Introducing a pension ISA could dramatically lower savings and reduce the size of the economy over 20 years according to the Association of British Insurers (ABI).
Based on estimates by the National Institute of Economic and Social Research (NIESR), the ABI calculated that switching the current tax relief system to tax exempt exempt (TEE) would cut savings by a sixth over two decades.
This would result in pension contributions being annually reduced by £383 on average, if applied directly to an average taxpayers' annual pension contribution of £2,280 per year. This was based on NIESR's research published last September that found the pension ISA with a government matching contribution of 30% would lead to a 16.8% fall in savings over 20 years.
The ABI's figures come just weeks before the Chancellor is expected to announce tax relief reform in his March Budget. While a pension ISA has been on the cards, George Osborne is expected to introduce a flat rate of relief instead.
The ABI also calculated that the size of the economy would reduce by 6% over 20 years, based on estimates by the Pensions Policy Institute. The PPI's research last September found a move to a pension ISA would create a fiscal deficit of over £5bn a year for future generations, based on an upfront government contribution of 30% relating to pension tax revenue alone.
Taking into account the wider economic impacts and the effects that would have on tax receipts, the fiscal deficit would be even bigger - over £12bn a year within 20 years, according to the ABI. This was based on NIESR's estimate of a 1.9% reduction in tax receipts as a result of switching from the current system to taxing contributions upfront.
ABI director of long term savings Yvonne Braun (pictured) said: "The pension ISA would hit savers and could create a fiscal time bomb for future generations. Many savers would be worse off and it would also damage the economy more widely because of its impact on saving and investment. It's superficially attractive because of the savings it can deliver in the short term - but as the IFS have said, this is no more than a ‘temporary windfall'."
The ABI is proposing instead a ‘savers' bonus', or flat rate of pension tax relief. It believes this would produce a simpler, fairer and more sustainable system for pension savings, and would encourage people to save more for retirement.
Even if Osborne does not opt for the radical pension ISA route, imposing a flat rate of tax relief would still have a big impact as it could deter higher earners and potentially damage pensions.
However, Standard Life's Jamie Jenkins has said auto-enrolment (AE) would not be undermined if the Chancellor introduced a flat rate tax incentive in next month's Budget.
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