With a Personal Injury Earnings Loss claim where the claimant has an Ill-health Pension and is also able to continue working (and so has Actual Earnings) then be very careful how those Actual Earnings are calculated – there may be a significant  impact on lost earnings.

When a claimant has an Ill-Health Pension, we know from Parry v Cleaver (1970) AC1 that this pension income is not to be deducted from their But For income prior to their Normal Retirement Age (“NRA”).

Rather, the ill-health pension is set against their But For pension, thereby reducing their pension loss:

Ok, that’s simple enough BUT there can be a ‘twist’ with identifying what the claimant’s Actual Earnings are when there is an ill-health pension in payment.

Let’s look at Sarah’s claim

Sarah was active in the Army Cadets at school where she excelled academically. She went on to Uni and gained a First-Class degree in electrical engineering before then joining the Armed Forces. Sarah was doing well in her forces career (she had reached the rank of Major and was on course to end her military career as a Brigadier) but unfortunately was badly injured in an accident in 2018, aged 40.  Sarah was medically discharged from the Forces in 2020.

But For injury Sarah had planned to stay in the forces until age 55 and then pursue a second career in the private defence sector. Fortunately for Sarah, her skills and experience meant that she quickly secured a well-paid civilian job, as an electronics engineer, on a salary of £100,000.

Keeping the numbers relatively simple, in the year ended 31 March 2021 Sarah’s total gross income was £125,000, which came from her Armed Forces pension of £25,000 plus her Civilian Salary of £100,000. So, for the 2021 tax year, Sarah’s actual net of taxes income was £76,640:

If we look at the above calculation of her Net Income. Sarah’s income (comprising Pension & Salary) was above the Personal Allowance limit for 2021 of £125,000, meaning that she got no personal tax allowance set-off against her income and her income was then taxed at 20% & 40%, plus Class 1 National Insurance contributions on her salary (but not her pension) income.  

Now, we know that Parry v Cleaver tells us not to deduct the Ill-Health pension until after Sarah’s Normal Retirement Age. That would be her normal discharge date from the Armed Forces of aged 55.  OK – that’s simple, got that!

So, we now have to calculate Sarah’s lost earnings (for the 13 years 2020 to 2033 when she is aged 55 and reached her Forces NRD). To do this we need to compare Sarah’s But For Injury Armed Forces Earnings with her Actual With Injury Civilian Earnings, for each year until she is 55.

The big question is – how (set against Parry v Cleaver) should we calculate Sarah’s after-tax Civilian Engineer’s earnings, when she is at the same time in receipt of (and taxed on!) her ill-health pension income?

Well, there are different ways of calculating Sarah’s Net (salary) Income – and they give wildly varying answers! I have just spent some time arguing what is a fair and reasonable approach in these circumstances.

Let’s take a look at two ways of calculating Sarah’s after-tax civilian salary

First method: Let’s ignore the Pension and pretend that the Civilian Salary is all that exists, let us call this Basis A. This calculation method produces a Net Earnings figure for Sarah of £66,640:

That was the method used by the Defendant’s accountancy expert, who asserted that Parry v Cleaver meant that one should ignore the ill-health pension, simply ‘pretend’ it does not exist.

Second method: let us look at the marginal impact the salary has on Sarah’s net income

 The Sarah is mitigating her lost Armed Forces salary by working in the civilian sector and generating alternative income, which is in addition to her Armed Forces Ill-health pension. The reality is that Sarah receives an Armed Forces Ill-health pension and in parallel works in her civilian job to mitigate her personal injury losses – and again the reality is that Sarah pays ‘taxes’ arising from both her pension and salary incomes.

To identify the marginal impact of the Civilian salary, income that is additional to her Armed Forces pension, we calculate the taxes arising on just the pension and compare these with the taxes arising on both the pension and salary. This is our second (basis B) method. The difference equates directly to the marginal impact of the salary.  On Basis B we arrive at Net Earnings (based on Sarah’s Civilian Salary) of £54,140, which is much less Basis A – where Sarah’s earnings are calculated on the Civilian Salary in isolation:

The Actual Net Income from Sarah’s Civilian Job will be deducted from her But For Net Income (from her Armed Forces Job) so as to identify her lost earnings. As such, it is (I would say, very) material that there is a 23% difference in Actual Net Income between the A & B calculation bases.  Ignoring discounting and uncertainty adjustments, over 13 years the difference in the two calculation methods (A & B) is a staggering £162,500.

The story doesn’t end there, as there are other potential ways one could estimate the taxes attributable to the Civilian Salary.

For example, one could identify the top slice of taxes in 2021 and attribute that to the salary or one could ‘simply’ pro-rata the actual total tax bill for 2021 between pension and salary incomes. I don’t like either of these methods; I feel they are somewhat artificial and theoretical. That is particularly, when those methods are compared against Basis B – which identifies the real financial impact of Sarah’s Civilian Salary ‘arriving’ in addition to her Armed Forces Pension.

The takeaway from this story is be aware that when there is an ill-health pension and the claimant is capable of working then be mindful that the way taxes are calculated can impact (potentially significantly) on Earnings Loss Quantum.

Richard Formby FCA MAE

We are always happy to give initial thoughts & advice on evidence and approach to loss quantum. Contact us today Richard@FormbyForensics.co.uk or tel. 01761- 437972

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