Being too sick to work could spark a tax bill

Workers who take early retirement due to ill health are being warned they may face an unexpectedly large tax bill. This is because they can end up breaching their annual allowance for pension tax relief.

Research from insurance giant Royal London suggests that hundreds of workers a year could be affected by this little-known tax issue.

Those most affected are likely to be in public sector schemes such as teachers or nurses, where pension benefits are salary related.

This 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 – and this huge growth in the value of their pension rights can easily exceed the £40,000 annual limit people can save into pensions and receive tax relief on, especially if a person is some years away from their retirement age.

This will typically affect those who are sick enough to qualify for ill health early retirement, but aren’t so poorly that they will never work again in any capacity. Whereas those who get certified by an approved doctor as meeting the severe ill health criteria won’t face large tax bills.

Steve Webb, former pensions minister and director of policy at Royal London, said: “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, and it is quite wrong to saddle them with a large tax bill as a result.”