Strengthening the incentive to save: a consultation on pensions tax relief

10 July 2015
We summarise the issues raised and questions posed by the consultation announced by the chancellor in his summer Budget.
Join the debate

Anyone wishing to contribute to the consultation should do so by 30th September 2015.

Find out more

The outcome of this paper and the Government's response could have significant implications for all those who distribute and advise on pensions and other savings.

It is important that these issues are considered carefully and that the implications are fully thought through.

We will certainly be doing so and will respond to the Government in due course. In the meantime this note provides a summary of the issues and questions.


With increased longevity and the changing nature of pension provision, the Government states the need to make sure that the tax system incentivises more people to take responsibility for their pension saving in order to meet their aspirations in retirement. They also want to ensure that the system is sustainable.

The central point of the paper is to explore whether the pension tax incentives should be changed.

The options could range from:

  • changing the principle that taxation of pensions should be deferred until retirement,
  • to one where no tax relief is given on pension contributions but the resulting pension (or funds withdrawn from the pension pot) is tax free (and providing a government top-up on contributions)
  • through to less radical changes such as retaining the current system, and
  • altering the lifetime and annual allowances.

Why has the consultation been issued?

In setting out the case for the need to explore change to pension tax relief the paper notes the following drivers:

  • Substantial and enduring increases in life expectancy meaning pension savings have to last longer or people need to work longer.
  • Changes in Government policy relating to pensions e.g. flat rate state pension, removing compulsory annuitisation (freedom and choice) and the introduction of auto enrolment.
  • The shift away from defined benefit schemes toward defined contribution schemes (in the private sector) meaning contribution levels become a key factor in the amount of pension an individual could receive. Current contribution rates look low if workers are to have a decent chance of having an appropriate income in retirement relative to their working wage.
  • Auto enrolment policy, while substantially increasing the number of workers saving, will not require contribution sufficient to provide the level of income needed in retirement, where the contributions paid at the minimum levels.
  • Innovation in design and distribution by the pension and savings industry, changes in the advice market driven by RDR and provider consolidation are also noted as drivers for the need for reform

These points and the fact that the pension tax relief now costs the Treasury around £50bn a year and rising have prompted the consultation to explore new ways of providing incentives to save.

The current system - EET

The paper outlines the current system (known as EET) as follows:

  • Exempt. Pension contributions by individuals and employers are exempt from income tax, and employer contributions are also exempt from National Insurance contributions (NICs) (although total contributions are subject to both an annual allowance and a lifetime allowance).
  • Exempt. No personal tax is charged on investment growth from pension contributions while in accumulation, subject to the lifetime allowance.
  • Taxed. Pensions in payment are taxed as income, but individuals are able to take up to 25% of their pension fund as a tax-free lump sum on retirement.

There are limitations to the annual amount of tax-privileged savings (currently £40,000) and a lifetime limit (currently £1.25M and to be reduced to £1M from April 2016) and some other restrictions in certain circumstances.

The cost of scheme tax relief has been rising and is expected to be around £50bn in 2013-2014.

The paper notes that the distribution of tax relief has also changed through time and states that two thirds of tax relief goes to the higher rate tax payers.

It also makes the point that the increase in personal allowance has also led to a decrease in the share of the relief that goes to people earning below £20k.

Principles for reform

The Government believes there are principles that any reform should meet. These are:

  • It should be simple and transparent. Simplicity and transparency may encourage greater engagement with pension saving and strengthen the incentive for individuals to save into a pension.
  • It should allow individuals to take personal responsibility for ensuring they have adequate savings for retirement. It should encourage people to save enough during their working lives to meet their aspirations for a sufficient standard of living in retirement.
  • It should build on the early success of auto enrolment in encouraging new people to save more.
  • It should be sustainable. Any proposal for reform should also be in line with the Government's long-term fiscal strategy. 

The Government recognises that there may be tension between the principles (for example the simplest way may not encourage personal responsibility) and will therefore need to consider how the principles interrelate.

It also recognises the need to consider wider macro-economic implications, the implications on the rest of the tax system and on employers, industry and HMRC itself.

Issues raised and questions posed by the consultation

Though the current system is deeply embedded in the processes of employers and pension providers, views are sought on viable alternatives and the issues. It does point out the need to proceed gradually and that the outcome may be that the current system is maintained or modified.

The paper expands on the issues and asks for views and evidence based on related questions. These are:

  • There's evidence to suggest that some are not aware or motivated by the tax benefits of the current system.
  • There is complexity in the way the current market and products work.
  • Some have suggested moving to system where pensions contributions are taxed up front (like ISAs) and then topped up by the Government making the state contribution more transparent. Others argue that the current system is simple to understand and provides incentives to leave money the pension pot.

The Government wants to know:

  • To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension?
  • Do respondents believe that a simpler system is likely to result in greater engagement with pension saving? If so, how could the system be simplified to strengthen the incentive for individuals to save into a pension?

On personal responsibility the Government again highlights the shift toward defined contribution pensions. It notes the importance of ensuring sufficient contributions are saved for future living standards and the need to ensure the incentives are there to support this.

The Government wants to know:

  • Would an alternative system allow individuals to take greater personal responsibility for saving an adequate amount for retirement, particularly in the context of the shift to defined contribution pensions?
  • Would an alternative system allow individuals to plan better for how they use their savings in retirement?
  • Should the Government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated?

The Government is also rightly keen to ensure that the early success of auto enrolment is built upon. It therefore wants to ensure that any change can work well with it and ensure employers have a strong incentive to pay to their workers pensions.

The Government wants to know:

  • What administrative barriers exist to reforming the system of pensions tax, particularly in the context of auto enrolment? How could these best be overcome?
  • How should employer pension contributions be treated under any reform of pensions tax relief?

The paper also notes the importance of considering the sustainability of any proposals particularly in light of pressure on public finances. They are also interested in considering the appropriate implementation period for any proposed change.

The question posed by the Government is:

  • How can the Government make sure that any reform of pension tax relief is sustainable for the future?

Next steps

We will be considering the paper carefully over the summer and also meeting with the Treasury to discuss the issues.

While we are doing so we will be urging the consideration of three simple principles to test any proposals against. These are:

  1. Do the proposals preserve the fiscal neutrality of long term saving? So everyone is able to continue to make meaningful contributions to their pension pots without the penalty of paying income tax twice.
  2. Are the positive incentives to save within the tax relief system shifted away from people on higher incomes to those paying lower rates of income tax? These are the people who would benefit the most from a tax incentive and assistance to save.
  3. Do the proposals remove the need for a "lifetime allowance"? So no longer preventing people from using their pensions to save for the full range of later life needs, such as long term care and inheritance.

Get involved

We'd urge everyone involved in pensions and savings to consider the themes discussed and to contribute to the debate.

Read the consultation on pensions tax relief in full, including details on how to respond. The closing date is 30th September 2015.

About the author

Ronnie Morgan

Strategic Insight Manager

Ronnie has worked in Financial Services for over 25 years with experience in customer service, pension scheme implementation, pensions policy and marketing. He's an Associate of the Chartered Insurance Institute, a Chartered Insurer and qualified to diploma level by the Personal Finance Society.

Last updated: 18 Nov 2015

This website is intended for financial advisers only and shouldn't be relied upon by any other person. If you are not an adviser please visit

The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London EC3V 0RL.