A single tax relief rate for all pension contributions could spread the advantages of tax breaks more evenly and better incentivise private savings, according to new research.
A Pensions Policy Institute study has found that a flat tax relief rate of 30 per cent could bring these advantages at a cost similar to the current system.
Reviewing the pension tax relief system and whether it meets its objective of incentivising pension saving, the PPI found the system is tax-advantaged compared to other savings such as ISAs.
However, PPI director Chris Curry said the system was poorly understood, and there was little evidence it incentivised saving despite its £35bn cost.
“The current system of pension tax relief favours higher and additional rate taxpayers. Even with pension saving boosted for lower earners by automatic enrolment, basic rate taxpayers are estimated to make 50 per cent of pension contributions, but receive only 30 per cent of pension tax relief on contributions,” Curry said.
A clearly-presented 30 per cent flat tax relief rate could improve the situation, Curry said, creating a larger incentive to basic rate taxpayers to save while leaving pension saving at least tax neutral for higher rate taxpayers.
“But implementation of a single rate of tax relief would be far from straightforward, with significant changes in the administration of pension contributions required. The resulting tax charges could be very difficult to understand and lead to changes in behaviour by employees and employers.”
The single tax relief rate was among a range of options considered, along with adjustments to the current framework of the tax relief system and changes to the tax-free lump sum.
The research was cosponsored by Partnership, Age UK, the Institute and Faculty of Actuaries (IFoA), and TUC.
Partnership chief executive Steve Groves said a single tax relief rate system would ease the tax burden on future generations. Higher rate taxpayers would still benefit, Groves said, although not to the level they do under the current system.
“The 30 per cent single rate option for pensions tax relief analysed by the PPI alongside other reform options - which is a seemingly simple intervention, albeit with implementation challenges - can really make pension savings more effective and attractive for the majority, at a limited cost to the government.”
The IoFA said the research was a “worthwhile first step”, but stressed that introducing a single tax relief was only one possible policy option.
IoFA president David Hare said it is important to consider how employers can be incentivised to provide pension saving.
“Most pension saving is already made via employer sponsored provision and this will increase under auto-enrolment. It would be interesting to examine how removing complexity and using tax incentives to reduce costs could encourage employers to wholeheartedly embrace pension provision. A simple regime that is easily understood could have many benefits for both employers and employees.”
Royal London research showed almost half of basic rate tax payers felt a single tax relief rate would encourage them to increase contributions.
“There aren't too many tax changes that would cause such a material change in behaviour, so this should be welcomed with open arms,” Royal London CEO Phil Loney said. "Today's proposal by the Pensions Policy Institute is an encouraging suggestion and such a move would go a long way to rectifying the public scepticism regarding the viability of pensions as a source of retirement income.”