Government eases pain of NHS pension tax bill crisis

The government will pay pension tax bills of high-earning NHS staff caught by the annual allowance taper.

The government has addressed the problem of high-earning NHS doctors refusing to work extra hours because of the fear of being penalised on excessive pension contributions and facing unexpectedly high tax bills as a result.

NHS services have been impacted by consultants refusing to work outside of their regular hours because of the fear of becoming subject to the tapered annual allowance, which kicks in to progressively reduce the amount of pension tax relief available once earnings are above £110,000 for “threshold income” (includes dividend income and other income sources) and £150,000 for “adjusted income”.

- Pension tax pain causing doctors to hang up their stethoscopes early

In order to fix dire staffing shortages as the winter weather increases demand on resources, health service management says that it will allow the NHS pension scheme to make use of its “scheme pays” process to cover the taper element of consultants’ tax bills.

Tapered annual allowance is calculated for each tax year, which means it is possible to be subject to it in one year but not the next, with “carry forward” rules furthering complicating matters. As a consequence, many high-earning doctors have been unexpectedly caught out by the rules.  

The “scheme pays” method the NHS is proposing would normally lead to a reduction in pension at retirement, but in addition to covering the taper allowance element of tax bills, the NHS says it will also make good any possible pension reduction that could arise.

Where’s the NHS getting the money from to pay taper tax bills?

However, the potential difficulties with this improvised solution don’t end there.

Because the NHS pension scheme does not hold any funds due to its “unfunded” structure, the extra cash required to mitigate doctors’ increased tax liabilities would need to come out of the general NHS budget, which in turn implies that funds would have to be reallocated from frontline clinical services.

The government is yet to clarify whether new money will be made available to meet the full costs associated with the “scheme pays” approach.

Steve Webb, director of policy at insurer Royal London, is scathing about the new proposals. He says: “The plan for the NHS to pay the tax bills of doctors amounts to a bizarre money-go-round, with one part of the public sector paying money to another in order to resolve a short-term crisis.”

With the NHS currently at the top of the political agenda and the country in the throes of a general election campaign, the government’s announcement is likely to be seen by its opponents as having politics written all over it, and as such is a break with the convention that policy announcements are not made at such times.

“While political focus is understandably on averting a winter NHS crisis – and the negative headlines that would accompany this as a general election draws near – this proposal effectively means handing one particular group of workers more generous pension tax terms than everyone else,” comments Tom Selby, senior analyst at fund shop AJ Bell.

Tapered annual allowance is fiendishly complicated, adding an extra layer of difficulty to an already highly complex pension allowance system.

Taxpayers are penalised for earning over the threshold or adjusted income, as their £40,000 annual allowance for pension contribution tax relief is progressively reduced. In effect, for every £1 of adjusted income over £150,000 an individual loses 50p of their annual pension allowance. The minimum annual allowance is £10,000, available to taxpayers with income of more than £210,000.

Because of the way pension accruals are calculated in the public sector’s defined benefit schemes, the unintended consequences have been dire for high earners.

The taper annual allowance was introduced on 6 April 2016.

Preferential treatment made necessary because of ‘broken’ pension system

Jon Greer, head of retirement policy at wealth manager Quilter, suggests the government had little choice but to take action with yet another NHS winter crisis looming, even if the timing from a political perspective might be deemed controversial.

“It would be a radical move by the government to pay the pension tax bills of NHS workers,” he says. “It is an effective admission that the pension annual allowance taper is a broken policy that is too unpredictable and punitive; however, it has taken the country to be on the cusp of a winter crisis in the NHS during an election for the government to address it.”

The government has in effect gifted to high-earning NHS doctors a more generous pension system than that available to the rest of the taxpaying UK population, but it will mean that high-earning doctors can return to working the overtime that the NHS has come to depend on without being penalised by large unforeseen tax bills.

- How public sector workers can sidestep pension tax traps

Nevertheless, Steve Cameron, pensions director at Aegon, said the solution is “convoluted” and could have its own unintended consequences.

“Effectively, tax bills as a result of [doctors] and their employer paying in above the tapered annual allowance will be paid out of doctors’ pension pots. Then later the NHS will top up those pensions to compensate. Ironically, this could trigger another tax charge if the total paid into the pension in a future year exceeds the allowance then,” Cameron explains.

Another risk is a backlash against the government from other high-earning public sector workers, not to mention from those outside in the private sector. “There is also the danger that this will lead to calls for similar treatment from other senior public sector workers,” said Gary Smith, chartered financial planner at financial planning and investment firm Tilney.

- Calls for pension rules to be changed for all higher earners and not just doctors

Smith is calling for all political parties to make clear their position on NHS pensions, the final salary link and specifically the tapered allowance in their manifestos.

Today, Public Health England issued a cold weather alert; cynics might say that the timing of the taper announcement is arguably related.