice but not essential to have.