Media reports over the final weekend of January 2023 suggested that the government is considering raising the lifetime allowance (LTA) for pensions, as part of a drive to encourage the over-50s back into work. The reports followed a speech from the Chancellor, in which he said “… to those who retired early after the pandemic or haven’t found the right role after furlough, I say: ‘Britain needs you’ and we will look at the conditions necessary to make work worth your while”.
If raising the LTA is under consideration, HM Treasury might have begun looking at this before the 17 November 2022 autumn budget. At that event, most then-current threshold freezes were extended by two years, but the current LTA freeze (until 2026) was not extended. It would have been politically-naïve, and presented an open goal to political opponents, if the Chancellor had announced in November 2022 that the LTA freeze would be extended to 2028, if he thought it possible that he would announce in March 2023 that government was raising its level.
Raising the LTA would be widely welcomed, although it would be correctly recognised as a measure benefitting higher earners. The government could present this as a resetting of the LTA in light of recent elevated levels of inflation (it might choose not to describe it as countering the cost-of-living crisis, given that it would benefit those least likely to have been struggling) and something that makes planning easier for the aspirational – those who were expecting to build pension savings approaching the current LTA (although raising the LTA simply kicks the problem a little further up the income distribution). After all, when the LTA was introduced in April 2006, it was set at £1.5m (and subsequently raised to £1.8m) which at that time was seen as the analogue of the maximum tax-approvable pension under the previous HMRC pensions tax regime. Subsequent reductions in the LTA to £1m, together with movements in annuity rates, means that the savers at the current LTA would struggle to convert their pensions savings into anything approaching the old HMRC maximum pension.
If government does raise the LTA, it might deem it sensible to also do something for the majority of pension savers, those for whom the LTA is no more than an aspiration. For this group, the government could (and likely would) point to non-pension measures, and to the triple-lock on the State pension, but the optics might be easier if there were also an element of symmetry.
The government could disapply or raise the Money Purchase Annual Allowance (MPAA). This would remove, or at least ameliorate, one barrier to individuals who have ceased work (and drawn on any defined contribution pension savings, flexibly) from returning to employment and making further pension saving. Removing it would be simple to achieve and would genuinely simplify the pensions tax regime and pensions tax planning. And, of course, a barrier to re-entering employment would be torn down. However, what the government would wish to avoid is opening the door to older workers repeatedly reducing their tax liability by channelling part of their income into a pension and then promptly drawing it out (with one quarter of the withdrawal exempt from income tax). The government would need to think carefully about an alternative mechanism to protect against this. Demonstrating how no policy change is ever free from unwanted behavioural effects, it would also need to consider the extent to which removing the MPAA might actually encourage some people to retire early, as they would know that they could return to work and top-up their pension savings, if necessary.
Delving into whom it is that the government wishes to encourage back into work, the starting point must be everyone. But it might perceive that it has more interest in some than others. It is reasonable to assume that government is considering potential pensions tax developments at least partly as a response to the difficulties that the NHS is facing (and, in turn, that government is facing with the NHS). It seems equally reasonable to assume that the government would only raise the LTA in isolation if it believed both that doing so would dissuade doctors and senior clinicians from retiring early from the NHS and that it might also encourage some of those who have already retired to return.
Increasing the LTA would undoubtedly alleviate some of the pressures in the NHS attributed to doctors retiring early, but their reported key issue has been the annual allowance (AA). In 2020, the government increased the AA taper thresholds as a response to the problems being faced by doctors and senior clinicians. While that was welcomed, it was insufficient to stem the flow of withdrawals from the NHS. If the AA is the tax provision that is provoking early withdrawal from the NHS and if that remains unchanged, it is difficult to see how an increase to the LTA would solve the problem. Doctors and senior clinicians, backed by their unions, might believe that there has never been a better time to maintain the pressure and continue to push for a comprehensive solution to the AA problem.
The government is very aware of the powerful position of the NHS. The public and media are sympathetic towards the cause of NHS workers and particularly so when it comes to front-line care givers such as nurses and doctors. On top of this, little more than six months ago, the then Chair of the Health and Social Care Select Committee (Jeremy Hunt, who now happens to be the Chancellor) presided over a report referring to the possibility that NHS pension arrangements were forcing senior doctors to reduce working hours as a “national scandal”. Furthermore, at the beginning of 2023, the Prime Minister identified falling NHS waiting lists as one of his five key pledges to the country. Making changes to the pensions tax regime to alleviate any problems caused by that would enable him to point to action being taken to address key NHS concerns.
Despite the government’s resistance to reopening last year’s pay award for the NHS, it will be incredibly keen to break the impasse.
There are alternative ways in which the government could address the pensions issues for senior clinicians and doctors. It could, for example, establish an unregistered pension scheme, akin to that which is in place for judges, but it ruled that out only last year (albeit for the NHS as a whole).
It could also offer a cash alternative to pension contributions, with a government policy paper “Our plan for patients” published last year encouraging NHS Trusts to explore solutions such as this. While this type of arrangement is not uncommon in the private sector, it is unusual in the public sector. Such arrangements can be complex to establish and give rise to questions of fairness (eg to whom should they be offered?). NHS Trusts (and the government) would not wish individuals lower on the income distribution to be “tempted” by what would effectively be a choice between a) salary plus pension or b) a higher salary and no pension. As well as potentially encouraging current expenditure over saving (and possibly undermining automatic enrolment), there is an Exchequer cash-flow issue that biases the government towards favouring pension savings. This is because when the NHS pays employer, and passes employee, contributions into the pension scheme, those funds (in a roundabout way) return to the Exchequer (which underwrites the NHS pension scheme). If the NHS instead pays workers a higher income, the Exchequer does not recoup that money (beyond any tax and National Insurance Contributions levied on it). Any cash alternative offered to an individual would also usually be net of the employer National Insurance saving available on the pension contribution foregone. And any cash alternative received would be subject to income tax and National Insurance. The administration burden would be significant and it would come at a time when the NHS pension scheme is also seeking to implement the gargantuan task that is the McCloud remedy (correcting the unlawful age discrimination found to have taken place when the government reformed public service pension schemes in 2015).
Returning to the media speculation (informed or otherwise) about raising the LTA, this is not as straightforward in practice as the headline might suggest. If the purpose is both to encourage people to remain in (or to return to) work, HMRC will need a mechanism to ensure that individuals who have already crystallised an amount close to (or above) the current LTA, can benefit from any increase.
Example:
Such an outcome is unlikely to offer scope for remaining in (or returning to) employment for long. Ideally, the government would want to be able to offer access to the full LTA increase (in the above example, £200,000 (£1,250,000 - £1,050,000) or an additional £10,000 pa of pension accrual under the defined benefit (DB) NHS pension scheme).
If the government is considering raising the LTA for the general population (rather than solely for NHS workers), it will also be looking at the feasibility of alleviating AA issues within DB pension arrangements. One approach would be to exempt DB arrangements from the AA, leaving tax reliefs for DB arrangements to be controlled by the LTA alone. In turn, DC arrangements could be controlled by the AA alone. This would avoid the perceived unfairness of members of DC arrangements being taxed at punitive rates on ‘excessive’ investment performance. Obviously, there would need to be mechanisms to deal with individuals who had more than one form of pension provision (either historical or ongoing) and this would not be straightforward. But the new complexities could, depending on design, prove simpler than the status quo – they would certainly be so for individuals without benefits in both DC and DB arrangements. Such an approach would also build-in a degree of future proofing, enabling adjustments to either LTA or AA without the tortuous consequential adjustments experienced in a regime that applies dual controls across all types of pension provision.
The pensions industry has become accustomed to successive governments considering the pensions tax regime to be ‘low-hanging fruit’ when it comes to finding potential Exchequer savings. A move in the opposite direction would be rare indeed. The obvious political question arising from any relaxation is how much would it cost? Given the hotly-debated costs of pensions tax relief and the fact that the majority of benefit accrues to higher-paid individuals, it would be a brave government that makes any change that increases the costs to the Exchequer. Whatever the answer to the question of cost, perhaps the government’s modelling suggests that an increase in employment and productivity (and perhaps government approval ratings) would counter any additional tax relief cost to the Exchequer (or be a price worth paying, anyway). And if the government later needs to revisit the position, so be it … Or perhaps any cost of increasing the LTA could be absorbed by other changes, such as reducing the AA (within a split tax regime for DB/DC)? After all, no official policy announcements have been made by anyone, yet …
