The introduction of the tapered Annual Allowance some three years ago added a layer of complexity to an already complicated and overlapping system of allowances – the annual allowance (AA) and the lifetime allowance (LTA) – and has never been fully understood by most employers and individuals affected by it.
It was, and is perverse in the way it operates and acts as a disincentive to long term saving.
Over three years later, the complex tapered AA rules continue to cause confusion and discontent and in recent weeks this has been extensively highlighted by how it is affecting clinicians in the NHS Pension Scheme.
How many individuals understand the complex mix of threshold income, adjusted income, value of pension savings and other rules, for example, those relating to mandatory and voluntary Scheme Pays?
The complex tapered AA calculations require the gathering of various pieces of information relating to pension contributions or savings, as well as income - some of this may not be known until or after the end of the tax year.
The AA tax is most acutely felt by people on the cusp of activating the tapered AA. Slight increases in income can lead to huge increases in tax liability.
The removal of the tapered AA will eliminate the cliff edge around the £110,000 threshold income that results in a marginal rate of tax of more than 100 per cent on extra earnings with no increase in pension if the extra earnings is not pensionable.
The AA taper is felt to disproportionately affect members of defined benefit (DB) schemes where there is little or no flexibility of pension accrual.
However, DB pensions are more generous than defined contribution (DC) benefits and so any change to the AA taper should not create an even larger gap between DB and DC pension schemes than there is currently.
The Treasury has announced that “the Government has listened to concerns raised by clinicians in the NHS pension scheme and in response the Department of Health and Social Care (DHSC) has opened a consultation inviting views on giving senior clinicians full flexibility over the amount they put into their pension pots and expect this to be in time for the next tax year, subject to the findings of the consultation.
Alongside the proposals for full flexibility within the NHS scheme, HM Treasury is also reviewing how the tapered annual allowance operates in order to support the delivery of public services.
It is not just the clinicians in the NHS Pension Scheme affected by the AA taper.
There are many non-clinician members of the NHS Pension Scheme, such as executives of NHS Trusts, who have also been impacted by AA tax charges caused by the AA taper.
There would be extreme resentment if any change to the tapered AA is restricted to a select group of public sector employees.
The AA taper should be scrapped for all taxpayers, doctors as well as all others in the public and private sectors.
The AA taper is, of course, not the only questionable aspect of the system at the present time.
Do we also need the Lifetime Allowance (LTA) and why is the LTA so much more generous for DB schemes than for DC?
There is also an argument that people who breach the LTA in the future will in all likelihood have breached the AA at some point in the course of them making pension savings for retirement. These individuals will find they are being taxed twice, both while saving for retirement and also at retirement.
What should be done? As a minimum the AA needs to be simplified.
It seems common sense to have a set of rules which can actually be followed and adhered to.
Beyond that, having just one tax for oversized pension pots would eliminate what is seen as an unfair whittling away of people’s pension savings.
Out of the two, the LTA would ideally be eliminated, as this would enable savers to plan knowing there are no future extra taxes associated with retirement savings.
HMRC’s statistics show that in 2017/18 26,550 taxpayers reported a liability for the AA tax charge through self-assessment.
The total amount exceeding the AA was £812m. This equates to tax revenue of £325m if all of the excess was taxable at the marginal rate tax of 40 per cent.
In 2017/18, 4,550 counts of LTA tax charge were paid by schemes through accounting for tax return. The amount of LTA tax revenue was £185m.
The same statistics show the estimated net cost of pension tax relief, gross pension tax relief less tax revenue on private pensions in payment, for 2017/18 was £19.5bn.
Do we need both the AA and the LTA or will one suffice?
Given the above statistics, in particular the amount of LTA tax revenue relative to the gross pension tax relief of £37.8bn, the LTA should also be scrapped with the AA taper and move back to a flat rate of AA for all, say £35,000.
There is also the added complication of the introduction of the Money Purchase Annual Allowance (MPAA) over 3 years ago. Even if it was necessary to stop recycling of tax-free cash, was it right to reduce the figure to as little as £4,000?
Mark Futcher is partner and head of DC and workplace wealth at Barnett Waddingham.
