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Pension tax relief ‘valuable but poorly understood’ by savers

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The current pension tax relief set-up offers significant advantages over ISAs but is poorly understood by savers, a report has concluded.

The Pensions Policy Institute (PPI) report said the 25% tax-free lump sum available on retirement was “particularly valuable”. It also highlighted that people who pay higher rate tax when working – and so get tax relief at the higher rate – but who pay basic rate tax in retirement get an even larger benefit.

However, PPI director Chris Curry said despite the relief on contributions costing up to £35bn a year (after allowing for the introduction of auto-enrolment) tax relief remains poorly understood.

He said: “There is little evidence that it encourages pension saving among low and medium earners.

“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% of pension contributions, but receive only 30% of pension tax relief on contributions.

“Pension tax relief on lump sums, at an estimated cost of £4bn a year, is similarly uneven. While only 2% of lump sums are worth £150,000 or more, they attract almost one-third of tax relief on lump sums.”

The PPI added that while recent reforms have reduced the cost of tax relief they have not increased the value of savings for any individuals.

Curry suggested “more radical alternatives” such as a single rate tax relief applied to all pension contributions could spread the benefits of tax relief more evenly.

“A tax relief rate of 30% could have a cost similar to the current system. If presented clearly, a 30% rate could give a larger incentive to basic rate taxpayers to save, while still 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,” he added.

Tax relief for pension saving in the UK was sponsored by Age UK, the Institute and Faculty of Actuaries, Partnership and the TUC.

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