Understanding tax efficiency of pensions

15 May 2012

David Downie
Technical Manager at Standard Life

If people understood the tax efficiency of pensions, more would save for their retirement

Over a third (35%) of people in the UK aged 18 to 65 who aren’t actively investing in a pension say that they would be likely to invest an average of £159.60 each month into a long term savings product that ‘added an extra £1 to every £4 invested’ if such a product existed. But according Standard Life’s ‘Financial Efficiency’ research, over three in four (77%) people aged 18 to 65 who aren’t currently investing in a pension are totally unaware that this benefit is already available from a pension(1).

If over a third of people who are not actively investing into a private pension did start to invest an average £159.60 a month, their total pension investment would increase to £199.50 a month when basic rate tax is added(2). If this was invested from age 30 into a pension, it could result in a sizeable pension pot of £144,000 in today's money by age 67(3). This could help to close the savings gap and tackle concerns about long term financial security.

According to the Pensions Policy Institute, 61.5% of people in the UK do not invest in a private pension, which equates to over 24 million people in the UK. If over a third of them started to invest £159.60 a month, this could add up to over 8.6 million more people saving an additional £20.6bn(4) in total towards retirement each year, assuming they are basic rate tax payers.

Commenting on the findings, David Downie, Technical Manager at Standard Life, said:

"It's unsurprising that those who aren't currently saving towards their retirement are still unaware of the tax benefits that pensions can offer. Pension tax relief remains an extremely valuable incentive. This is demonstrated by the number of people who indicated they would start investing if they fully understood the benefits.

While these figures are encouraging, they highlight the need for better education of how tax privileged investments such as pensions and ISAs work. Clearer signposting of the benefits they offer would encourage a greater number of people to save towards their retirement."

Communicating the benefits is key

These findings are in line with the Keep on Nudging Report Standard Life published last year, which looked at how to make auto-enrolment a success and showed just how important education and communication can be. The report found that four in five people would remain members of an auto-enrolment pension scheme, but only if information and education on the benefits of pensions were presented in a clear and effective manner.

“Communicating the tax benefits of pensions in a clear way is vital. We have a huge opportunity here. If a third of us without a private pension actually start to invest each month it would be a really positive result. In fact, even if only half that number understood the tax benefits of pensions better and started to save for their retirement it would be a really good outcome. Not many people will be able to survive on the state pension, so planning our own finances for retirement is crucial in this day and age.”

To help people to understand more about tax efficient investment in products such as pensions and equity ISAs, you can visit the financial education section which includes free guidance, tips, tools and also an independent risk questionnaire to help you understand your risk profile.

As with any investment the value of your fund can go up or down and may be worth less than what was paid in. Laws and tax rules may change in the future. The information here is based on our understanding in May 2012. Your personal circumstances also have an impact on tax treatment.

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  1. For all basic rate tax payers 2011/12 tax year, on qualifying contributions
  2. People in the UK automatically receive basic rate tax relief on their qualifying pension contributions. Those paying higher rate tax can claim higher rate tax relief
  3. Source: Standard Life, assuming monthly investments for a basic rate taxpayer, which increase each year in line with price inflation and receive the current basic rate tax relief and investments growing at 2.5% a year above price inflation. Tax treatment is subject to personal status and may be subject to change
  4. ONS stats show there are 39,972,600 people aged between 18 and 65 in the UK. According to the Pensions Policy Institute, 61.5% of people in the UK  (24,583,149) aged 18-65 do not invest in a non-state pension. The YouGov research for Standard Life suggests that 35% of these people aged 18 to 65 (8,604,102 people) would invest an average of £159.60 a month into a long term savings product that adds an extra £1 for every £4 they invest. If all these people were basic rate tax payers, this could potentially equate to an additional £20.6bn being invested for retirement.

About this article

Please note that the opinions and comments expressed by contributors in the article are personal and not necessarily those of Standard Life group (Standard Life Plc and its subsidiaries).

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