Pension taxation isn’t working. It is benefiting those who find it easy to save and not incentivising those who don’t. It is causing doctors to work below their peak capacity and demanding up to 25% more in contributions from our 2m lowest earning savers.

It is creating confusion amongst those moving from saving to the spending phases of their retirement savings. Pension taxation is – as Liz Truss says- “too complex and could do with simplifying”.

Some might say she is kicking the can down the road when she says it is a job for the next Prime Minister. I take that comment to mean that finally reforming pension taxation should be a priority for an incoming leader and something to be dealt with before the next general election. That puts reform at the top of the political agenda (as Jo comments).

A group of us, Chaired by Baroness Ros Altmann, is determined to help the cause of pension tax reform. Reform cannot come too soon, not just for the higher earning doctors but to millions who pay pension contributions but are denied their promised incentives.

More than just doctors

Yesterday I went back to the last pension tax consultation which began in July 2015 and petered out in the run up to the Brexit referendum early the next year.

You can read the consultation here

It’s entitled “Strengthening the incentive to save” and is quite clear about what the incentive to save for those auto-enrolling will be.

1.24 Average contribution rates will rise as the minimum contribution levels under automatic enrolment increase to 8% in 2018 (of which the individual will pay 4%, the employer will pay 3%, and the government will add tax relief of 1%).

However, it is still important that the right incentives are in place to support individuals to take responsibility for making sufficient contributions to their pension to meet their expectations. That is why the government is considering how it can go further to ensure that individuals are supported to save.

The Treasury’s policy intent is clear. The Government will put in 1% if the employee puts in 4% and the employer 3%. There is an intent to go further but no commitment.

1. The date of the move to 8% of band earnings was delayed to early 2019
2. Up to 2m low earners are not getting the promised 1% and are thus paying 25% too much by way of contributions (5% and not 4%).

Instead of doing more, they have done considerably less than they promised. I suspect there are reasons for the Treasury’s failure to deliver , but that those reasons aren’t “good”.

The Treasury’s estimates of the number of new savers by now proves to have undershot actuality by 15-20% (10.5m rather than 9m). AE has been more of a success in terms of inclusion than anyone dared think. But greater pension savings lead to lower Treasury revenues which is why the Annual Allowance and Lifetime allowance have been brought in. There is an explicit link in the 2015 paper.

The lifetime and annual allowances were introduced at ‘A-day’ in 2006. They were originally set at £1.5 million (the lifetime allowance) and £215,000 (the annual allowance), and were designed to ration the  amount of tax-privileged saving an individual could make into a pension. By 2010-11 they had risen to £1.8 million and £255,000 respectively.

Over the course of the last Parliament, both limits were gradually reduced in order to manage the growing cost of pensions tax relief. The annual allowance is now £40,000 and the lifetime allowance is £1.25 million. However, it was announced at Budget 2015 that the lifetime allowance would be reduced to £1 million in April 2016, and then uprated by the Consumer Prices Index from April 2018.

Complexities such as the Money Purchase allowance (stopping recycling) and the Annual Allowance Taper (a kind of pension super-tax) are additional to the core AA and LTA legislation outlined above.

Not to put too fine a point on it, the Treasury underestimated demand for tax-relief and appear to be balancing the books by not paying it (to those who need help most).

Pension taxation policy intent is to take from the haves and give to the have nots. We know from the state of today’s NHS waiting list that the taxation of the well off has succeeded not just in reducing Doctor’s pensions, but in their willingness to practice.

We also know that the money that they are paying to the Treasury through Scheme Pays or directly (via self assessment) is not going as it should to incentivise the lowest earning into saving. Instead the low earners are paying more than they anyone else to save (as a proportion of their net disposable income).

Impact on saving

In February, This is Money ran an article on the high-opt out rates among young low-earning NHS staff .

Why are NHS staff quitting generous pensions at an alarming rate 

A typical nurse on £25,000 a year currently has to pay a contribution of 7.1 per cent before tax relief so saves £1,420 by opting out of NHS Pensions, according to Royal London figures.

This suggests to me that there is a point at which pension contributions become too expensive and that the assumption that 2m low earners will continue to pay 5% rather than 4% for their pension contributions is a dodgy one.

For low paid NHS workers , auto-enrolled into the NHS pension schemes without tax-relief , the cost of not getting the basic rate tax incentive is 1.42%, which is a lot of pay if you weren’t getting pay increases.

The Government should not be complacent, there is a point at which savers can save no more and it’s not just consultants who have reached it.

So it’s time to tackle pensions tax

The 2015 consultation points out that “Over two thirds of pensions tax relief currently goes to higher and additional rate taxpayers”.

It also hints at an emerging problem which has grown since 2015 with the phasing of auto-enrolment contributions.

Increases in the Personal Allowance in recent years have also led to a decrease in the share of pensions tax relief which goes to those with an income below £19,999.

I suspect that the Treasury knew even then that the squeeze would come both at the top (AA and LTA) and at the bottom (through the failure of net pay to pay the promised tax incentive to lower earners.

Let nobody think this will be painless.

The group of people who stand to lose most from change are those who benefit most from the current system. They are the mass affluent who don’t get hit by the AA and LTA and get the bulk of the “two thirds of pension tax relief”.

Restricting their lucky status by moving towards a flat rate of relief or even TEE would be extremely painful. It was too painful for Osborne and Cameron in 2016 and it may be too much for a minority Government in 2020-21.

But this bullet must be bitten if the pension system is to retain fiscal credibility. We cannot go on as we are and it’s clear that the Government know it. Liz Truss is not the only person who wishes to take up the Doctor’s grievances, future prime ministers are saying the same/

It’s a shame they aren’t saying the same for the have nots, who are being so badly failed today.