Pensions Change: Rationale Uncovered

The Spring Budget headline was unquestionably the scrapping of the lifetime allowance charge from the start of the new tax year and the abolishment of the lifetime allowance the following year.

Cue UK Twitter meltdown.

“…a Budget for the rich…”

“…tax breaks for millionaires…”

“…ditching pension limit widens inheritance loophole for wealthy…”

While reading the comments to posts such as this prove that satire is indeed dead.

Just why did the Chancellor hand such an apparent tax break to the wealthiest in society and gift Labour another open goal?

To appreciate this fully, you have to understand some of the more complicated differences between money purchase and final salary pensions.

The given motive was to help the senior NHS workforce - preventing them from retiring early or working less due to the disincentives created by pension tax charges.

These pension charges are a by-product of the complex set of rules relating to final salary annual and lifetime allowance calculations.

There wasn’t only one possible solution, but the quickest was to implement something that benefited all of pensions, which was raising the lifetime and annual allowances.

Technical Corner - Final Salary Pensions

When you retire from a final salary pension, you receive an income for life. But how do you measure an annual income against a lifetime allowance.

Well you could have complicated formula which takes account of underlying economic conditions and individual life expectancies. But they didn’t. Someone came up with an idea, “why don't we just multiply the income by 20”.

Let’s take a GP who has been working in the NHS their whole adult life and is nearing the end of their career. It is reasonable to assume an income of just below £100,000 for a senior GP. A maximum NHS pension could be up to two thirds of their £100,000 final salary, let’s round down to say £65,000.

£65,000 x 20 is £1,300,000.

£300,000 over the £1m lifetime allowance. So at 55%, a £165,000 tax bill.*

* I’ve rounded the £1,073,000 down. Plus there are other ways to deal with the tax bill such as having the income reduced, but that could amount to more or less the same tax equivalent over a lifetime so for simplicity sake, lets use the 55% figure

That is before we take account of any private pensions they have in addition.

To remain under the lifetime allowance, this individual would have had to reduce their NHS service by 25%...or say 10 years…the very point at which they are the most valuable and experienced.

Then there is the annual allowance.

How much you contribute annually into a money purchase pension is simple to understand and fundamentally, within your control.

Not so the annual contribution to a final salary pension. This formula is not quite as simple as the 20 times rules, but equally arbitrary and almost impossible to predict or restrict.

It is described as “the capitalised value of the increase in the accrued benefits over the tax year.”

In broad terms, its 16* times the increase in your pension over the year, with some margin for inflation, plus any personal contributions.

*prior to 2011 the factor was 10 times, so they could have altered this to fix part of the problem

Suffice to say, it doesn’t take much of an increase for deemed contributions to exceed the annual limit of £40,000. With inflation at current levels, the amounts this year are even higher. I have seen some where the calculated contribution is in excess of £80,000.

That’s £40,000 over the annual allowance, and assuming no carry forward is available, £16,000 of additional tax that must be found*, despite not having earned the additional £40,000 with which to pay it.

A recent Freedom of Information request showed that the number of NHS doctors exceeding the annual allowance on their pensions has increased by 68% in the last year to around 56,000. In the 2018/19 tax year, just 16,807 breached the annual allowance.

* there is a way to make the scheme pay, which has the roundabout effect of accruing no pension benefits anyway.

I understand an individual with a £65,000 pension to look forward to is not poor. Nor however, I suspect, are they the wealthy your mind leaps to when you read the Budget headlines.

"Tax savings for the rich" would not be such a divisive headline if it was "Tax savings for our essential workers" pictured alongside these images we were clapping for not so long ago.

This is why I believe they choose GPs to defend their decision.

As a country we pride ourselves on making the most of yourself. At school we are encouraged to aspire to such professions. Work hard and you will be rewarded.

This is not just an issue for GPs, its affecting everyone in the NHS, our teachers, police and emergency services. Careers that to many, are a calling.

Careers where higher incomes may be achieved elsewhere, and their recompense in part, is the retirement benefits offered.

The bigger problem here for successive Governments is not the annual or lifetime allowance, it’s the final salary pensions themselves, and how we as a nation are going to continue to afford to keep them in place, but that’s an issue for another article.

But What About…

Yes, what about the bankers or the lawyers or the Tory party donors. Isn’t this just a massive tax break for them?

Well, yes and no. Or rather, it's not the massive tax windfall that is being reported.

Financial advisers deal with a disproportionate percentage of individuals affected by the lifetime and annual allowance, especially here in London.

Two full weeks since the announcement and I have spent a lot of time speaking with people who have:

• unlimited protection

• fixed protection at £1.8m, £1.5m and £1.25m

• used up all of their lifetime allowance

• are just below the lifetime allowance and have stopped paying into pensions

• who are earning well above the taper thresholds so are limited to £4,000 annual allowance

The conclusion?

With the exception of very small pockets of those who were expecting to pay a lifetime allowance charge and are now not (a lottery win until it is reversed by Labour), this isn’t the tax giveaway that’s being reported…it just isn’t, especially when you take into consideration the capping of tax free cash in excess of the current limits.

The vast majority of money purchase pension savers who have been affected by the lifetime allowance have dealt with it previously using protections.

There is not the opportunity for all to kick start pension funds.

Those who can afford to pay in the maximum £60,000 per annum are typically high earners and so will be restricted back down to £10,000 anyway.

In Summary

This is my take on Jeremy Hunt’s thinking on this.

The reason given was the NHS GPs. That was cosmetically preferable to "all final salary members", which of course includes Members of Parliament.

The simplest way of dealing with the issue was to increase the lifetime and annual allowances.

Putting the lifetime allowance back to £1.8m would have garnered the same amount of backlash so why not abolish it altogether; the negative public reception between £1.8m and abolishment would be negligible. This won’t lose any votes. But it may gain some.

Plus it doesn’t actually benefit that many money purchase pension millionaires anyway, but that’s a hard explanation, so let’s just ignore it.

If all goes well and they are voted in again, people will forget about the headlines and it actually does a lot of good for pension members of final salary schemes, yes including the GPs.

If it doesn’t go well, they lose the General Election, Labour may well unwind it, but they probably won’t, because as this Guardian article from last year shows, it was their idea in the first place.

And this is where I have a problem.

We have a huge savings gap.

Life expectancies are increasing. Most children born in developed countries today can expect to live to more than 100.

It is highly unlikely they will ever be able to save enough for retirement.

The constant changing of pension rules is both confusing and off-putting.

Having a lifetime limit of any sort discourages savers, especially when that limit continues to reduce, coupled with a generation who think they can make millions from cryptocurrency trading!

Both parties for too long have been using pensions as a political football.

People plan for the long term and that relies on confidence the goalposts won't constantly shift.

We have a system in place for ISAs that works. Annual limit capped at £20,000 and unlimited growth potential.

This is possible for pensions with a sensible annual allowance for all.