How the pension contributions annual allowance is crippling the NHS

NHS doctors are responding to the perverse financial incentives of the pension contributions annual allowance scheme by just not doing any extra work. The system needs fixing. And not just for doctors.

Doctor walking away from camera © Christopher Furlong/Getty Images

Many doctors are simply walking away
(Image credit: Doctor walking away from camera © Christopher Furlong/Getty Images)

It's a bad time to be needing an operation in the UK. Waiting lists have risen "up to 50%" in England; consultants are refusing to do any unplanned work or overtime; and delays on the are "becoming increasingly common" says the BBC. They are also beginning to retire earlier than they did.

Why? Because that is what the financial incentives we are giving them tell them to do.

We have long had a system in the UK that limits the amount anyone can contribute to a pension scheme and still receive tax relief every year. It started out at a very high level £255,000 in 2009-2010 so almost no one had to worry about breaching it. Then it started to fall to £40,000 now.

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Then in 2016, George Osborne did something very silly. In an attempt to show that he was as keen to make the well paid suffer financially as everyone else, he introduced a taper to this. It sounded simple(ish) at first. Anyone earning over £150,000 would gradually have their allowance cut until, at £210,000 it would be a mere £10,000.

The system is overly complicated

It is actually anything but simple. There are complications around what makes an income of £150,000 earn more than £110,000 (the threshold income) and you are automatically in the firing line for the taper.

That's something people with defined contribution pensions and one main source of income can usually mitigate they know if they will breach it with their auto-enrolment from their PAYE jobs for example and ask for cash in lieu of pension.

It's still a huge pain for anyone with variable income (if you don't know what your earnings will be in any one year you can't know what your tax-free pension allowance will be) but that disincentive for private sector workers to take on extra work is not, of course, a big enough problem for the front pages of the paper.

Public sector pensions are a different matter. They are mostly pretty generous (this is where much of the tax relief goes) and the taper was introduced in part to address this (you might say it would just be easier to make them much less generous rather than complicate things at the other end but you are not a politician). But that's the thing that causes the problem.

Doctors often have no idea if and when they will go over the taper. The pension contributions made on their behalf are high; their schedules and overtime payments in particular are uncertain; and any growth in the value of their pension (something that is outside their control) gets added to the income calculations and ups their risk. And when they do go over the taper they get a bill: that charge needs to be paid in the year that it is incurred. This is the real killer.

In theory you should come out evens from paying the penalty tax. The pension contributions are still made; you benefit from their capital growth tax-free until your retirement; and in the long term that should result in you having the same amount of money you would have had if you paid ordinary income tax on it in the year it was earned. The problem then, in the main, is a cash flow problem: you have to pay tax now on money you won't get until you retire. And a lot of tax, at that. Some public sector workers have reported bills of over £80,000.

It is, I know, hard to have sympathy with people on this kind of income and with the kind of pensions on the way that these tax bills suggest they have on the go. And it is possible for them to ask their schemes to pay the bill and to reduce their pension accordingly but this comes with high interest rates (it counts as a loan) and with endless admin.

Anyway, it doesn't really matter whether one has sympathy or not. If the pension system means that doctors are incentivised not to work, and that our already unsatisfactory health system is becoming even less satisfactory, something must be done.

Possible solutions

We are very against an NHS-specific solution to all this. It affects all high earners and it's a level of boring admin that is entirely unnecessary.

Our own view is that the taper system and in fact the entire annual allowance system should be abolished. Any reduction in the tax take can be dealt with by simply reducing the lifetime allowance to a more suitable level (bearing in mind that the point of tax relief on pensions is to encourage us to save enough to prevent dependence on the state in old age and nothing more). This would irritate everyone with defined-benefit pensions, of course, but would not have the same nightmare annual cash flow issues as the taper and annual allowance do.

Another possible option is to change the tax relief on contributions so that the cost is less skewed towards high earners 25% for everyone, perhaps, rather than 20% for low earners and 45% for very high earners.

Yet another is to cut the income-tax-free lump sum you can get from your pension when you are 55. It's currently 25% but there is no obvious reason for it not to be 10% 15% or 20%.

Hammond has ruled out all these things. The best he has done so far is to suggest ways to make the NHS system more flexible (spot the oxymoron). Hopefully, the next chancellor will be less of a twit. If he isn't, it won't be long before every senior doctor in the NHS is spending an awful lot more time on golf courses than in hospitals.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.