Simplicity and forward planning must be at the heart of the Government’s pensions taxation reform, or future generations could be put off saving towards their retirement – according to PwC. The Chancellor looks set to announce his long-awaited changes to pensions taxation in the Budget, with two key alternatives to the current system being considered.
- a system of “flat rate” tax relief (potentially in the range of 25% to 33%) and
- an “ISA” style system in which pensions are paid tax free, but contributions are paid from after tax income, with a government top up
PwC research found that six in ten people in the West Midlandsare put off saving more into their pension because they don’t understand the system.
The same research also found that 56% of people in the West Midlandsdon’t understand how their pensions are currently taxed.
Steve Blackmore, pensions director at PwC in the West Midlands,said:
“This is a pivotal moment in the history of pensions. Get it right, and millions more people could be encouraged to start saving or save more towards their retirement. Get it wrong and you could have a huge number of people disenfranchised with the pensions system.
“Upfront incentives are an important element of the current pensions tax system, but incentives need to be better understood by people if they are to encourage people to save towards their retirement.
“For basic rate tax payers, a flat 33% tax relief rate would increase incentive to save and individuals might respond by contributing more to their pension pot. Meanwhile higher rate tax payers would lose out from such a flat rate system. However, it is unclear whether they would seek to reduce contributions significantly, particularly if still benefitting from generous employer contributions. The analysis for everybody becomes trickier if there are changes to the tax free lump sum.
“There will also be an impact on employers, particularly those with matching contribution scales, which could mean an immediate and unpredictable cost impact. Employers will need to quickly plan for, and model, this impact and potentially review contribution scales to make sure they remain efficiently targeted.
“Employers in the West Midlandswill also need to consider the administrative impacts, to allow time to meet new payroll challenges as pension scheme administration becomes increasingly complex.
“In the longer term, a more transparent tax system will help to underline the value to employees of good quality pension schemes. In particular, as the war for talent continues, access to a generous, flexible scheme could move up the wish list of employees when making job decisions. This, in turn, will encourage other companies to review their schemes accordingly.
“With the position currently very uncertain, many employers in the regionwill be monitoring Budget developments closely and pensions look set to remain high on corporate agendas.”
PwC predicts that any new system would not be introduced until April 2017 at the earliest. For the sake of simplicity it is therefore important that there are no further measures that may discourage saving between now and then. Even changes that only affect higher earners for example, may negatively affect sentiment for lower earners around auto-enrolment.
However, innovative measures that look to boost incentives for younger workers, to get them into the habit of long term saving early on in their adult life, would be welcomed.