Doctors may have done other high earning UK taxpayers a favour by pushing the issue of the Annual Allowance Taper up the political agenda. What are the issues? Are doctors really being treated badly?
Pensions tax for higher earners
- Since 2016 tax relief on Pension contributions has been capped at £40,000 per year.
- Those who have annual income exceeding £150,000 see the allowance taper off. It gradually reduces the tax-free contribution limit from £40,000 to as low as £10,000.
- For every pound of income over £150,000 the individual loses 50p of their annual pension allowance.
- 'Income' for these purposes also includes capital gains and investment income, such as dividend income and rental income, plus pension contributions made by the employer.
- Where the annual allowance is exceeded not only is tax relief restricted, the Excess is subject to income tax and for higher earners this is at 45%.
- The tax is expected to raise £1.2bn this financial year.
These rules, and the possible solutions, apply to every UK resident taxpayer making pension contributions, they are not exclusive to doctors. So why the fuss?
What are the facts?
Under pensions Auto-enrolment, the level of minimum pension contribution is currently set at 8%, of which 3% is paid by the employer.
Most private-sector employer schemes pay pension benefits according to contributions made and accumulated pension investment performance.
In contrast, it is estimated that NHS consultants pay (on average) around about 14% of their salary contributed to their pension. This is usually matched by the NHS employer.
In addition, NHS pensions are primarily defined benefit schemes; your pension is not based on what you put in, but on your final salary.
- A consultant, from 1 April 2019, will have a salary of £79,860 to £107,668 per year, depending on the length of service (according to Health Careers NHS).
- Doctors and consultants under older versions of NHS contracts may earn different amounts.
- In practice, overtime and NHS bonus payments can boost salary levels considerably.
- In addition, many consultants have private practices and investment income.
NHS higher earners have one disadvantage over the private sector. There is an increasing trend for private-sector employers to pay staff a bonus rather than a pension contribution.
The medical profession says it is unfairly hit by the charge since it has no choice on the rate of pension contributions being made as this has been set by public sector pay rules. In many cases, as they do not know what extra income they might make in a year, they are hit with unexpected large tax bills after the end of the tax year.
The fact is that as a group, doctors are much harder hit by the annual allowance charge than the average worker because they earn more and the amounts paid into their pensions, under the NHS schemes are much higher.
The fiction is that these rules are targeted at NHS doctors when actually they apply to all higher earners (and other public sector workers).
In reality, this is a problem that is 'nice to have'. The consequence of receiving a final salary pension is that you will generally receive a higher pension on retirement.
If doctors earned less, there would be no issue.
Is there a way out?
Doctors pay is negotiated under a contract and it is difficult to vary employee contracts.
Up until now, one solution has been Scheme Pays Election (SPE2) to pay the annual allowance charge. It can be used by anyone in a scheme authorised by HMRC.
- In 2016-2017 the NHS paid almost £35m in annual allowance charges on both its mandatory and voluntary pension schemes.
- The average tax bill was £14,000.
- For any employee taking advantage of SPE2, the employer classifies the payments as a loan.
- Interest is charged.
- Future pension payouts and lump sums may be reduced, depending on the scheme.
Or you can simply withdraw from your public sector pension scheme.
The NHS has undertaken to settle annual allowance tax charges of more than £2,000. It will be done through the pension scheme with an undertaking to adjust benefits with interest at retirement. The measure only applies to the 2019/20 tax year.
The problem is that:
- It comes too late for some taxpayers.
- There is no confidence that policy would not change under another government. Additionally the Health Secretary Matt Hancock is reported to have warned NHS officials that in some cases the scheme may be classified as 'tax avoidance'.
In Scotland, a temporary fix has already been agreed and the Scottish health secretary has announced that from 1 December 2019 NHS staff will have the option to have their employer pension contributions paid as part of their basic pay (and taxed accordingly), giving eligible staff an alternative to cutting back on their hours or retiring early.
Is it unfair to doctors?
In a word, 'No': it potentially applies to all high earners.
In the case of the NHS doctors and consultants, this is a classic case of supply and demand.
Is it fundamentally unfair that someone on £110,000 can contribute £40,000 to their pension, while someone on £210,000 can only put in £10,000?
The argument takes a new meaning when:
- Median household disposable income in the UK was £28,400 in the financial year ending (FYE) 2018, from the ONS.
- The average total pension pot in the UK is £21,441.
- Any scheme paid through the NHS will ultimately be picked up by every taxpayer.
What may be regarded as absurd is the taper tax itself. By all means limit the tax relief on pension contributions above a certain level, but taxing them to the extent it is better not work seems counter-intuitive. In addition HMRC gets the benefit of Income Tax on the way into a pension and when it later and inevitably comes out.
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