Armed forces high earners breach UK pension allowance

The number of armed forces personnel hit with tax charges for breaching their annual pension saving allowance has nearly doubled in a year, as the government has reined in retirement saving perks for higher earners.

The annual allowance governs how much can be saved, or grow, in a pension each year and benefit from tax relief.

Savings above the annual allowance threshold, currently £40,000 for most savers, and as low as £4,000 for the highest earners, are subject to tax charges.

The government has made successive cuts to the annual allowance since the 2010-11 tax year, reducing the threshold from £255,000 to £40,000. This has brought more high earners into the scope of tax charges, particularly in the public sector.

Some 4,140 members of the Armed Forces Pension Scheme exceeded the annual allowance in 2019-20, an 80 per cent increase on the 2,300 breaches recorded in the previous tax year.

The figures, obtained through a Freedom of Information request, put the number of armed forces personnel exceeding the annual allowance at a record high since the numbers peaked at 3,920 people in 2016-17.

“Since the rules around the annual allowance were changed, we have seen a slew of senior members of key public services impacted,” said David Gibb, a chartered financial planner at Quilter, which lodged the FOI.

“The most notable profession impacted was doctors, who were declining extra shifts to avoid spiralling tax bills. However, this data shows that these pension tax rules have the capacity to cause staffing crises across the public sector.”

Armed forces leaders have said the tax policy was affecting not only the highest ranking but non-commissioned and middle-ranking officers, including Royal Navy lieutenant commanders and commanders, army majors and lieutenant-colonels, whose salaries are around £80,000-£90,000.

Major General Neil Marshall, head of the Forces Pension Society, said: “More and more military people are being forced to consider the impact this tax may have on their financial future and many then begin to question their commitment to service in the armed forces. This cannot be the intended consequence of the government’s pension taxation policy.”

Pension scheme members facing tax charges for annual allowance breaches confronted the difficult choice of paying these hefty tax bills, declining overtime or considering early retirement. 

Because of the way pensions grow and are arranged in the public sector, members have little choice but to opt out of saving, or work fewer hours, if they want to avoid the tax charges for breaching the allowance.

Since 2016, greater numbers of public sector staff have been brought into the scope of the allowance, following the introduction of a tapered annual allowance that initially only hit those with “threshold” incomes of more than £110,000.

However, in 2020 the threshold income was raised to £200,000 after concerns the taper was contributing to a staffing crisis in the NHS. Doctors were reducing their hours or retiring early to avoid falling foul of the taper tax.

Savers with “threshold” or broadly net incomes of more than £200,000 lose £1 from the annual allowance for every £2 of “adjusted income” over £240,000. This threshold reduces down to just £4,000 for individuals with total earnings of £312,000 or more. 

Adjusted income is broadly all income that is taxable, including dividends, savings interest and rental income, as well as the value of someone’s contributions to their pension and those of their employer.

“Certain public sector workers in defined benefit pensions historically have been particularly vulnerable [to the taper],” said Gibb.

“This is due to the way benefits accrued under a defined benefit pension are calculated and means a worker can easily see their pension accrual docked under an annual allowance tax charge.”

In contrast, those saving into “defined contribution” schemes, which are more common in the private sector, can avoid the taper by reducing or stopping their contributions, and potentially use other vehicles to save for retirement, such as Isas.

The Treasury said: “The Armed Forces Pension Scheme is a generous non-contributory scheme, meaning members pay no pension contributions, with the costs of the scheme met through employer contributions paid by the Ministry of Defence.

“We want people to save into a pension for their future and 99 per cent of pension savers save less than £40,000 into a pension annually, which means they don’t incur annual allowance pension tax charges. 

“We restrict tax relief available for the highest earners to get the balance right between encouraging saving and managing government finances.”