‘Workers forced to retire early could face tax shock’

Hundreds of workers a year who take early retirement due to ill health may face an unexpected tax bill due to a breach of their annual allowance for pension tax relief, according to new research.

The study from mutual insurer Royal London shows workers most affected are likely to be those in public sector schemes such as those for teachers or nurses, where pension benefits are salary related.

The Royal London says the issue arises because those who are no longer able to work because of ill health can be awarded a significant overnight boost to the value of their pension rights. In some schemes, a worker is treated as if they had continued working from the date of early retirement right up to pension age, and the additional pension rights from that assumed service are added in one lump. The income tax system then treats this as if they had made massive contributions into their pension in a single year. This huge growth in the value of their pension rights can easily exceed the £40,000 annual limit, especially if they are some years away from retirement.

Steve Webb, Director of Policy at Royal London said: “Pension schemes do not hand out early retirement benefits lightly, and it seems very harsh to punish those who are in poor health with big tax bills. It is not the case that the workers who face these bills have been shovelling money into a pension in order to max out on pension tax relief. They have simply found themselves unable to do their job, often through no fault of their own, and it is quite wrong to saddle them with a large tax bill as a result”.

The Royal London bases its assessment of how many people may be affected on information from Greater Manchester Pension Fund, the largest local authority pension scheme in the UK.

It found that for those in the scheme who are ill enough to qualify for ill health early retirement, but not so severely ill that they will never work again in any capacity, the growth in their pension is subject to testing against the annual allowance for tax.

An FOI to the Fund showed that in 2018/19 10 members of the scheme received letters to say that their pension growth had taken them above the annual allowance and six of these were subject to a tax charge. If this rate is typical across all public sector pension schemes, the Royal London says it suggests that hundreds of workers taking ill health early retirement are facing tax charges of this sort each year.

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