The highest earners in Britain could have NHS doctors to thank for boosting their financial health in retirement. An expected relaxation of pensions tax limits in Wednesday’s Budget aims to cure the malady of medics reducing their hours or taking early retirement to avoid tax bills arising from breaching pensions limits.
However, the chancellor’s medicine will also put a spring in the step of the wealthiest workers, no matter how they earn their living. Jeremy Hunt is expected to lift the annual and lifetime allowances limiting how much workers can save tax-free into their pensions — and it looks as if he will do so dramatically.
While the precise numbers have yet to be confirmed, it is expected the annual allowance will rise from £40,000 to £60,000, and the lifetime allowance from £1.07mn to a rather more generous £1.8mn.
This latter figure could massively reduce the blood pressure of high-earning professionals. Although “pension tension” is not an illness you will find in a medical dictionary, it is a significant cause of financial stress for workers of a certain age. Rather than celebrating when their various pension pots approach the £1mn mark, they have been more likely to make a panicked phone call to a financial adviser. Why? Anyone who saves more than the lifetime allowance faces a 25 per cent levy on additional income from their pension or a 55 per cent tax if they withdraw it as a lump sum.
Taking early retirement has enabled doctors and other workers with more generous defined benefit pensions to escape these charges. Typically, those who retire in their 50s will receive a lower level of annual pensions income, which can be enough to take them below the lifetime limit. However, it has also added to an acute shortage of NHS doctors and consultants.
The chancellor will be hoping that solving this justifies boosting the pension prospects of the wealthiest during a cost of living crisis in which growing numbers can no longer afford to save for retirement.
But directing all of that valuable tax relief at those with the plumpest pensions ignores the much more worrying problem of lower and middle-income workers who are not saving anywhere near enough to fund even a semi-decent retirement. And, as pensions expert John Ralfe points out, this quick fix “does nothing to close the unfairness in the rules” governing the valuation of the defined benefit pensions common in the public sector compared to the less generous defined contribution plans common in the private sector.
For the past decade, Conservative chancellors have reduced pension tax limits rather than raising them. An additional £727,000-worth of investment headroom is a significant windfall. More than half of those who responded to the FT’s recent bonus survey said tax limits were restricting what they could invest into their pension, with 28 per cent capped out entirely and a further 23 per cent restricted by the annual allowance taper.
We shall have to wait until Wednesday to find out if there will be a related tweak to this and the MPAA (money purchase annual allowance) which permanently reduces what older workers can save if they’ve already accessed some of the cash inside their pensions. There could also be a sting in the tail, such as removing the generous tax treatment of pensions upon death.
For older workers who have already accessed a tax-free lump sum or started taking some of their pension benefits, some challenges remain. These “benefits crystallisation events” mean that pensions providers must test the value of an individual’s pensions against the current lifetime allowance.
David Hearne, a chartered financial planner at Financial Planning Partners, gives the example of someone who has already tested an £800,000 pension, using up roughly 80 per cent of the current £1.07mn lifetime allowance. He would expect that person only to be able to access 20 per cent of any enlarged lifetime allowance, and not the full £727,000 increase that the chancellor is expected to make.
Bring out the world’s smallest violin, you might say. But if you might be tempted to raise a toast to doctors after the Budget, another worrying piece of pension tension remains. Hunt may be bold enough to raise pensions limits, but there’s nothing to stop a future Labour government from taking the knife to them.
The writer is the FT’s consumer editor and the author of ‘What They Don’t Teach You About Money’. [email protected]