Tax free limit on annual pensions savings could be increased

The amount that people can save tax-free into their pensions each year could be raised in a bid to persuade the over-50s to stay in work.

The Treasury is looking at raising the annual allowance, which currently stands at £40,000 for all but the highest earners, to dissuade professionals – including NHS doctors – against early retirement.

Above this level, people have to pay income tax on the amount they pay into their pension pots.

The plan is being considered by Jeremy Hunt, the Chancellor, as part of his push to decrease the rising levels of inactivity that are hampering Britain’s economic progress.

It could also help the NHS to retain older doctors, many of whom are planning to retire early over complaints that their pension pots were being too highly taxed.

However, it is understood that while the idea is “on the table”, the Chancellor is concerned about the potential cost of the move.

Mr Hunt believes that, alongside halving inflation, getting more people back into the labour market is essential to driving growth.

In a major speech last month he pledged a “fundamental programme of reforms” to end the “enormous and shocking waste of talent and potential” in Britain’s economy.

Some 8.9 million people in Britain are not in work despite being of working age – 570,000 more than before the pandemic. The figure includes students, those looking after families such as stay-at-home mothers and carers, the long-term sick and early retirees.

It was already known that ministers were considering raising the lifetime pensions allowance, under which people have to pay up to 55 per cent tax if their pension pot exceeds £1.073 million.

This rule leads many people – including many NHS doctors – to decide that continuing to work is not worthwhile.

Now it has emerged that they are also looking at the annual allowance.

This follows the Institute for Fiscal Studies last week calling for a substantial increase in the allowance.

A report said: “There is good reason to doubt the usefulness of a limit on the amount an individual can contribute to a private pension in a single year.

“With a more rational tax treatment of pensions – and in particular one that limits the extent to which those who are not at risk of undersaving for retirement are able to receive an effective tax subsidy on additional pension saving – then the case for a constraining annual limit would be reduced further.

“We therefore recommend that it is made much more generous so that fewer people are affected.”

Baroness Altmann, the former pensions minister, said the annual allowance had not increased for many years and was a “punishment” for higher earners, as well as being far too complicated.

She said: “The way the annual allowance works needs a radical overhaul. It is far too complicated and has been stuck at current levels for years.

“Also, the high inflation levels we are seeing now make it unfair for many senior staff who are penalised by the way the complex calculations work.”

Steve Webb, a partner at pension consultants LCP, said: “There is no doubt that there are some senior doctors who have retired or considered retiring because they have faced big pension tax charges.

“A targeted measure to deal with this issue could have a major impact on NHS recruitment and retention.

“But there is very little evidence that a general increase in tax-free limits for all workers would make much difference to decisions about retiring or coming out of retirement, and this money could be better spent on more effective measures to get the over-50s back to work.”

On top of the allowance, there is also a “taper” that affects high earners and significantly reduces the size of the annual allowance. This has applied since April 2016 and cuts the amount people can save into their pension tax-free.

This is calculated based on a “threshold” and “adjusted” income. The threshold income includes income from all sources, not just a person’s salary, such as investments and buy-to-let properties. Adjusted income is calculated in a similar way but includes pension contributions that both employee and employer make from gross pay and via salary sacrifice.

If a person’s threshold income is more than £200,000 and adjusted income is more than £240,000 a year, then the annual allowance will drop from £40,000 to a minimum of £4,000.

The annual allowance falls by £1 for every £2 of adjusted income over £240,000.

Last year, there was a spike in the number of NHS doctors breaching the annual allowance. Some 56,000 doctors breached the £40,000 level – up 68 per cent in a year.

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