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Tax hurdles ahead in public sector pension reforms

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Public sector retirees face crucial pension choices as the McCloud Remedy comes into force and will present some tough tax challenges.

22nd Sep 2023
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From 1 October 2023, some individuals retiring from the public sector will need to make an important decision about the pension they will receive as phase two of the McCloud Remedy is implemented. This will affect the amount of pension they receive and could also have significant tax implications.

What is the McCloud Remedy?

In April 2015 the government replaced existing public sector pensions, 'legacy schemes', which calculated pension entitlements based (mostly) on final salary, with 'reformed schemes' based on career average salaries.

This affected the pensions of each of the main workforces - local government, teachers, the NHS, the armed forces, firefighters, police, the judiciary and the civil service.

Transitional arrangements, designed to avoid confusion and potential discrimination for those closest to retirement, allowed older individuals to remain in the legacy scheme until their retirement or 31 March 2022, whichever came first. All other members were moved onto the reformed scheme from 1 April 2015.

As explained by Andy Keates in AccountingWEB, the Court of Appeal ruled in December 2018, in the case of McCloud and Sargeant that the transitional arrangements discriminated unlawfully against younger members.

To remedy this, the government introduced changes which returned all individuals to their legacy scheme for the transitional or 'remedy' period (1 April 2015 – 31 March 2022). This is widely referred to as the McCloud Remedy.

The reforms were designed, in part, to even out disparity between the pensions of the highest and lowest earners in the public sector. So, while the legacy schemes would have been more beneficial for many individuals, others, particularly lower earners, will in fact be better off under the reformed schemes.

Members will therefore be given a choice on retirement whether to receive benefits under the legacy or reformed pension scheme for the remedy period.

The government intends to make this option available on retirement from 1 October 2023 and changes should be applied retrospectively – and payments backdated - for members who have already retired by this date.

Correcting the tax position

So what does this mean from a tax perspective?

The vast majority of scheme members will see no changes to their tax position. However, for some the retrospective adjustment to their pension between 2015/16 and 2022/23 could impact on the annual allowance (AA) tax charge payable in some or all of the remedy years. Each year an individual's pension input amount, being the actuarial increase in defined benefits under the scheme plus any direct contributions, is measured against the AA and any excess is taxed at the taxpayer's marginal tax rate (up to 45% for an additional rate taxpayer – higher for Scottish taxpayers).

The AA was £80,000 for 2015/16, £40,000 from 2016/17 to 2022/23 and £60,000 from April 2023.

Depending on the individual position of the taxpayer, changes in the pension input amount as a result of returning to the legacy scheme for the remedy period could trigger an increase or decrease in an existing AA tax charge, or cause a new charge to arise.

Some members may also fall foul of the Lifetime Allowance (LTA) charge if their pension is increased to above the LTA under the remedy. The LTA was set at £1,073,000 for 2022/23 but has been abolished for 2023/24.

HMRC to the rescue

HMRC has said that affected taxpayers will not need to resubmit self assessment tax returns for the relevant years. Nor will an adjustment be required on the 2022/23 tax return. Instead, a new digital service is due to be launched on 1 October to enable affected members to:

  • pay excess or new AA tax charges or apply for refunds for the years 2019/20 to 2022/23; and
  • apply for compensation for AA tax charges overpaid in the years 2015/16 to 2018/19.

As the earlier years are outside the four-year time limit for HMRC to correct an error that is not the fault of the taxpayer, any amounts underpaid as a result of the McCloud Remedy will not be payable to HMRC for those years but compensation will be given for any overpayment.

The pension input amounts will be recalculated by the schemes and new remedial pension statements sent to affected members. It will then be down to the members to use the HMRC digital tool to make any additional payment or apply for a refund and/or compensation. Affected members may be reimbursed by the schemes for reasonable fees incurred in obtaining tax or financial advice or engaging an agent to help with this.

The schemes have assured their members that where additional tax is payable, this will not be higher than the tax that would have arisen had they remained on the legacy scheme, and will correspond to an increase in their pension pot. Nevertheless, some members may well be hit with a substantial amount of unexpected tax to pay.

An HMRC spokesperson said: “We are delivering a wide range of support to those whose tax position is impacted by the McCloud judgement, including interactive guidance and a digital service for members to correct tax contributions and claim compensation where appropriate. 

“The necessary legislation is in place and all impacted members will receive information from their pension scheme in due course.”

According to HMRC the interactive guidance and digital service, designed to assist both affected individuals and schemes, is expected to be available in early October as planned.

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Replies (14)

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By Justin Bryant
24th Sep 2023 10:21

Another interesting final salary pension story here re collapse in cash transfer values: https://www.thisismoney.co.uk/money/pensions/article-11315527/Why-pensio...

I like the way it's explained as being of little consequence, like Harold Wilson explaining the collapse of sterling. Presumably if you'd have cash transferred out to a SIPP before LT's madness you'd be laughing.

https://www.msn.com/en-gb/money/other/the-cash-transfer-value-of-my-pens...

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Replying to Justin Bryant:
Should Be Working ... not playing with the car
By should_be_working
25th Sep 2023 10:59

Justin Bryant wrote:

Another interesting final salary pension story here re collapse in cash transfer values: https://www.thisismoney.co.uk/money/pensions/article-11315527/Why-pensio...

I like the way it's explained as being of little consequence, like Harold Wilson explaining the collapse of sterling. Presumably if you'd have cash transferred out to a SIPP before LT's madness you'd be laughing.

https://www.msn.com/en-gb/money/other/the-cash-transfer-value-of-my-pens...

The DM article simply explains that interest rates are rising hence the fall in transfer values.

Not sure what any of this has to do with 'LT's madness' - the only real relevance of that period was the scandal of the use of LDIs in pension funds which was conveniently swept under the carpet while Liz Truss was taking the blame for everything.

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Replying to should_be_working:
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By Justin Bryant
25th Sep 2023 11:19

Eh? UK Gilts crashed in value around this time last year thanks to LT (if you believe otherwise, see the link below), so it was thanks to her mainly and people who cashed out of UK Gilts in any way shape or form before then were basically sitting pretty (that's how Crispin Odey made a bit of a killing recently):
https://www.bbc.co.uk/news/business-66897881
https://www.euronews.com/next/2022/09/23/britain-hedgefunds-odey

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Replying to Justin Bryant:
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By flightdeck
25th Sep 2023 13:50

Justin - as an aside,as it's not to do with public sector pensions, how quickly did the bond markets recover after she left office? (if they did)

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Replying to flightdeck:
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By Justin Bryant
25th Sep 2023 14:47

Gilts were never as high after LT's shenanigans in case that's what you mean (this is known in the trade as the "moron premium"), and emergency BoE intervention merely halted the death spiral in UK Gilts at the time you may recall (Google it if you don't).
https://www.ft.com/content/7bad4783-e6d1-4776-8fa7-4188bbb9d86f

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Guest speaker Brian Wright
By Brian Wright
25th Sep 2023 14:56

Absolute disgrace!

"As the earlier years are outside the four-year time limit for HMRC to correct an error that is not the fault of the taxpayer, any amounts underpaid as a result of the McCloud Remedy will not be payable to HMRC for those years but compensation will be given for any overpayment."

We'll not recover taxpayers monies where additional employment benefits are given, but we'll use taxpayers monies to compensate where the benefits are reduced.

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Replying to fbdconsultancy:
Ray McCann
By Ray McCann
25th Sep 2023 15:26

Sounds fair, public sector pensions have been subject to change after change after change for decades all for the worse whilst their pay was held back.

These issues are entirely down to Government putting money saving as the number one priority.

Thanks (1)
Replying to RayM55:
Danny Kent
By Viciuno
25th Sep 2023 16:20

RayM55 wrote:

Sounds fair, public sector pensions have been subject to change after change after change for decades all for the worse whilst their pay was held back.

.

I know exactly zero poorly paid public sector workers; especially the older generation.

My mum paid into a local council pension for 5 years, her pension is worth (in cash terms) nearly 1/2 of my dads, who has paid in diligently every month, through thick and thin, for the last 35 years into his private pension.

Public sector workers are well paid (despite what they say), eligible for discounts everywhere, secure jobs (can you even get fired from the public sector?), gold plated pensions (not to mention the % E'er contributions), great holidays, morons for bosses who accept turning up as "doing a great job", working for home as standard....

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Replying to Viciuno:
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By Justin Bryant
25th Sep 2023 17:45

Yes. This analysis/forecast from 2008 looks pretty accurate: https://iea.org.uk/in-the-media/press-release/pension-debts-could-bankru...

Except things are of course even worse now.

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Replying to Viciuno:
paddle steamer
By DJKL
25th Sep 2023 18:38

Are you sure?

Up here classroom assistants are not particularly well paid, whilst they get long holidays unlike teachers they do not get extensive paid holidays (their salaries are spread out over the year including the unpaid holidays), they attend work (rarely work from home), can often work late (7.00 pm meetings not out the norm) and tomorrow , for the first time in years, they and others like them are going on strike. (About time)

Why do I know this, well my other half happens to be one.

They are certainly worth the money in most cases, they are often very well educated returnees to the workforce taking a job that fitted with school holidays for their own children.

My other half has an MA and an MSc, was a stockmarket registered Rep yet gets paid (on a full year basis, in reality less re unpaid holidays) well below £20k pa. (She was earnings far more than that way back in 1988)

As for experience, my other half was, back in the day, a Quant /Data stockmarket analysts with in turn Natwest, Bankers trust, BT Alex Brown, Deutsche Bank, then did similar with both Standard Life and Baillie Gifford. In the 80s she was earning far more than she gets today, same individual, same education, greater experience and she can still manipulate excel/databases to make my eyes water, but she is paid a pittance.

Schools etc have for years played on loyalty etc to get them to continue churning out the work they do for hee haw pay.

Thanks (2)
Replying to DJKL:
paddle steamer
By DJKL
26th Sep 2023 09:57

To get an idea how poorly paid some are, chatting last night it transpires my wife's strike pay from Unison will be circa £90 a day, this seems to be same/slightly more than she normally earns- they are so badly paid they are possibly better off on strike!!!!!

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Replying to DJKL:
Danny Kent
By Viciuno
26th Sep 2023 16:45

Obviously I can't comment on your wife's circumstances; and I don't know the difference between extensive paid holidays and long holidays (is a holiday not just a holiday?) - but comparing her salary working as a stock market analysts with that of a classroom assistant is comparing apples and oranges.

If I went to work at Tesco tomorrow stocking shelves I wouldn't expect to be paid what I do now; you don't get paid based on the letters after your name.

For the record, most people working in banking are horrendously overpaid, hardly a benchmark for pay across the board and the public sector (or the private for that matter!) certainly cannot afford to pay wages like that to everyone!

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Replying to Viciuno:
paddle steamer
By DJKL
26th Sep 2023 18:17

Yes- but her quant skills are used by the school (The education system makes a lot of use of databases), classroom assistants do not just sit in classrooms assisting children (though that too is actually quite skilled), they often cover much of the school admin processes.

However all now too late, yesterday she handed in her notice, early retirement now beckons.

Will not bother the local authority, am sure they will find another sucker.

For the record, would you be happy to work for barely above minimum wage rate?

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Replying to Viciuno:
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By CathyM1
25th Sep 2023 19:24

I know exactly zero poorly paid public sector workers; especially the older generation.

Never met a nurse, a teacher or a lecturer then? I took a 7k pay cut when I moved from being an accountant to lecturing in it and that was 30 years ago. My pension contributions also went up by 50% a few years later, for no extra pension benefits.

Cathy

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