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Call for flat rate tax relief on pensions

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The Pensions Policy Institute (PPI) has called for a flat rate of tax relief on pension savings to encourage low and middle earners.

It said that while tax relief offers important advantages to pension savers, it does little to encourage saving, particularly among low and medium earners, who the Government has said are at risk of not having saved enough by retirement age.

The PPI report published today, Tax relief for pension saving in the UK, found the pension tax relief system is poorly understood by savers and favours higher rate taxpayers.

The report examines a range of alternative pension tax regimes, including introducing a single-rate of tax relief at 30% and capping the tax-free lump sum people can take at retirement at £36,000.

"Pension tax relief offers important tax advantages, particularly to higher rate taxpayers," said PPI director Chris Curry.

"However, despite tax relief on contributions costing up to £35 billion a year after allowing for the introduction of auto-enrolment, tax relief is poorly understood and there is little evidence that it encourages pension saving among low and medium earners."

The PPI said there are concerns that tax relief is expensive, poorly targeted and does not achieve its policy objectives.

Tax incentives are seen as a means to encourage pension saving amid concerns that people are not saving enough for retirement. Pension saving attracts a level of tax relief that compares favourably with other types of saving.

Curry said: "The current system of pension tax relief favours higher and additional rate taxpayers. Even with pension saving boosted for lower earners by auto-enrolment, basic rate taxpayers are estimated to make 50% of pension contributions, but receive only 30% of pension tax relief on contributions.

"Pension tax relief on lump sums, at an estimated cost of £4 billion a year, is similarly uneven. While only 2% of lump sums are worth £150,000 or more, they attract almost one-third of tax relief on lump sums."

Tom McPhail head of pension research at financial services provider Hargreaves Lansdown, said a change to the system would not be beneficial for savers.

"The PPI report is a useful analysis of the tax treatment of pensions. However, for many people the amount of money which they choose to put into pensions has got less to do with the tax rates and more to do with how much they can afford to save," McPhail said.

"Any changes to the tax relief rates in the midst of auto-enrolment would probably do more harm than good."