Complying with today's pension tax rules is akin to playing rugby with only the referee being allowed to know where the ball is. HM Treasury provides pensions to attract and retain senior NHS medics and other public servants. They reduced the Annual (AA) and Lifetime (LTA) Allowances for personal pension savings from £255,000 and £1.8M in 2010 (thereafter to rise with inflation) to £40,000 AA (with no inflationary rises) and £1.055M LTA (inflation linked) today. Worse still, the “Tapered AA” shrinks the £40,000 to £10,000 for “adjusted income” over £150,000. [1] Exceeding the Allowances triggers unexpected tax demands, removes the incentive for senior medics to give their time and skills precisely when they are most needed and promotes early retirement. All disastrous for the NHS. The allowances are for the annual increase in pension values based on defined benefit (CARE [2] and final salary) pensions, not the amounts put into pension pots by NHS employers and employees.
Those increases in pension are obscure but HMRC have a formula. The Pension Administrators will provide a statement for the previous tax year if one does not mind waiting at least three months. The nub is that higher earners have no means of knowing when the ceilings are breached. Government has talked about the issue since April 2019, and even encouraged the NHS to break the law to get around it, but the policy error has yet to be corrected. The “sticking plaster” current fix and all the briefings the NHS has to provide its staff are costing millions of pounds. The January House of Commons Briefing Paper (HoCBP) sets out the problems, and in October last year the Office of Tax Simplification also made suggestions. This note suggests solutions, or at least ameliorations. The present system is too complex so the ideas of introducing more pension flexibility or different tax systems do not merit further consideration (7 February HoCBP).
Abolishing AAs and LTAs altogether would be the simplest solution but HMT would need to find the income elsewhere. The changes were aimed at the private sector with the argument that it was “unfair” to allow the well-off to make so much pension provision free of tax. This is nonsense because deducting pension contributions only defers tax; the pensions themselves are taxable in due course, albeit, perhaps, at lower rates. It would be complicated, but possible, to tax the future pensions at the levels at which the contributions were deducted, i.e. 45% for top earners. I doubt if HMRC could cope with that. Exceeding the Allowances is unfair in that those savings are taxed twice: on original earnings and then on the pensions themselves.
Alternatively, the AA and LTA should be returned to their 2010 levels. Failing that, raising them to £100,000 and £1.5M, say, would ameliorate the immediate problem. But the employee would still need to know when those ceilings are being reached. At present they are completely in the dark. The PAYE change proposed in paragraphs 4 and 6 below would apply irrespective of the levels of AA and LTA.
The Tapered AA should be abolished forthwith.
The levels at which AAs and LTAs are set pose less of a problem than the complexity and lack of understanding by pension savers, leading to large unexpected and incomprehensible tax bills. The main employer PAYE should track the individual’s annual pension gains against AAs and LTAs on monthly payslips and P60. Those for the month that either or both ceilings are breached should warn the employee that pensions tax deductions will cease for the rest of the year. Remaining in the scheme even without the tax benefit would usually be beneficial; it would not be practical to drop out of a scheme when the levels are breached and rejoin at the start of the next tax year. The net monthly payment for the rest of the tax year would be the usual PAYE amount less the tax on the employee pension contribution. The first month of breach should be called the “grace month” and HMRC should not recover the relatively trivial excess.
Legislation would also be required to allow the main taxpayer’s payroll department full transparency, with the employee’s consent, on his or her pension entitlements, e.g. from prior employment. At present this information is limited to the Pensions Administrator, e.g. NHS Pensions.
Paragraph 4 above does not deal with pension savings funded by income other than from the main employer. Tax relief on these only represent 1.3% of the total. Consultants, for example, often have private practice alongside the NHS. The simplest procedure here is not to allow any deduction for tax purposes during the year but for HMRC to refund the tax on any pensions savings where the total gain would be below the AA (if also within the LTA and given proof that the non-main employer pension savings at least cover that amount), as part of the annual tax calculation. Thus some taxpayers would receive welcome refunds rather than unexpected bills and HMRC cash flow would benefit.
Whenever these changes are introduced, a year should be allowed for programming changes to PAYE and payroll systems. This year, called perhaps the “grace year”, should be free of all forms of AA and LTA or, failing that, return to 2010 levels plus inflation since as originally envisaged.
The assistance of Mark Belchamber, Income for the Third Age Ltd, is gratefully acknowledged.
[1] Adjusted income is total gross earnings, plus employer contributions, dividends, property income, and interest on capital. The AA tapers by reducing by £1 for every £2 of Adjusted Income over £150,000 and reaches £10,000 after Adjusted Income exceeds £210,000.
[2] Career Average Revalued Earnings