In his Autumn Statement 2022, the Chancellor, Jeremy Hunt, froze or extended the duration of existing freezes for thresholds in relation to Inheritance Tax, Income Tax and National Insurance Contributions. Commentators had been predicting a similar extension of the Lifetime Allowance (LTA) freeze (currently lasting until 2026), but it didn’t happen.
While the pensions industry welcomed this reprieve, it was, perhaps, surprising, given the very high cost that parliamentarians often attribute to pensions tax relief. Recently, in its response to the petition to “Make the NHS Pension scheme tax unregistered” the government said that it is “one of the most expensive reliefs” and that “in 2019-20, income tax relief on total contributions and National Insurance relief on employer contributions for pension savings cost the Exchequer £61 billion”. This figure is misleading for a number of reasons – see our article “Might a new PM bring change to the pensions tax regime” – but the true number is sufficiently high that the regime is perennially under scrutiny for cost savings.
We suggested in our Pensions Briefing overview of the Autumn Statement that concern as to the reaction of NHS representative organisations to any LTA freeze extension might explain its absence. Over recent years, the British Medical Association (BMA) has been engaged in a high profile and highly effective campaign, citing the Annual Allowance (AA) as a major contributor to senior clinicians retiring early from the NHS. In the run up to the Autumn Statement a BMA press release also warned the Chancellor against extending the LTA freeze, quoting back to Mr Hunt from a report published by the Health and Social Care Committee (then under his chairmanship), which referred to NHS pension arrangements forcing senior doctors to reduce working hours as a “national scandal”. Combined with fragile employment relations and a treatment waiting list of 7.1 million, the risk of exacerbating disruption to NHS services as the nation approaches winter might just have been too great.
If the government would like to tighten the pensions tax regime, it finds itself in a difficult position. It will be working hard to negotiate a settlement with the NHS that averts (or cuts short) industrial action. If it is successful in doing so, it will be very wary of undermining that by subsequently tightening the pensions tax regime.
The next opportunity to announce changes to the pensions tax regime is the Spring Budget, but is it likely that the government would have made sufficient headway with the NHS challenges that it could then simply ride out the likely response to any pensions tax regime tightening?
Acknowledging that, by then, we are likely to be through the worst of winter, many would suggest that NHS challenges are likely to remain very significant for many years to come. In which case, might that (continue to) constrain the government’s ability to make changes to the pensions tax regime? It could make special arrangements for the NHS, but were it to do so, it would need to anticipate the reaction of other public sector workers who would, most likely, demand the same or similar treatment.
But the government does have options. One that it is known to have considered before would be to acknowledge publicly that defined benefit (DB) and defined contribution (DC) pension provision is now so fundamentally different that each needs its own set of tax rules. This would result in different tax treatment for most public and private sector provision (the former being the mainstay of open DB provision and the latter overwhelmingly operating DC).
Currently, a single pensions tax regime covers all shapes of pension provision, utilising two main controls – the AA and LTA – to do so. But the AA is a very poor fit for DB and the LTA a poor fit for DC.
If DC provision were to be controlled on input only (through the AA), retirement planning would be far more straightforward. The government could reduce the AA and even move to a flat rate of tax relief for DC contributions, if it so wished (flat-rate tax relief for DB would be horrendously complicated).
DB provision would be controlled by the LTA only. The primary issue for senior clinicians within the NHS relates to the AA and splitting the tax regime could help to mitigate that problem. That would still leave the LTA, but under Liz Truss’ brief premiership, the then-Secretary of State for Health and Social Care, Therese Coffey, indicated that the government would require NHS trusts to allow pensions recycling – effectively to offer cash in lieu of pension. The government’s policy paper “Our plan for patients” that followed didn’t quite meet that expectation, instead merely encouraging NHS Trusts to explore solutions such as pensions recycling. So, it isn’t yet clear what the government is, or is not, committed to. However, if pension recycling is mandated, changes to the LTA may then be less politically difficult. The same government statement also suggested that it would make changes to the NHS pension scheme rules to ease the AA impact of rapid in-year increases in inflation (as experienced in the current, 2022-23, tax year). However, the AA has been a problem for senior clinicians for many years and while elevated inflation has exacerbated the issue, it will not simply disappear if inflation falls.
As is always the case, the reality of introducing a split regime would introduce a whole new set of problems and complexity (including a long transition). But none appears insurmountable and if the government wishes to take back control over pensions tax relief costs, this could be the mechanism it chooses for doing so.
While we do not believe that any tightening of the pensions tax regime is needed, we doubt that the government shares this view.
