How pension reform can encourage people back to work

• The lifetime allowance freeze has impacted many workers including some NHS doctors who have chosen to retire rather than pay large tax charges
• The cost of living crisis has seen an increase in those accessing their pension earlier than planned – but pension allowances can hamper the route back to work for over 55s

The workforce in the UK has shrunk as a result of the sharp rise in working-age adults neither in work nor looking, and this is causing concern for the economic outlook. It’s an issue that the Chancellor will no doubt want to address in next week’s Budget, and the hope is that he’ll remove some of the blockers in the pensions tax system to encourage more people back to work.

Clare Moffat, Pensions & Legal Expert at Royal London says:

"A key focus of the Budget needs to involve addressing pension lifetime and annual allowances. The freezing of the former has meant that many more people are impacted by how much they can save in a tax efficient way, but crucially has been key in the decision making of many, including doctors in the NHS, to choose to leave their professions and retire rather than pay large tax charges. 

Lifetime allowance – unfreezing the freeze to encourage more people to continue their career

"The pensions lifetime allowance is a tax charge that used to impact only a small number of individuals. It is now felt much more broadly, including by a greater number of NHS doctors and other high earners in the public sector. It used to rise each year in line with inflation but has been frozen at £1,073,100 until 2025/26. Had it continued to rise by inflation, it would have reached around £1.25m in the tax year 2023/24.

"Unfreezing the lifetime allowance and reinstating the link to CPI would mean it would increase by 10.1% in April 2023 and could encourage some people back into the workplace.

"If the lifetime allowance had increased even by the government’s inflation target of 2% during the freeze, then by April 2026 savers would have been able to build up a pension pot of £1,184,789 without a lifetime allowance tax charge applying. The lifetime allowance remaining frozen at £1,073,100 until April 2026, could result in a tax charge exceeding £60k* on the same pension pot. This is having a particularly negative impact on senior clinicians in the NHS, a group essential to clearing the NHS waiting lists in the wake of the Covid 19 pandemic.

Money Purchase Annual Allowance (MPAA)

"The MPAA currently hampers any decision to return to work for any over 55s who have accessed their pension flexibly. It doesn’t apply if you just access your tax free cash and move the rest into drawdown nor does it apply to defined benefit plans including public sector pensions. However, it will apply if you take any cash lump sum or drawdown income in excess of tax free cash. The MPAA is currently set at £4,000 and a tax charge is payable if total pension contributions by an individual, an employer or anyone else on the individual’s behalf, are more than £4,000 in the tax year. To encourage people back into the workforce who have stopped working and triggered the MPAA, it would greatly help to raise this allowance.

"But for those doctors in the NHS who have retired due to pension tax charges – this increase won’t make a difference if their only pension was the NHS pension as public sector defined benefit pensions aren’t limited by the MPAA.

"However, it will make a difference to those people who have found themselves having to take pension money from their defined contribution pension pots while striving to deal with the cost of living crisis. Royal London research shows that a combination of rising costs and challenging economic conditions has prompted many to want to access their pension earlier than they planned, according to almost a third (31%) of advisers. But this may mean they will need to carry on working and saving into their pensions for longer to provide the retirement they were aspiring to.

Health issues restricting economic activity

"There are clearly a significant number of people unable to work due to longstanding, untreated health issues, including those directly related to Covid. But there are other, under-reported issues.

"Lack of support for menopausal employees is having a huge economic impact with almost a million leaving their job and many more reducing their hours. Not only is this preventing some women from working, it means they could miss out on important pension savings of up to £126,000, widening an already significant gender pensions gap. Helping to solve the issue, through improving how women experiencing the menopause are accommodated in the workplace, will help many more women fulfil their potential and ensure the economy reaps the benefits too.”