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Improving incentives for
medium and long-term savings
A thought paper by Fidelity International
IMPROVING INCENTIVES FOR MEDIUM AND LONG-TERM SAVINGS
UK household saving is inadequate. This is so when considered against both historic
levels and the level required to support increased life expectancy in retirement. At the
same time, broad understanding of tax incentives is poor and the savings industry has
developed over-complex product structures in response to years of adjustments to the
savings taxation landscape. Our proposals are based around a desire to support an
increase in overall levels of saving from all sections of the population with the capacity
to save, to encourage more persistent saving and to promote a whole-of-life approach
to saving – which we believe can all be achieved through better deployment of current
Exchequer support for medium and long-term savings and simpler, more
Importantly, the current proposals for auto-enrolment into occupational pension
schemes will still not provide the broad level of savings required for a comfortable
retirement. Without an increase in the general level of saving, many will reach retirement
• building on the success of ISAs through the provision of an annual bonus paid on
investment and at each subsequent anniversary
• introducing an annual cap on pension contributions for all (e.g. £50,000) as a fairer
and more transparent mechanism to replace recent taper proposals for incomes of
• encouraging whole-of-life savings by incentivising transfers from ISA savings to
• promoting flexibility in retirement by ending compulsory annuitisation beyond an
BACKGROUND – THE SAVINGS GAP
British people are not saving enough. In the absence of sufficient savings, people face
hardship in retirement. There are furthermore specific life events for which savings may
be desirable (e.g. education, long-term care). As the concept of a ‘job for life’
disappears, it is also important that people have a ‘rainy day’ pot to cover gaps in their
Based on current demographics and ongoing pressure on the public finances, it appears
unlikely that the State will be able to provide adequately for most people’s retirement or
other periods of need.
One way to increase levels of saving is compulsion, but there remains significant
resistance to obligatory savings.
Individuals might also be encouraged to save more through better education. This is
desirable and should run in parallel with any system of incentives. Likewise, better
guidance on the level of income that needs to be saved and the total level of savings
required to provide a meaningful benefit should be encouraged.
The State currently provides encouragement to save through ‘tax breaks’ and this kind
of incentive is likely to be a key element of any future plan to reduce the savings gap.
Monetary incentives are, therefore, the main focus of our proposals.
ENCOURAGING NEW SAVINGS
Monetary incentives have long underpinned the pensions industry and, more recently,
shorter-term savings via individual savings accounts (ISAs). There remains some
uncertainty about the degree to which these incentives encourage new saving or simply
lead to the re-allocation of existing savings, especially among higher-earners. Our
proposals are, therefore, designed to encourage new saving by groups who are currently
not saving adequately while minimising any associated disincentive for existing savers.
Hence we explore in this paper ways to widen the pool of those saving via ISAs. It is our
view that simply increasing ISA limits will have only a limited effect on encouraging new
saving whereas efforts should be focussed on increasing the participation rate.
Current Exchequer support differentiates between short to medium-term (ISA) savings
and long-term (pension) savings. The principal distinction is the way in which pension
savings are locked down until a pre-determined retirement age while ISA savings are
fully accessible. In compensation for restricted access, greater incentives are provided
for pension savings, including up-front tax-relief on contributions.
The current support provided by the Exchequer is skewed heavily towards pension
savings, as illustrated below:
SAVINGS VEHICLE TAX ESTIMATED COST
Approved Pensions Schemes Income tax £19.7 billion
Individual Savings Accounts (ISAs) Income tax £1.6 billion
Employment related share savings Income tax £0.4 billion
Source: HMRC; Table 1.5 Estimated costs of the principal tax expenditure and structural reliefs (December 2009)
Although greater incentives are currently applied to pension savings, the requirement to
forgo access to saved capital acts as a disincentive, particularly to younger savers. The
pension incentive is also disproportionately enjoyed by high earners. The tax incentives
for ISA saving are relatively insignificant, especially for basic rate tax-payers. This is the
group most likely to be motivated by tax incentives to create new savings and most at
risk of falling back on the state in retirement.
THE VEIL OF IGNORANCE
Although tax incentives are currently the principal means by which Government encourages saving, research suggests
that tax is poorly understood. Recent independent research carried out for Fidelity International reached inter alia the
• Almost one in five (18%) UK taxpayers do not know their income tax band
• A quarter of people earning more than £50,000 think they pay the basic rate of tax
• Half of the population does not know anything about forthcoming changes to tax legislation
• Those earning under £30,000 a year are twice as likely as higher earners not to know anything about savings and
• Just 10% of people with the option to do so pay the full amount into their company pension scheme
• Of those who had the option to join a company pension scheme but hadn’t done so, nearly a fifth did not know why
they had not
• Of those who do contribute to their company pension scheme, 22% still do not know the tax advantages that their
workplace pension offers
Source: Fidelity’s Great British Tax Conundrum: Research conducted by Opinium Research, online survey of 2,000 people (nationally representative) between the 24th to 28th September 09.
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IMPROVING INCENTIVES FOR MEDIUM AND LONG-TERM SAVINGS
Proposals 1. INCENTIVISING ISA CONTRIBUTIONS
Proposal: ISAs to receive a small cash bonus on entry, with subsequent payments
at the same rate on each anniversary, for the life of the account
1.1 ISA savings are flexible but are perceived to offer a limited incentive to save,
especially for basic-rate taxpayers. They are generally accessible, can provide a
buffer against unforeseen eventualities (e.g. redundancy) and, if not needed during
working life, can be used in retirement.
1.2 ISAs are the mainstay of short-medium term savings, especially since the recent
increase in the annual allowance to £10,200 (£20,400 for couples). A strong case can
be made for a greater proportion of the overall incentive budget to be used to
encourage this form of ‘unlocked’saving. However, there must be a demonstrable
incentive to save in this way.
1.3 Currently, the investment return from an ISA is tax-free at a cost to the Exchequer of
£1.6 billion (excluding any forgone CGT). The incentive arises predominantly from
interest-bearing investments. We believe that investors should see adequate and
equal incentive for equity as well as interest-bearing investments.
1.4 Based on current annual investment levels of around £37.5bn*, some form of
up-front incentive should be considered. Enhancement in line with basic-rate
pension contribution relief (20%) would cost too much but a smaller incentive
may be affordable. We propose that each contribution to an ISA should receive
a small cash enhancement on entry, repeated at the same percentage of the
current value on every subsequent anniversary in perpetuity.
There are five principal advantages to incentivising unlocked savings in this way:
• simplicity – savers would readily understand the concept of a cash enhancement
• persistency – the payment of an annual incentive would discourage ‘raids’on
• affordability – the cost to Government would be spread over many years
• fairness – the payment of an annual bonus would apply equally to equity and
interest-bearing investments, going some way to restoring the status of ISAs
following the abolition of the dividend tax credit
• youth appeal – it will encourage new savings from groups e.g. young savers
who traditionally shy away from saving.
*Source: HMRC, Table 9.4 Individual savings accounts (July 2009)
2. INTRODUCING AN ANNUAL LIMIT ON PENSION
Proposal: An annual cap on pension contributions (say £50,000), which would
attract tax relief at a saver’s highest rate, to replace the recently
announced tapering of pension relief for incomes above £150,000
2.1 We believe that the latest changes to pensions tax relief announced in the 2009
Budget, including tapering relief for incomes of £150,000 reducing to 20% at
£180,000, are poorly developed, too regressive in nature and damaging to overall
levels of pension saving. They erode predictability of Government support for
pensions and make the administration and provision of benefits for these earners
excessively complicated and the benefits hard to quantify and understand.
2.2 In our opinion a better way of achieving the same policy goals (reducing the
Exchequer cost of tax relief and rebalancing the proportion of relief enjoyed by
higher rate taxpayers relative to lower earners) would be to set an annual cap on
contributions (say £50,000) which would attract tax relief at a saver’s highest marginal
rate. As well as achieving policy goals, this would maintain the simplicity of the
current system by offering full marginal tax relief on pension contributions. The level
of the annual cap could be varied to achieve different policy goals (including paying
for the ISA incentive set out above).
3. LINKING ISA SAVINGS TO PENSION SAVINGS
Proposal: To permit transfers from ISAs to pensions in excess of the annual cap on
3.1 There is considerable merit in promoting an easy to understand, whole-of-life
approach to savings and we believe that Government should formally encourage the
transfer of ISA savings into pension savings. In effect, investors would be given a
financial incentive to transfer their accumulated ‘unlocked’ savings into a ‘locked’
pension pot. At that time, they would receive the same monetary incentive available
to non-transfer pension contributions. The pot would then remain locked until
retirement and become taxable in payment.
3.2 These ISA transfers should be permitted notwithstanding any annual limits on
pension contributions (i.e. ISA transfers would be permitted in excess of the
[£50,000] annual cap on pension contributions). This would encourage the build-up
of savings in the earlier years of working life in anticipation of being able to make
enhanced pension contributions closer to retirement. In earlier years, savers would
retain flexibility over access to their ISAs until they were ready to lock their savings
down in a pension.
3.3 There is a case for considering a similar incentivised transfer from Child Trust Funds
to ISAs in addition to any ongoing ISA contribution limit.
FEBRUARY 2010 5
IMPROVING INCENTIVES FOR MEDIUM AND LONG-TERM SAVINGS
4. FLEXIBILITY IN RETIREMENT
Proposal: To update annuity rules to introduce an index-linked threshold above
which annuitisation of pension pots is no longer compulsory
Proposal: To update trivial commutation rules to allow cash withdrawals of small
Proposal: To allow early access to pension savings for certain defined life events
4.1 We believe that the holistic and incentivised approach to saving for retirement
should continue in retirement. Incentives given to assist or promote saving
(accumulation) are easily undermined if it is perceived that the retirement phase
(decumulation) is penal or restrictive.
4.2 Compulsory annuitisation removes individual choice and responsibility. Having asked
people to take individual responsibility to save for retirement, it is then unfair to
exert too much control over the way in which benefits can be taken. We believe that
the highly restrictive annuity rules should be updated. This will go some way to
restoring the attractiveness of pension saving.
4.3 It has always been argued officially that annuitisation was a not a topic for discussion
politically as only well-off people benefited. This will no longer be true with the
advent of personal accounts. Although the build-up of amounts in personal accounts
will take some time, altering the annuity rules will increase the attractiveness of
pensions saving immediately.
4.4 Some control is inevitably needed to prevent those with small pension pots from
exhausting their savings and falling back on the State but the regime should be as
flexible as possible. This could be achieved by introducing an index-linked threshold
level up to which pension pots must be annuitised. For pension savings above this
level, there should be complete flexibility to annuitise or draw down throughout life
as the individual chooses.
4.5 This would also mitigate the perceived unfairness that pension pots which have been
annuitised cannot be passed on at death. There is anecdotal evidence that people
who are aware of this kind of restriction on annuities sometimes choose to put their
savings elsewhere (for example, into an ISA).
4.6 We also believe that the trivial commutation rules should be reviewed and updated
so that those who have saved during their working lives but have not amassed a
pension pot which is worth annuitising can draw the entire pot as a cash lump sum.
These trivial commutation rules should be applied on a consistent basis to
occupational and personal pension schemes.
4.7 We also believe that there is a case for allowing early access to pension pots for
defined events e.g. long-term unemployment or serious illness. This list of events
would need to be carefully circumscribed to avoid this option being seen as another
easy way to obtain credit. One option for consideration would be to limit any
withdrawals to the value of the accrued tax-free lump sum.
5. OTHER MEASURES
Proposal: To roll out auto-enrolment without delay
Proposal: To review the interaction of means-tested benefits with medium and
5.1 We welcome the policy goal to introduce auto-enrolment into employer pension
schemes and encourage Government to roll this out without delay. This harnesses
employee inertia and should lead to almost complete coverage for employees in
their employer schemes (subject to the individual’s right to opt out). There are also
additional flanking measures that can be envisaged, e.g. automatic contribution
increases as salaries rise, which will help individuals progress beyond the basic level
of saving that the auto enrolment regulations require.
5.2 Beyond this, Government needs to review the interaction of means-tested benefits
with medium and long-term savings. If individuals take the view they are better off
not saving and relying on means-tested benefits to top up their state pension, this
could lead to very significant numbers of people exercising their right to opt out of
auto-enrolment. This might threaten the viability of the entire project.
The current system does not encourage a whole-of-life approach to wealth accumulation. Nearly all today’s support is
given to pension planning, which is inaccessible until retirement. For an average saver, this represents a serious
disincentive. Savings are locked away and unavailable as a buffer against unpredictable but probable financial needs.
It is recognised that the primary focus of incentives must be on longer-term retirement provision, but the current
structure does little to incentivise a more gradual or transitional approach to retirement, which would allow savers to
balance the possible need to access money with a commitment to their eventual retirement.
By contrast, we believe that our straightforward and easy to understand proposals would, in combination, encourage:
• early adoption of a whole of life savings habit
• the reassurance that savings can be accessed if required
• the transfer of savings from unlocked to locked retirement savings
• the ability of the government of the day to flex future incentive levels to encourage either greater locked or unlocked
By doing so they would achieve the principal goal of increasing the level and persistency of household savings, fairly and
at an affordable cost.
FOR FURTHER INFORMATION, PLEASE CONTACT:
Sam Slator Anne Read
Fidelity International Fidelity International
01737 837 847 020 7961 4409
07841 783882 07850 549839
Press Office Address: Fidelity International, Kingswood Place, Millfield Lane, Lower Kingswood, Tadworth, Surrey, KT20 6RP
FEBRUARY 2010 7
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