Taper tantrum: could your retirement plans be left out in the cold?
Senior Adviser Richard Rochford delves into the maze of pension annual allowances, and discusses your options if you fall foul of the ‘tapered annual allowance’ restrictions.
The combination of varying forms of tax relief on pension savings are unquestionably weighing heavily on the government. Over the years, successive Chancellors have attempted to reduce the immense costs (forecasted to hit £40 billion this year1), with cuts to the amount that can be saved tax-efficiently – resulting in a minefield of stringent and complex pensions allowances.
One of the major issues is the so-called ‘taper trap’, which can see some individuals having their annual pensions allowances cut to as little as £10,000 a year. But with a frosty reception from savers, politicians and the pensions industry, is taper reform on the cards?
What is the ‘taper trap’?
The ‘tapered annual allowance’ is a measure introduced by former Chancellor George Osborne in 2016 to gradually limit the amount of pension tax relief that can be claimed by high earners. This has led to thousands being hit with an unwelcome tax charge.
The Annual Allowance itself is the total amount that can be paid into your pension each year for tax relief purposes – today it sits at £40,000 for those with a total ‘adjustable income’ (total taxable income) up to £150,000. Above this, the ‘taper’ kicks in: between £150,000 and £210,000, the taper reduces the annual allowance by £1 for every £2 of adjusted income. Once your income reaches £210,000, you’ll be left with just £10,000 (as shown in the table below).
The NHS pensions crisis
Unsurprisingly, there has been confusion over the tapered annual allowance ever since its introduction. The gravity of the issue has recently hit the headlines due to its role in the current NHS crisis, which my colleague, Samantha Kaye, recently covered.
In summary, owing to the tax trap, senior NHS clinicians have begun to turn down extra shifts due to facing higher tax bills for working additional hours. As a result, waiting lists have since risen by 50% in some hospitals, increasing worries over patient safety following last year’s ‘worst winter on record’ for the NHS.2
However, last week (22nd November 2019), the NHS intervened, with Chief Executive Simon Stevens confirming a temporary “solution”, whereby the government will cover doctors’ pensions tax bills in this financial year.3 It is hoped this short-term fix will encourage consultants to continue to take on extra duties.
The wider problem
Despite alleviating staffing pressures in the short term, the new NHS proposal has been criticised due to its failure to deal with the root of the problem. Sir Steve Webb, Director of Policy at Royal London and former Pensions Minister, said:
“The fundamental problem here is the complex system of pension tax relief. The failure of the government to address this issue has resulted in emergency measures having to be taken in the middle of an election campaign simply to avoid a winter crisis in the NHS.
“The Treasury could have avoided all of these problems if it had simply admitted months ago that the pension tax relief system is too complex and had abolished the tapered annual allowance altogether.” 4
Indeed, the problem is not unique to NHS employees, or even just public sector workers. Thousands of people in the private sector have been caught out by the clampdown on their pension allowances, and many more could be caught out in the future. ‘Adjusted income’ includes earnings, rental incomes, dividends, and other investment income, meaning the taper trap doesn’t just ensnare those with high salaries.
It has been reported that the number of pension savers that were hit with annual allowance charges increased year-on-year from 23,800 to 37,300 in 2017/18. And HM Revenue and Customs has already taken about £173 million in annual allowance charges from more than 10,000 savers this year.5
The culprit is almost certainly the tapered annual allowance and the money purchase annual allowance (MPAA) – yet another restriction on pension saving. Under the current MPAA rules, the annual allowance is reduced to £4,000 for anyone who has taken their retirement pot flexibly.
Ripe for reform
Many across the political spectrum are now calling for wholesale reform, claiming that tapering is not fit for purpose. Another former Pensions Minister, Baroness Altmann, has also demanded urgent action from the government, while the pensions industry itself continues to lobby for greater clarity and simplicity.
Claire Trott, Head of Pensions Strategy at St. James’s Place, commented:
“We’ve continued to advocate for change in this area – whether that’s scrapping the tapered allowance entirely or making it more user-friendly by having it calculated a year in arrears. By calculating in arrears, it would make pension planning accrual and contributions possible, rather than just being hit by a surprise tax charge at the end of the year.”
Looking past pensions
Despite calls for reform, there appears to be a lack of appetite among ministers to scrap the taper entirely. This means many high earners will continue to be left with the challenge of investing tax-efficiently once their pension allowances have been exhausted.
Clearly, pension arrangements are the most tax-efficient investments, but all is not lost! Maximising ISA contributions, using your Capital Gains Tax annual exemption and making the most of various allowances and exemptions for dividends and savings income, will ensure you make the most of tax-free streams, helping you to secure a comfortable financial future.
If you have a question about receiving financial advice, or would like more information about my services, please contact me on 01444 244551 or via email at firstname.lastname@example.org.
1 HMRC Estimated Costs of Tax Reliefs, October 2019
5 HMRC, Personal Pensions Annual Allowance Statistics, 26 September 2019