Government review of NHS pensions - what are the options?

07 January 2020

The Conservatives pledged in their election manifesto that they would take measures to address the NHS pensions crisis. On 18 December they said that they would announce their solution on Budget day (11 March).

What options might they be considering?

  1. Scrapping the tapered annual allowance.
  2. Removing the £110,000 'threshold income' cliff edge by increasing the figure, or removing the threshold income test from the calculations altogether.
  3. Scrapping annual allowance tax charges in defined benefit (DB) pension schemes entirely as suggested by the Office of Tax Simplification (OTS).
  4. Revisiting the 'pension input amount' multiple as applied to DB schemes.
  5. Bringing in a mechanism to average out spikes in income over multiple tax years to avoid a sudden jump in pension input figures - combined with allowing reductions in pension to produce a negative pension input to be carried forward for use in future years (currently restricted to £0 so negative growth is lost).
  6. Extending the NHS clinician annual allowance tax compensation mechanism for the 2019/20 tax year into 2020/21, or making it permanent for the future.
  7. Bringing in the proposed pension flexibilities allowing pension members to choose how much of their income to allocate to pension contributions, in 10 per cent increments.
  8. Allow a concession for NHS clinicians to forfeit tax relief on their pension contributions in exchange for not being assessed to annual allowance tax charges on their pension growth (as an echo of the now removed ESC A9 concession which used to apply to medics).
  9. Do nothing.

Ultimately the Government will not want to turn off the tap to wider tax revenue whilst fixing the NHS pension problem.

Any changes made to the tapered annual allowance will decrease tax revenue, which was upwards of £200m  in 2017/18, but would certainly go some way to solving the crisis. The £110,000  threshold income cliff-edge issue is a particular problem as it can often lead to marginal tax rates of over 100 per cent due to the way that the calculations work. A word of caution though that whilst removing the threshold income test would prevent a cliff-edge, it would draw more pension members into the tax net. Scrapping the taper altogether should be the only option considered when looking at this area.

The 16x multiple factor used to determine the 'pension input amount' to test against the annual allowance has not aged well. It should have been updated when the annual allowance fell from £50,000, as it no longer meets two of its stated objectives of 'deliver[ing] consistency between the treatment of defined benefit and defined contribution members' and 'avoid[ing] discouraging or encouraging defined pension provision unnecessarily'. If this factor was reduced to the previous 10x multiple which applied before 2010, most NHS pension members would have their tax charges wiped out whilst still recognising that those with the largest growth should still incur a tax charge.

Looking purely at the NHS problem, a combination of options 2,4 and 5 above would largely solve the NHS workforce issue (there will always be some outliers for whom a tax charge would arise where pension growth and income are high) without opening the floodgates to other sectors, and would bring more fairness to the system. Option 7 is unpalatable to the NHS as it also reduces pension benefits as a by-product of reducing the tax take. Option 8 would likely  prove popular but is as yet unexplored by the Government on the face of it.

To do full justice to the OTS and its role in advising the Chancellor on setting policy, scrapping  the annual allowance charge in DB schemes and the lifetime allowance in defined contribution schemes would be the most robust route forward and avoids having to constantly revisit this issue ad nauseum.

Doing nothing will see the issue worsen, as any brought forward unused allowances from earlier years will now have been used up in many cases. This is a crucial time for the problem to be resolved rather than applying more ‘sticking plaster’ solutions and decisive action is needed.