However, the Government must be certain that it will lead to greater saving levels before making such a significant change because whilst a flat rate system appears simple at first glance, in reality it would create significant complexity* around the treatment of defined contribution (DC) employer contributions and defined benefit (DB) accrual.
If it did not lead to greater pension savings it would turn out to be an expensive and worthless exercise.
In its response to the consultation on pension tax relief, platform and SIPP provider AJ Bell also says that an ISA style taxed, exempt, exempt (TEE) system could hinder pension savings because of a lack of up-front incentive and result in savers spending their pension savings too quickly without any tax considerations to limit withdrawals. It would also create similar complexities* as highlighted above for a flat rate system for DC employer contributions and DB accrual.
A solution that would make all options under consideration simpler and more achievable would be to separate the DB and DC pension frameworks and build the tax relief frameworks for each in isolation. New incentives for DC pensions could then be considered without introducing complications for DB pensions.
The lifetime allowance should be removed for DC pensions because it is an unnecessary complication. If the Government is concerned with the sustainability of the current DC system it should focus its efforts on limiting DC tax relief at the point of contribution by reducing the annual allowance.
For DB pensions the tax relief available should be limited when benefits are taken. This could be achieved by maintaining the lifetime allowance for DB schemes and reducing it. The annual allowance should be removed for DB schemes.
The separation of the DB and DC systems** would make it simpler to introduce new up-front incentives for DC schemes. However, a flat rate of tax relief or 2 for 1 matching contributions would still introduce complications for DC employer contributions and detailed analysis needs to be carried out to test whether that really would encourage people to save more.
In a poll of AJ Bell customers 54% said they would save more into their pension if a flat rate of pension tax relief was introduced. However, 80% of respondents said they would save more when this was described as a matching contribution or top up system. So, arguably, how the incentive is explained is more important than a consistent incentive for everyone.
Andy Bell, chief executive of AJ Bell, comments:
“The danger is that a move to a populist 2 for 1 matching contribution system turns out to be fool’s gold. Without real evidence that it will encourage people to save more it could just introduce more complexity to the system and turn out to be worthless.
“Regardless of what other changes come out of the current consultation on tax relief, the one must have is a separation between the DC and DB frameworks. That would remove a lot of the complications around introducing new incentives to save via DC schemes. The introduction of the pension freedoms, which only apply to DC schemes, is an acknowledgement on the part of the Government that DC and DB are simpler when separated.
“I also don’t believe the objective of simplification can be met in the DC framework whilst the lifetime allowance and the seven separate forms of protection which support it continue to exist.”
Additional explanation:
*Higher and additional rate tax payers would be taxed on employer contributions and DB accrual. This would increase complexity and act as a disincentive.
**AJ Bell proposes a test on transfers between DB and DC to ensure no abuse.