The tax system affects the post-tax returns an individual can expect from investing in different financial assets. The Government is therefore able to influence individuals’ incentives – and so behaviour – by changing the tax treatment of private pensions and savings products. In recent years, the Government has made a number of changes in this area and introduced a variety of government top-ups on specific savings products. This has generally shifted incentives in a way that makes pensions saving less attractive – particularly for higher earners – and non-pension savings more attractive – often in ways that can most readily be taken up by the same higher earners.
The main measures we consider are:
- Restrictions to the pensions annual allowance and lifetime allowance – these lower annual tax free pensions contributions to £40,000 and lifetime contributions to £1 million;
- Pensions flexibility – this allows people to access their pension funds ahead of retirement, from age 55;
- Secondary market for annuities – this allows pensioners to sell their current annuities on a secondary market;
- Savings allowance – this introduces a £1,000 allowance before tax is due on interest income (£500 for higher rate payers);
- Increase in ISA limits – this raises the maximum amount that can be saved in an individual savings account (ISA) to £20,000 per year; and
- Help to buy ISA, lifetime ISA and help to save – these are new savings products supported by government top-ups, though subject to certain conditions.
Our results show how the effect of decisions on the public finances over the medium term may be different over longer horizons.
Total wealth of British households
The Office for National Statistics’ ‘wealth and assets survey’ provides a snapshot of the assets and liabilities of households in Great Britain. The latest survey, relating to July 2012 to June 2014, estimated the aggregate total wealth of all private households in Great Britain was £11.1 trillion, equivalent to six times the UK’s national income in 2014. Chart 1 shows the breakdown, in order of size, across private pensions (£4.5 trillion in the latest survey), net property assets (£3.9 trillion), financial assets (£1.6 trillion) and physical assets (£1.2 trillion).
Chart 1: Aggregate household wealth by category
Central estimates of long-term costs and yields
The estimated yield over the medium term from reducing generosity on private pensions slightly exceeds the estimated cost of increasing it for other savings. But some of the private pensions measures only bring forward receipts from the future, whereas the cost of some of the savings giveaways will continue to rise over the long term as interest rates return to the levels we expect.
Chart 2 presents our central long-term aggregated cash estimates to illustrate how the effects of these measures tended to build up over the forecast periods that they initially affected. The net effect on the public finances is positive in the early years, peaking at £2.3 billion in 2018-19 before turning negative from 2021-22 – the year after our March 2016 forecast horizon.
But the small net gain to the public finances from these measures over the medium-term is reversed in the long term as the net cost continues to rise, reaching £5 billion by 2034-35. Expressed as a share of GDP – a more relevant metric when considering fiscal sustainability – the net cost builds up until it reaches a steady state toward the end of the period of just over 0.1 per cent of GDP. If that steady-state effect was to continue to the end of our usual long-term projection horizon of 50 years, that seemingly small cost would add 3.7 per cent of GDP to public sector net debt.
Chart 2: Combined long-term costs and yields