We need a complete review of how pensions allowances work

With people on average enjoying longer lifespans, the system should be encouraging them to save as much as they can into a pension.

It should be welcomed as the right thing to do, with the added bonus to Government and future taxpayers that it makes people less reliant on the state in future years.

Unfortunately, nothing in pensions, or more specifically the tax rules around them, is ever that simple.

Pensions do, and rightly so, come with valuable tax incentives.

The problem is successive Chancellors have often been more focussed on what they are ‘losing ‘ in terms of collecting less income tax from pension savers than in thinking about the long term social good of individuals saving for their retirement futures.

The pension route ironically could trigger another tax charge if the total paid into the pension in a future year exceeds the allowance then

The logic behind setting limits on pension contributions (as well as on the overall fund that can be built up on a tax favoured basis) is to limit the amount of pension tax relief the government pays to higher earners.

But we are now seeing some highly adverse unintended consequences with senior medical professionals in the NHS deciding to cut back on the amount of work they do, or worse still retire early to avoid breaching the ‘tapered annual allowance’ which would land them with a hefty tax bill.

So we now have an obscure pensions tax rule getting in the way of people receiving NHS treatment they urgently need.

And with the NHS facing winter pressures and a spike in admissions as a result of colder weather, no-one would dispute that an urgent solution is required to ensure that front-line care is delivered.

The temporary solution (this year only) being put forward by NHS England is to allow staff who find they have breached their annual allowance to ask for the scheme to pay any extra tax bills in return for a reduction in pension benefits.

This ‘scheme pays’ approach is not a new concept, although not all pension schemes offer it.

What is new is that NHS England are making a ‘contractually binding commitment to pay them a corresponding amount on retirement’.

It is not clear if this will be through the pension scheme or through a separate mechanism.

The pension route ironically could trigger another tax charge if the total paid into the pension in a future year exceeds the allowance then.

But payments outside of the pension may come with other tax implications and if paid on a regular basis will require a new payment mechanism.

While it is the plight of healthcare professionals which has put the issue firmly on the radar, it is not an issue that just affects the retirement plans of those working in the NHS. 

Offering special concessions to NHS professionals may address concerns over early retirements there, but should pension rules vary by occupation?

Doing so would create both complexity and unfair comparisons with those affected in other professions.

So what’s the solution?

One approach offered by some employers in the private sector is to allow individuals affected by this to swap future employer pension contributions for an increased income.

We are keen to see this extended to those in the NHS scheme and other public sector employments.

Interestingly, this appears to be the approach being taken by NHS Scotland.

This is not a simple exercise, leading to someone on Twitter suggesting doctors will have to become ‘mini actuaries’. Of course, a far more palatable solution is to seek advice.

But even this solution detracts from that simple starting point that saving for your retirement is a good thing and should be seen as such.

All Governments have budgetary constraints to live within, and they need to make sure the tax system is fair across wealth bands.

But when pension tax rules become so complex that they discourage doctors from taking on extra work, then something has gone very wrong.

It is time to take a step back and make sure the pension tax system does what it was intended to do and that’s incentivised people to save more, not less, for their retirement.

So, rather than rearranging the deckchairs, what we need is a fundamental review of how pension allowances work, not just for the NHS, so they reward good savings behaviour and never penalise taking on extra work.

Steven Cameron is pensions director at Aegon