Taxing problem

Pension tax has been the NHS issue of the summer. It has been blamed for senior doctors leaving the NHS, considering retirement, reducing their hours or refusing to take on additional work – to reduce waiting times, for example – because they fear being saddled with significant tax bills. The issue is regarded as so serious that, over the course of 16 days this summer, the government moved twice to settle the issue.

The problem has arisen due to the tax policies set by the Treasury, but both the health department and Treasury accept the need to resolve the issue. It affects a relatively small number of highly paid staff. Some will find it difficult to sympathise, but it is important to remember how vital they are to patient services.

There is evidence that the problem is having an impact on the delivery of services and trusts’ financial position (see box). But the NHS pension is also a key element in recruitment and retention of staff. And, though the pension scheme remains generous even when the pension tax issue is taken into account, the service would not wish to see it devalued.

The issue has sprung from the introduction of an annual allowance to limit the amount of tax relief received by higher earners. The value of the allowance rose steadily from its introduction in 2006 to £250,000 in 2010/11, but fell sharply under austerity measures and stood at £40,000 for the 2018/19 tax year.

While this means more people are facing tax bills, the allowance can be tapered down further, potentially increasing the size of the bills. If a doctor, for example, earns less than £110,000, they keep the full £40,000 allowance. For those earning more, there is a further test. Their income – from all sources – is added to the growth in their pension over the year – this is known as their adjusted income. If this totals less than £150,000, they retain the £40,000 allowance. If it’s more than £150,000, the allowance is tapered, falling to £10,000 for adjusted incomes of £210,000 and above.

Tackling the issue is now high on ministers’ agendas. Just before Boris Johnson took over as prime minister, on 22 July Theresa May’s government proposed a scheme where employers and employees reduced their contributions to 50%. In exchange for this 50:50 option, clinicians would cut their rate of pension growth in half. A consultation paper was published, but the proposal was rejected immediately by the British Medical Association, the doctors’ trade union.

Shortly after Mr Johnson took the keys to number 10, it became clear that the 50:50 option was to be abandoned in favour of a more flexible proposal that will allow, from April 2020, clinicians to set their contribution rates to limit their chances of having to pay pension tax.

Exactly what the government is now proposing is unclear – it has promised a new consultation, but this had yet to be published as Healthcare Finance went to press. What is clear is that it will apply only to senior clinicians – chiefly doctors and nurses – but not to managers.

There is no flexibility in the current scheme – staff are either opted in (paying 100% contribution) or opted out (paying no contribution) of the pension scheme, but the new proposal would allow greater variation in contribution rates.

A Department of Health and Social Care press release gives an example of a senior clinician giving ‘30% contributions for a 30% accrual rate, or any other percentage in 10% increments depending on their financial situation’.

This would mean the senior clinician reducing their pension contribution to 30%, but it would also mean their pension on retirement would be reduced commensurately. In the case of a clinician earning more than £111,377, their contribution is currently 14.5%, so their new contribution would be 4.35% (30% of 14.5%).

The cut in employee contributions can be tailored in 10% increments to suit their personal circumstance and ensure they do not fall foul of the pension tax rule or, for very high earners, reduce their exposure.

By reducing the potential tax bill – or eradicating it totally – it is hoped the clinicians will maintain or return to the additional hours they have worked previously.

The proposal has a number of other potential benefits. It could keep senior clinicians in the NHS pension scheme – any significant outflow of contributors could undermine the scheme.

Additionally, by remaining in the scheme, even with reduced contributions, clinicians can continue to take advantage of some of the attractive add-ons to the pension scheme, such as life and ill-health insurance, which are important in recruitment and retention.

What is less clear is how reduced employee contributions would affect employers. Though not confirmed, it appears that employer contributions could decrease, either by an amount agreed with the clinician or to match the employee’s reduced rate.

It is not a given that an employer’s contributions will align with their employee’s. For example, in the local government scheme, employees can reduce their contributions to 50%, but employers are still required to pay the full contribution.

It is possible that employers will have to maintain a level of contribution to fund other benefits, such as the insurance safety nets mentioned above.

Any funds not paid as an employer’s contribution could be paid to the employee as salary, though the clinician should be keeping one eye on how increased earnings – fuelled by reduced employee pension contributions and recycled employer contributions – might affect their exposure to pension tax.

BMA council chair Chaand Nagpaul said the proposal was a step forward. ‘We said clearly when it launched that the earlier consultation on the 50:50 model – whereby doctors and employers halve what they put into their pension pots – was not fit-for-purpose and we are pleased that the government has heeded the BMA’s concerns by ditching it. This method is overly restrictive and can leave doctors putting either too much or too little into their pensions.

‘The government has listened to us on offering full flexibility – meaning doctors can choose the amount they and their employer wish to put away – and we note the assurance that this will not mean doctors “losing out on the value of unused employer contributions”. This must mean full recycling of the entire employer’s contribution being paid back into doctors’ salaries.’

Dr Nagpaul insisted the proposed flexibilities were a short-term measure and tackling the underlying problem meant tax reform. In particular, changing the annual allowance taper was imperative.

The Treasury has committed to reviewing how the allowance operates with a view to supporting the delivery of public services.

Guidance will also be given to employers, setting out how they can use existing local flexibilities to address the pension tax issue.

NHS Providers welcomed the government’s ‘pace and focus’ on the issue. Chief executive Chris Hopson added: ’The government needs to listen carefully to the views of those affected – for example, there is a strong argument that income for extra work beyond normal contracted issues should not be counted in annual allowance taper calculations.’

It is important the government recognises that the issue affects managers too, he said. 

Some providers have taken steps locally to mitigate the tax allowance issue. Three types of scheme are most common, according to NHS Providers. One scheme pays staff who have opted out of the NHS pension scheme the equivalent of the locally administered employer pension contribution (14.3%).

Staff would not be subject to pension tax unless they join an alternative pension scheme. A higher proportion of an affected employee’s pay could be made non-pensionable, possibly by splitting their role into two assignments with separate employment contracts (one where the pay is non-pensionable). In a third scheme, staff could be given additional leave in return for working more than their contracted hours.

But all three approaches could be problematic. For example, while the first option may be a relatively simple and potentially cost-neutral option, there are concerns that it could be discriminatory, and risks being seen as an inducement to opt out of the pension scheme.

A handful of trusts have explored the idea of paying for services from consultants who have formed a limited liability partnership.

The trusts believe this arrangement could allow more flexibility for the staff to manage their pension savings. But these could fall foul of IR35 tax rules.

Clearly, there is an appetite at trust level to sort out the issue. Surveys from the HFMA (see box) and NHS Providers have both found that trusts have developed or are considering local schemes – a signal of the importance of affected clinicians to trusts’ performance. But most providers would prefer a national solution and will be looking in detail at the consultation and eagerly awaiting the review of the taper.