Resolving pensions tax issues might ordinarily be low on a government’s list of priorities (perhaps other than when it has sought to reduce Exchequer costs), but it appears as though time may be running out for kicking that particular can further down the road.
The government has multiple domestic challenges and one that is attracting considerable media focus is the industrial action currently being undertaken by the NHS. Alongside this, many consider the NHS to be failing. The public is sympathetic to the cause of NHS workers, and at the beginning of this year, the Prime Minister identified falling NHS waiting lists as one of his five key pledges to the country.
Pensions issues affect employers and individuals across all sectors and, although the NHS industrial action is about very much more than pensions, backed by its union, it has repeatedly argued that the current tax regime is forcing senior clinicians to cut their hours or to retire early. The former Chair of the Health and Social Care Select Committee appeared to agree with that criticism (presiding over a report last year which referred to the situation as a “national scandal”) and that same person – Jeremy Hunt – has since been appointed Chancellor. He is, therefore, now in a position to push through a solution and, combined with the Prime Minister’s pledge to tackle waiting listings, inaction might be difficult to defend.
Perhaps (or perhaps not) coincidental to this, over recent weeks media has reported 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 and, separately, that it is considering raising the annual allowance (AA).
Both these measures could help retain NHS doctors and senior clinicians (and possibly encourage retirees to return), easing some of the pressures faced within primary care. If the government does intend to increase the LTA and/or the AA, it might be difficult to restrict this solely to the NHS. To do so would not sit well with other public sector workers. And if the increases were instead applied to the broader public sector, the private sector would feel understandably aggrieved. In either case, complex provisions would be needed to cater for movement between the sectors (and concurrent membership).
The government could remove the AA from defined benefit (DB) arrangements (as a proxy for the public sector), leaving them controlled by the LTA alone. In such circumstances, it would be equitable to also remove the LTA control from defined contribution (DC) arrangements. This would leave a coherent regime, which should also be simpler for those who only ever save in one type of pension scheme, but it could be costly and/or involve new complexity for those who have both DB and DC savings (assuming that the government would not be content for people to ‘max out’ both allowances without adjustment). It would also take time to make the procedural and IT systems changes needed. The government may not have that time, given the immediacy of NHS-related pressures.
Increasing the level of the LTA and/or AA is simpler, less disruptive, can be delivered more quickly and is easier to sell as a solution (although it too could be more costly). The rest of this article focusses on the AA, but see also our separate article “Pension lifetime allowance to rise in the spring budget?”
Since 2011, the AA (together with subsequent new offshoots – the Money Purchase AA and tapered AA) has grown successively more complex and, in turn, disruptive to pension planning, administration and understanding.
Increasing the AA would be straightforward and there would be few legislative amendments needed elsewhere in the pensions tax regime to address “knock-ons”.
The AA was reduced from £50,000 to £40,000 with effect from the 2014-15 tax year. Restoring it to £50,000 in 2023-24 would take it almost exactly to the level it would have reached (£49,970) if the allowance had been indexed to CPI inflation throughout that period. An AA of £50,000 would allow DB members to accrue new pension entitlements worth up to £3,125 pa in retirement, as opposed to £2,500 pa with a £40,000 AA.
The AA has long been a thorn in the side of doctors and senior clinicians within the NHS. The government has already proposed “changes to the pension rules regarding inflation” that will address part of the issue, at least within the NHS schemes. The changes will align the CPI rate used to revalue accrued benefits with the rate allowed for in AA calculations. The intention of the AA (within DB schemes) has always been that it should capture only pension growth above inflation, but currently different CPI indexation can apply to each element and, in times of rapidly increasing in-year inflation, this can lead to a significant overstatement of new savings.
The change noted above does not apply beyond the NHS scheme. A parallel increase to the level of the AA would benefit all schemes (DB and DC, public and private sector) and would offer further comfort to the NHS that government is listening and responding.
The natural corollary to questioning the level at which the AA is set is whether it is necessary at all. The AA was brought in as part of the A-day reforms and the government’s 2002 consultation on this – “Simplifying the taxation of pensions: increasing choice and flexibility for all” explained that the AA was intended to be “a light touch compliance regime” and its “prime purpose [was] to limit the leakage of tax relief which could occur if a determined opportunist tried to wash contributions through a pension fund quickly, planning to extract the proceeds improperly”. It was introduced at the level of £215,000.
It seems reasonable to conclude from this that, once the LTA regime proved effective, the AA could have been discarded. HMRC has since had approaching 20 years’ experience of its operation, which seems sufficient time to identify and resolve compliance risks.
The Institute for Fiscal Studies’ view on the AA, within its “Blueprint for a better tax treatment of pensions” seems aligned with this, stating that for “a given level of lifetime contributions, it is not clear why the government would want to penalise making occasional large contributions rather than frequent smaller ones. Indeed, from an individual’s perspective, it may be preferable to contribute considerably more when earnings are high than to contribute a steady amount each year of working life”. (Accordingly, the IFS favours a lifetime contribution limit as the primary control on saving via DC schemes.)
However, the purpose of the AA has changed fundamentally over time, largely for reasons of political expedience.
In 2010, the then-new coalition government confirmed within a consultation response document that, from 6 April 2011, the AA would reduce to £50,000 (it had reached £255,000). Its stated rationale for the reduction (together with a reduction in the LTA level, from £1.8m to £1.5m) was to “raise revenues from restricting pensions tax relief”, but in a less complicated way than under the plans it had inherited from the Labour Party’s administration.
In the Autumn Statement 2012, the government reduced the AA further, to £40,000 (from 6 April 2014) to “ensure that everyone pays their fair share in a progressive tax system” and to “protect the public finances from [pensions tax relief] growing cost”.
Recent media speculation (which may have been well-informed) suggests that cost considerations might no longer be such a driving factor in the pensions tax regime. If the AA and/or LTA are increased, such a move would be welcomed, but it could also be temporary. Few would be surprised to see a consultation on fundamental review, most likely after the next general election. This policy sequence – relax restrictions in the current regime and then replace it – might favour people who already have substantial pension savings, whilst delivering a new regime less generous for at least the higher earning members of younger cohorts.
