Beware the reasonable Ralfe

Ralfe nice

John Ralfe has written an article on the problems highly paid NHS staff are having staying members of the NHS Pension Scheme.

He has a number of remedies for the Doctors, most involve Doctors being able to swap pension accrual for extra cash. All of this is standard fare and to be expected from an arch pension dismantler.

But there is a further remedy being hinted at and it’s referenced early in John’s article

What is more, the tax rules are softer for defined-benefit schemes than for defined- contribution ones.

What John is talking about, is that a DC benefit is not measured as a multiple of the annuity the pot can buy but by the value of the pot itself. By comparison a DB pension is valued in a quite different way.

For defined benefit pension schemes, you calculate the total value by multiplying your expected annual pension by 20. In addition, you need to add to this the amount of any tax-free cash lump sum if it is additional to the pension. In many schemes, you would only get a lump sum by giving up some pension, in which case the value of the full pension captures the full value of your payouts.

So you are likely to be affected by the lifetime allowance in 2018-19 if you are on track for a final salary pension (with no separate lump sum) of more than £51,500 a year.

Can you draw a pension of £51,500pa from a DC pot of £1,030,000 (the current Lifetime Allowance)?

Well yes you can though it wouldn’t keep pace with inflation or last long , but if you wanted to buy an equivalent annuity to the defined benefit equivalent, you’d need about £2m. Put another way, if you were offered a CETV for a £51,500 pension – you’d get at least £2m.

That’s what John means by the tax rules being softer for DB than DC – you get twice the allowance for your DB than you do for DC.

In this he is reasonable – and right.


Beware the reasonable Ralfe

In case you think I agree with John’s article – then let me disabuse you.

John has written to Matt Hancock , the current Health Secretary with some scheme specific remedies which go into the mix . But then he goes further

….the way the annual value and total value of defined-benefit retirement schemes is calculated should be brought more into line with private sector defined-contribution pensions. That would give a more realistic assessment of the value of these schemes.

This is not a proposal relating to the negotiations between BMA, NHS pension scheme and the employer, this is a proposal to fundamentally destabilise what’s left of DB pensions by encouraging John’s favoured mark to market approach  for DB valuations.

If we consider the DC value of a DB pension , we have only one measure – the cash equivalent transfer value (CETV). We all know that CETVs are huge- and that’s because they are increasingly being calculated using a risk-free discount rate. This risk-free discount rate reflects the risk-free investment strategy espoused by financial economists (John among them).

The NHS pension promise is “risk free” to Doctors because it is gilt-edged, it is made by the Treasury and Britain would need to fail for the NHS pension scheme to fail.

So any attempt to value the NHS pension scheme as a DC benefit would need to use an ultra-low discount rate producing an ultra-high cash-equivalent and a pension falling within the LTA of considerably lower than £51,500. My guess is that it would be around half the pension.

Put another way, to value DB and DC in the same way could halve the effective lifetime allowance for members of the NHS scheme.


Do we want to start taxing pensions of £25k or more at 55%?

I suspect that John would not mind if HMRC did, but I suspect that the entire civil service, including HMRC, GAD, the Treasury and the DWP would not like it very much at all.

I suspect that deferred members of private sector DB plans and those relatively few members still accruing would not be very impressed at the idea that a pension of £25k breached their lifetime allowance.

I doubt that the MPS, including the Pensions Minister – would consider it a good idea either. For almost everyone having or considering a lifetime career in public service can aspire to a decent pension and a significant proportion to a pension plus cash settlement that on a “DC equivalent” basis, would breach the LTA.


The dumbing down of pensions

There is, and I am sorry to say this, a politics of envy in the UK which dislikes the pension grant made to public service workers and those in private sector DB plans

It manifests itself in proposals like John’s, which are designed to erode the basis of the tax settlement made to people who became members of defined benefit pensions. John’s proposal imposes retrospective tax-legislation , depriving members of their full pension promise.

In simplest terms, this politics of envy wishes to dumb all pensions down to the lowest common denominator, a cash pot where all the risk is taken by the member and where employer costs are controlled by a defined contribution. The pension settlement is non-existent, what is left is deferred reward – there is no pension.

This is why I fundamentally disagree with what John is arguing. He is arguing, driven by the politics of envy for the total dismantlement of the UK pension system, to be replaced by a a savings alternative which would leave ordinary people at the mercy of the market.

If that’s what the members of the NHS pension scheme want, then it is what they should have. But I see absolutely no evidence of that.

The valuation of DB and DC benefits for LTA purposes is critical for high earning medical staff. They should recognise that for all the problems with AA and the taper, they can still earn a pension of £50,000 + a year and be treated as any other tax-payer. Any pension settlement that involved an increase in the pension multiplier for the LTA should be considered very carefully

Beware the reasonable Ralfe.

John Ralfe

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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