“Constant tinkering” and a confusing system provide little incentive for pension saving, leaving millions at risk of poverty in old-age, new research suggests. This is despite the government giving out “free” money in the form of tax relief.
These tax reliefs cost the government £40bn a year, yet just one in three savers say they are the reason they save into a pension, according to the data from pension provider, Cushon, while more than half have no idea how pension tax relief works or how much they get.
It’s fair to say the pension system is complex. Savers are expected to know their annual allowance and tax rate, national insurance reliefs in salary sacrifice, the lifetime allowance, and whether tax reliefs are given at source or through a net-pay agreement.
Workers of all incomes seem equally puzzled by the system, and 47 per cent of those earning £100,000 or more said they had no idea how tax relief on pensions work.
But is it really all so confusing that we don’t bother engaging?
According to the pensions regulator, 87 per cent of employees had a private pension via their company’s auto enrolment scheme in 2019, up from 55 per cent in 2012 when it was introduced.
While this isn’t 100 per cent, it’s still a healthy majority, showing that people are still putting money away.
However, if the system is too complex, as the research suggests, how can anyone be incentivised to put more money away, or to spend time researching the best place to put their money to secure a safe and comfortable retirement?
“Tax relief in its current form just isn’t working,” says former pensions minister, Baroness Ros Altmann.
“It’s meant to offer an incentive to get us to save for retirement, but it is so complex that most people don’t understand it. Without knowing how it works and how valuable it is, it clearly cannot provide much incentive for increasing contributions.
“Requiring people to know their annual allowance and tax rate, not to mention the lifetime allowance and whether their tax relief is given at source or through a net pay arrangement, plus constant policy tinkering, has left most savers in the dark about how pensions work.”
There are several pension tax reliefs available to savers.
When you put money into a private pension, you get tax relief in the form of a bonus amount of money from the government, based on the rate of income tax you pay. Those paying basic-rate tax get 20 per cent pension tax relief, those paying higher-rate tax can claim 40 per cent, and additional-rate taxpayers can claim 45 per cent.
For example, if you pay £100 into a pension pot you actually only put £80 in, and the government pays £20.
There is an annual pension tax relief limit set by the government and for the current year it is £40,000.
To add to the confusion, the way you get the tax break differs depending on the type of pension you save into.
If the pension scheme you use is described as a “net pay” scheme, you will automatically get the tax break. However, if your pension scheme is a “relief at source” scheme, the additional money from the government comes via HM Revenue & Customs (HMRC) and higher and additional-rate taxpayers can only get it by filing a self-assessment tax return.
You can also benefit from pension tax breaks if you’re earning a low income and don’t pay tax, or not earning at all.
If you earn £3,600 or less, the maximum you can contribute to a pension is £3,600, including the government top up so the amount you personally can save is £2,880.
Ben Pollard, chief executive officer and founder at Cushon, is calling for the tax relief system to be simplified.
He says it needs to be explained to people in a language they can understand so they can comprehend its full value, as well as making it fairer for those who earn less.
He said: “When stood against products such as the Lifetime ISA, with its simple message of ‘Receive a £25 bonus for every £100 you invest’, the current pensions system of basic, higher-rate and additional-rate relief, adjusted income, tapered annual allowance and lifetime allowance can be quite bewildering.”
A clear, simpler pension system that people understand would benefit all savers, but the challenge of how to create this is yet to be answered by the government.
Altmann adds: “A simpler, readily understandable system could go a long way to increasing understanding – and could encourage people to contribute more to their pension pots too.
“At the very least, people need clear explanations of the extra money they receive for their pensions, in language they can genuinely understand, to make the huge government spending more effective.”