Hundreds of workers taking early retirement due to ill health may face an unexpected tax bill over annual allowance (AA) breaches, research from Royal London has revealed.

Workers in public sector schemes are most likely to be affected due to their pension benefits being salary dependent.

Many schemes treat those who are retiring early due to ill health considerations as if they had continued working from the date of early retirement until their pension age, with any additional pension rights from this assumed service added in one lump.

This can often mean a significant “overnight” boost in the value of an individuals pension rights, with the income tax system treating this as simply a “massive contribution” to the pension in a single year, often “easily” exceeding the £40,000 annual limit.

Royal London director of Policy, Steve Webb, commented: “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 group examined the Greater Manchester Pension Fund (GMPF) as a case study, with a freedom of information (FOI) request revealing that, in 2018/19, ten members saw their pension growth exceed the AA, with six of these subject to a tax charge.

In its guide to members, the GMPF stated: “If [the member] retires on ill health under tiers 1 or 2 they may be subject to an annual allowance test unless the approved doctor certifies that they are suffering from ill health which makes it unlikely that they will be able ….to carry out gainful work (in any capacity) before reaching their state pension age.”

Royal London emphasised that if this trend was typical across all public sector pension schemes, then it suggests that “hundreds of workers” are facing this type of tax charge every year.

Issues around the annual allowance have gained attention following issues for NHS members, which saw some doctors cutting back hours and retiring early to avoid punitive pensions taxation.

However, the Royal London research has highlighted the broader tax implications across the public sector, while a FOI request from Quilter last year also echoed this, revealing that 3,840 members of the armed forces had breached the annual allowance in 2017/18.

The government confirmed that a review of the allowance is underway earlier this month, with experts calling for any solutions to the NHS pensions taxation to be applied across the public sector.

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