Repeated warnings from hospital leaders of an NHS crisis — cancelled operations and serious increases in waiting times — have been hitting the headlines over the past few months.
It’s not some deadly new pandemic to blame, but rather the rules limiting pension tax relief for all those with incomes — including pensions — totalling more than £150,000 a year. The extra tax — 22.5 per cent on top of the 45 per cent top rate of tax — means some of the highest paid hospital consultants are now choosing not to do extra shifts over their contracted hours. The doctors’ trade union, the British Medical Association, has been furiously lobbying for some pension tax rules to be scrapped.
The new government has just announced some changes. The prescription? A consultation is being rushed through in the next few weeks that could allow doctors in England and Wales to reduce how much pension they accrue in any year to cut their tax bills. Further flexibility, in the form of cash payments into doctors’ (taxable) pay in lieu of pension contributions, are also on the table, although this is not guaranteed.
The government has also promised to consult on loosening the pension tax rules for very high earners across the public and private sector.
But the last thing we need is a bigger pension tax break for people with incomes over £150,000 — the top 1 per cent of income taxpayers.
Instead, the new government should be changing pension tax rules for people on the average wage of about £28,000; not for hospital consultants (or hedge fund managers) on £150,000 plus.
Currently, people receive a tax top-up at their marginal tax rate on their pension savings, and their investments can grow tax free. When they retire, a quarter of the pension can be taken tax free, with the other three-quarters taxed at their marginal rate.
But the current system is heavily biased in favour of 40 and 45 per cent taxpayers, who end-to-end, get a much bigger tax benefit than the 20 per cent basic rate taxpayers for exactly the same pension saving.
The current system is not only unfair, it is inefficient. It encourages pension savings by the higher paid, not the lower paid. And as we have seen with the growing NHS row, the rules governing how much can be saved tax-free into a pension are increasingly complex.
As a fundamental matter of fairness, the UK should move to a flat rate of pensions tax relief of, say, 30 per cent that would apply to everyone. Estimates suggest the total amount of pension tax relief would be unchanged, so there is no “cost” to the chancellor. Those on higher incomes would pay more tax, but those on lower incomes — including part-time workers — would have a much greater incentive to save for the future. I believe it could also help to close the “gender pensions gap”.
For defined contribution pensions, the flat rate of tax relief would apply to the annual savings of employees, plus the employers’ contributions.
For defined benefit pensions — rare as hens’ teeth in the private sector, but standard in the public sector — the pension contribution would be the future value of the annual pension promise earned. This is a tricky point, but absolutely critical to the current debate.
The value of defined benefit contributions need to be calculated on a realistic basis — the current calculationunderestimates the annual value by a country mile. It should be applied to all defined benefit schemes, including MPs’ own pensions. As I’ve previously written in the Financial Times, these are far too generous.
The rules of all public sector pension schemes should be changed to allow people to opt out and receive higher pay instead — on which income tax and national insurance would be applied.
These changes would mean the £40,000 annual allowance rule and the complicated tapered annual allowance could both be scrapped — and for everyone, regardless of their occupation. People could then choose to save as much or as little each year into their pension, subject to the existing lifetime allowance of just over £1m.
Many FT readers who expect to be 40 per cent taxpayers in retirement may conclude that as the tax breaks of a flat rate are less generous, they would be better off saving outside a pension. There is already a generous Isa allowance of £20,000 per year.
Moving the public sector away from defined benefit final salary-style pensions also starts to close the gulf with the private sector, where most workers are saving into defined contribution schemes and importantly reduces the bill we are passing on to our children and grandchildren to pay tomorrow.
John Ralfe is an independent pension consultant; Twitter: @JohnRalfe1