In my article ‘What a relief!’ (Tax Journal, 8 March), I mentioned pensions relief and some of its complexities, including, in particular, the unintended consequences for doctors, many of whom are retiring early rather than face significant tax bills. An article in The Times on 28 April approached this issue from a very different angle, with its claim that the self-employed “face an old age of chaos and penury”. The subheading said that “most have nothing saved and changes to the tax rules stop them putting more money away.”
That seems somewhat muddled. If someone has nothing saved, then the tax rules will generally allow them to put up to £160,000 into pensions in one year (the current year’s allowance of £40,000 plus three years’ allowance brought forward), assuming they have sufficient funds to do so. But it is true that the self-employed find it hard to build up adequate pensions, as earnings can be unpredictable and many feel they cannot afford to make pension savings, particularly in their early years.
Meanwhile, apparently NHS consultants are refusing extra shifts, because the tax cost on their pensions mean the work is just not worth doing. So people who already have significant pension savings want to cap their earnings, because the tax burden is too high. Surely something must be going wrong somewhere?
It seems to me that one of the main problems is that the rules keep changing. When I first became self-employed (a long time ago), I could put a maximum of 17.5% of my earnings into a pension, with no lifetime allowance or upper limit. So it was relatively straightforward, given that I was earning well, to put aside a regular amount into a pension.
In 2006, ‘A-day’ was supposed to herald an era of stability, after some fundamental reforms. Instead, the rules have changed almost every year since then. Back in 2006/07, the lifetime allowance was £1.5m and the annual allowance was £215,000. The lifetime allowance grew to £1.8m by 2010/11 but has since been cut to £1m; with indexation, this is now £1.055m for 2019/20. Meanwhile, the annual allowance was cut to £50,000 in 2011/12 and has now been cut to £40,000, with a further restriction from 2016/17 for those earning more than £150,000. For earnings over that level, the allowance is tapered, reaching a minimum of £10,000 allowance for earnings over £210,000.
So most people can still save £40,000 a year into a pension, and the maximum pension pot which can benefit from relief is £1.055m – which, at a 4% assumed annuity rate (obviously the actual rate will depend on age, health and a host of other factors) would deliver a pension of just over £40,000 in retirement. In fact, the vast majority of people have much smaller pots. In 2015, George Osborne said that only 4% of pension savers would be affected by the cut in the lifetime limit from £1.25m to £1m.
Going back to The Times article, very few self-employed people earn enough to be able to save £40,000 p.a. in any case. The obvious (if not always easy) thing for them to do is to seek to save a reasonable percentage of earnings right from the start of a self-employed career, so that over time a pension pot can accumulate. The problem is more one of managing to save enough, rather than not having enough tax relief. Of course, there may be the occasional year where they have bumper earnings and find that the £40,000 limit is not enough, but that will be rare in practice.
Turning to NHS consultants, the issue is different. Many of them are earning at or near £150,000 and so are affected by the taper rules. And crucially, they are in the NHS pension scheme, which in common with most other public sector pension schemes is still a defined benefit (DB) scheme – and far more generous than most public sector employees realise. Indeed, when I worked for HMRC for a couple of years in my early 50s, I calculated that my pension was worth around 40% of my salary – a huge part of my total remuneration.
So it could be argued that NHS consultants are in a very fortunate position, with high earnings and generous pensions. What are they complaining about? The problem is that small private earnings can cause a disproportionate tax charge, particularly in a year when a pay rise has been received. A pay rise of £4,000 with an extra 1/60 of pension accrual would mean that someone would have a deemed pension accrual of £65,072 (calculated as £4,000 x 61/60 x 16) – well in excess of the allowance each year, and exacerbated by the impact of the taper rules.
Hence, those on low or unpredictable earnings may well not have enough pension savings, while those on relatively high earnings may find that the tax cost of their pension is surprisingly high. Neither issue is, of itself, a signal that tax relief on pensions needs to change. But where at one end of the scale people don’t save enough, and at the other people don’t want to work because of the tax cost, then something is going wrong. Surely what we need is something simpler? Perhaps everyone could save a stated amount of their earnings into a national scheme which gives an entitlement to a pension – and we could call it a ‘national insurance contribution’?
For more information, please contact Heather Self.
First published in Tax Journal on 3 May 2019