Is cutting pensions tax relief the right way to tackle student debt?
27th February 2015
Proposals to cut annual pension contributions limits make some sense but cutting lifetime limit makes it difficult to plan pensions properly
Still leaves public sector better off than typical private sector pension savers
There are better ways to use pensions to help students with debt
Damage pension confidence as rules keep changing: The proposals today to cut pensions tax relief in order to fund cuts in university tuition fees are likely to cause damage to pension confidence. I am not trying to make a political point here, and I agree that university tuition fees cause problems for young people who leave higher education saddled with huge debts. However raiding pensions to pay for this may not be optimal.
Higher earners and overseas students will benefit from lower tuition fees: Those who will benefit most from lower tuition fees will be students who have higher earnings or who come from overseas and are not traced once they return to their own country.
Let’s look at these issues in more detail.
Cutting annual contribution limit is a valid means of saving public money on pensions tax relief: Those who can afford to put £40,000 a year into a pension are clearly likely to be highest earners and limiting their annual contributions is unlikely to leave most of them in poverty in later life. (There could be a few exceptions to this, for example people who suddenly want to save large sums in later life due to receiving promotion or an inheritance, but these will be a tiny number).
Lifetime limit should be rethought as it is makes it too difficult to plan: Cutting the lifetime limit, however, makes it almost impossible to plan pensions properly, particularly close to pension age when it is most important. Many people will feel this is a retrospective removal of pension relief. The lifetime limit has never made sense to me as a policy tool. Yes, it can raise revenue when people inadvertently exceed the figure, but I cannot understand why policy should penalise good investment performance. Limiting the contributions is rational, but stopping people from being able to plan how much to contribute as they approach the upper limit undermines the aims of pension saving. IF you are in your late 40s or early 50s and have a sum close to the lifetime limit, should you keep contributing to pensions or not? If you add more and the investments do well, you will face penal tax rates. If you don’t contribute more and the markets do badly, you will have less pension later.
£1m lifetime limit will allow twice as much pension income for public sector or private DB schemes: The peculiarities of the calculation methods for the lifetime limit mean that those with final-salary-type pensions (which covers almost all public sector workers but only a minority of those in the private sector) are able to achieve nearly twice as much pension as those with defined contribution pensions.
£1m lifetime limit permits a £50,000 pension for member of typical public sector pension scheme: A £1m lifetime limit for a defined benefit pension scheme would be calculated as equivalent to a £50,000 a year pension from age 65. This is because traditional defined benefit schemes do not have a specific pot of money for each member, they just promised a particular level of pension. The law then requires that amount of pension to be converted to a capital sum to see whether it exceeds the value of the lifetime limit. The required calculation is that the amount of annual pension is multiplied by 20 (the logic might have been that this assumes the average person lives for 20 years in retirement). So £50,000 multiplied by 20 gives the £1m figure.
Typical private sector pension scheme member would need a £2m lifetime limit to get £50,000 pension: However, in the private sector defined contribution schemes, there is an actual pot of money which then needs to be converted into a lifetime pension income. So one needs to look at the costs of buying an annuity. As defined contribution pensions include inflation linking and spouse cover, the cost of buying a £50,000 a year pension equivalent to the lifetime limit available to a member of a defined benefit scheme is the cost of buying an inflation-linked, joint-life annuity from age 65. At current rates, this would actually cost around £2million. So a lifetime limit of £1million is worth twice as much pension to a typical public sector worker than to a typical private sector pension saver.
Auto-enrolment could be reformed to help with student debt: Another option that could help young workers to repay their student debt might be to extend auto-enrolment so that it could cover student debt repayments. Currently if young workers put contributions into a pension, they will receive extra help with their savings from their employer and tax relief in a £1 for £1 match. However, if they put the money into repaying student debts, they lose that employer contribution and pension tax relief. A worker in average salary of £25,000 year, contributing the minimum under auto-enrolment, would be putting £1000 a year into their pension and receiving a further £1000 from their employer and tax relief (a total of 8% of their salary). However, if that £2000 a year were to go into repaying student debt first, the young worker would not have lost the extra £1,000 a year in employer contributions and tax relief. Perhaps this would be a policy worth considering in order to help students repay their debts, which could be a more important form of saving than pensions in early life.
ENDS
One thought on “Is cutting pensions tax relief the right way to tackle student debt?”
I see no sense at all in linking pensions and university fees; it’s an entirely artificial construct. You might as well link university fees and the cost of a TV licence, or the rate of duty on beer. Actually, the latter makes more sense. Tell the students you’ll reduce their fees at the cost of shoving up the price of their beer. That should win their votes, eh?