The tapered annual allowance pension rules are a classic example of bad policy design. The rules are far too complicated, impossible to predict properly and have damaging side-effects which undermine the aims of the policy itself – as well as having harmful disincentives in other policy areas too.
Tax relief is meant to incentivise pensions. The tapered annual allowance drives staff to cut their contributions, adding another layer of penalties and complexities to a tax policy that was supposedly designed to ‘incentivise’ pension contributions.
The new restrictions not only disincentivise pension accrual, but also discourage senior staff from working too. Assuming the most senior employees are also the most valuable – and that is clearly the case in the NHS – the impact of these rules will be both costly to the employer, who will have to try to replace the reduced working hours with outside contractors at much higher cost, and damaging to the output of the organisation. For pension rules to be preventing valuable staff from doing extra work, cutting their hours or retiring early, is clearly counter-productive.
The policy is deeply flawed for several other reasons. Firstly, complexity. It is far too complicated, particularly for final salary-type scheme members to work out what their reduced annual allowance will be. Many people don’t realise just how difficult it is to calculate this.
Then there is the cliff-edge – the impact of basing the reduced allowance on both ‘threshold’ and ‘adjusted’ income means earning an extra £1 can tip senior workers over the limit, which incurs thousands of pounds in taxes. Penalising them in this way for working more is clearly damaging to the willingness to do extra work of the NHS or other organisations’ most valuable workers.
And then there is retrospection. This is a particularly flawed aspect of the way the taper particularly affects members of defined benefit schemes.
The taper calculation rules mean you cannot see what your reduced annual allowance actually was until after the end of the tax year it applied to, and you also do not know how much you will have been deemed to have ‘contributed’ to the scheme until after it is too late. In a DC scheme, the contributions are expressed as a sum of money that is more transparent, whereas in DB schemes, the calculations are based on different accrual rates and adjustments for inflation, requiring accurate information from the pension scheme and knowledge of these complex rules. Indeed, it is impossible to plan the pension contribution and your earnings precisely.
A financial adviser who specialises in tax and pensions can help you make an informed estimate, but you may not have final figures for the deemed contribution until after the tax year has ended. Preventing people from being able to plan their pension contribution and earnings efficiently is clearly flawed policy.
Annual allowances should be simplified and perhaps based on previous year’s earnings. This particular problem could be alleviated by basing any reduced allowance on last year’s earnings, not the current year. Then at least people could be clearer about what their allowance is. Ideally, the calculation should be much simpler, so it is straightforward to work out the allowances, without having to hire an adviser or work out impenetrable calculations.
Surely we want senior NHS staff to be medical experts, not pension buffs. That also applies to senior employees elsewhere.
The taper rules should be reformed for all schemes. The Government needs to ensure that it’s consultation addresses the flawed policy rules for all pension schemes, not just the NHS and some other public sector schemes.
The Government should consider scrapping the lifetime allowance and only restricting annual allowances. While consulting on a more sensible way to conduct this aspect of pensions policy, it is also worth considering a wider reform. It has never seemed logical to me to limit annual pension contributions and also have a lifetime allowance. Effectively this is punishing good investment performance and making it impossible to plan for the long-term.
Limiting the amount of tax relief available on annual contributions makes sense, and then there should be no upper limit on the growth that you achieve, so you are not penalised if your investments do well. It makes sense to have only an annual allowance and scrap the lifetime limit, especially for DC schemes which depend only on investment performance.