Is a pension the best way to save? It’s a question that comes up frequently, especially as those with cash to invest before the end of the tax year wonder whether to lock it away for retirement. Pensions have obvious attractions, including income tax relief at your highest marginal rate on up to £40,000 of contributions per year (unless you earn £110,000 a year or more, at which point your £40,000 contribution limit starts to taper off) and the right to take 25 per cent of your fund free of income tax when you retire.
I say “obvious attractions,” but spelling out even the most basic of them illustrates a problem: pensions are far more complicated in practice than most of us can handle.
The chief culprit for this is the government, which tinkers with the rules incessantly, trying each time to fix problems created by previous tweaks. This makes it hard to tell whether pensions are reliably the best way to save—the answer won’t keep still long enough for most people to pin it down.
With the Budget on 11th March, more tinkering is doubtless in store. This will probably attempt to reverse the unforeseen damage caused by recent cuts to the lifetime allowance—the maximum size your pension pot can grow to before tax penalties kick in—and the effects of rules to limit the amount of tax relief available to the highest earners. These rule changes left senior NHS consultants—who earn large salaries and have already built up big pension entitlements—facing tax bills if they upped their earnings, for example by taking overtime to treat more cases, and paid larger contributions. Rich and poor patients alike could lose out from the consequences of that.
Thus, we have ended up with an NHS that is even more stretched and a crazy situation where the government’s fiddling has made pensions a trickier way to save for high earners and a confusing one for others too.
However, for all this craziness, pensions still have major attractions—they just need to be made easier to understand. To that end, here are a couple of suggestions for the government.
First, we should stop talking about tax relief, which confuses people, and replace it with “top ups,” one from your employer (if you have one) and another from the government, which should be larger if you’re self-employed. Second, we need to tip the incentive to save more in favour of lower earners on new accruals. A standard government top up of 30 per cent of the amount employees put in would represent an increase for basic-rate taxpayers and a cut for higher-rate taxpayers, who are better off to start with and need less help.
