£7bn pa goes to High Rate tax payers whilst many young low paid workers get no incentive at all



Why we must incentivise young people to save for retirement.

Graham Peacock, Managing Director, Salvus Master Trust

With minimum contributions for auto-enrolment rising from next year, the proportion of those opting out is expected to climb. Early research shows that one group set to drop out in large numbers are those aged between 22 and 29, with a report by Scottish Widows putting the figure at more than 50%.[1] This casts a dark shadow over the project and risks undermining its success so far. But more importantly, it puts the younger age group in danger of a precarious financial future.

The decline of defined benefit pensions means younger people are now largely responsible for funding their own retirement. But the worry is that they are simply not equipped to do this. Many face insecure job prospects, and the rising cost of living and house prices mean getting on the housing ladder is a distant prospect to the average earner, particularly in the big cities. Overall, this adds up to a number of competing pressures on pay packets.

All factors considered, it is simply unrealistic to expect those at the beginning of their working lives to put away an adequate amount for their retirement. And yet, it is essential they do so. An effective solution depends on taking a dual approach: we must educate young people about pensions and the importance of saving early but we must also incentivise them so they actually put money away.

One simple and effective way of doing this is to raise the rate of tax relief they are eligible for to 30%. 

The current system of pension tax relief favours higher earners – with relief on pensions available at the individual’s marginal rate of tax. Therefore a higher rate taxpayer would be eligible for 40% tax relief, while someone on the basic rate of tax would be eligible for 20%. With the vast majority of young people on the basic rate, they are missing out on the more generous rates available for the higher earners.

If we are to truly engage with the younger age group, we need to send the message that the Government and the industry cares about their future and is invested in it even if it means making uncomfortable decisions - or even upsetting other demographics.

This could be tapered off as either their income increased, or once they hit the age of 35. Given the lower earnings expected at this stage of the career cycle, it would be a relatively inexpensive way to get young people engaged and encourage them to feel that the world of pensions is relevant to them. But it would also give young people a powerful lesson on the magic of compound interest and give them as many years as possible with which to leverage this.

However, incentives alone will not solve the perennial problem of lack of saving. Any move to offer an enhanced tax relief rate to younger people must be underpinned by a sustained and comprehensive educational programme. As a minimum, young people need to understand exactly why saving into a pension is so advantageous as well as how much they stand to gain by making full use of the more generous rates of relief that would be on offer from as early an age as possible.

The road to a financially secure future is complex. But it is only by taking bold steps that we can finally crack some of the barriers standing in our way.  

[1] http://reference.scottishwidows.co.uk/docs/2017-Retirement-Report2.pdf