Understanding pensions tax issues are a source of many a doctor’s headache. Ian Tongue cuts through the jargon and gives some smart tips.
Being prudent and saving for your retirement has historically been rewarded with tax relief, but, in more recent times, those with final salary-type pension schemes have been faced with worries over receiving a large tax bill.
Changes to the NHS Pension Scheme have been significant, so understanding your position and planning are the key to avoiding pension tax shocks.
Think of the issue as twofold involving the analogy of a bucket.
The rate at which you are filling the bucket is the pension annual allowance. If you fill the bucket too quickly, you get an annual allowance tax charge which is assessed every year as part of your self-assessment tax return.
Think of the lifetime allowance charge as the capacity of the bucket, which, when reached, prompts a lifetime allowance charge when you come to retire.
It is really important to note that the lifetime allowance is not a maximum figure that your pension can be, but a level at which the rate of increase of pension benefits can reduce due to a tax charge being incurred on the element of pension over the capacity of the bucket.
Working with an accountant and independent financial adviser who understands your NHS pension is crucial to your understanding of the pension, as the rules around this are complex and not easy to research yourself.
Definitely do not make decisions based on what others have done, as this can often be incorrect for your circumstances.
When you hear of colleagues having a tax charge on their pension, it is more than likely going to be an annual allowance charge, as these are calculated and included on your personal tax return annually.
These charges can either be paid with any other tax due for that year or the pension scheme can pay the tax due with what is called a ‘scheme pays’ election.
A ‘scheme pays’ election is a behind-the-scenes loan that incurs interest and when you come to retire, you lose some of your pension based on how much you owe.
For many, the ‘scheme pays’ option is the choice made due to cash flow constraints, but for those who are able to pay the tax, do not assume that the ‘scheme pays’ route should be avoided. Speak with your accountant and adviser to understand your position before making a decision.
The introduction of annual allowance tapering from 2016-17 was the tipping point for most consultants and GPs to have exposure to pension tax charges.
Instead of receiving a £40,000 allowance each year, it could be as low as £10,000 depending on earnings and pension growth combined once the earnings threshold of £110,000 is exceeded.
Concession too late
Compounding the problem was NHS Pensions’ reluctance to allow the ‘scheme pays’ facility where a member was tapered. Thankfully, NHS Pensions made concessions later on, but not until many had suffered significant tax charges and some even left the scheme directly as a result.
As things stand, the landscape has improved because the earnings threshold for annual allowance tapering is now £200,000, so you would need to have combined earnings and pension growth of £312,000 to hit the lowest available annual allowance which is now just £4,000.
For most, there are tax planning opportunities to ensure that you preserve all of your £40,000 allowance each year. Having a medical accountant should ensure that you are best placed here.
With a £40,000 allowance and the ability to look back three years to utilise any unused relief, most will be able to avoid tax charges, but certain key factors will always be a risk:
An inflationary pay rise;
A national merit award;
Other pensionable roles.
Having a combination of these factors can be the perfect storm for a significant tax liability and therefore having an accountant that can explain your circumstances and help you plan is the best way to mitigate or avoid annual allowance tax charges altogether.
In the run-up to the general election in 2019, many doctors were unable to carry out waiting list work without being hurt financially by the annual allowance tapering mechanism and this finally became the catalyst for change.
Changing tax legislation is a long process, so, as an interim measure, the Government announced a compensation scheme. This means any annual allowance charge for 2019-20 would effectively be compensated using a legally binding arrangement between the employing trust, NHS Pensions and the Government.
Most people are eligible for this, but notable exceptions are those working in Scotland and those who do not carry out clinical work.
There is a process to apply for the compensation scheme which requires a ‘scheme pays’ election for 2019-20 to be submitted first. The scheme pays election deadline for 2019-20 is 31 July 2021, so do not delay if you have an annual allowance charge for that year.
At the time of writing, the compensation scheme can be applied for up to 31 March 2022, so there is less pressure for that, but it is probably best to deal with both at the same time.
Lifetime allowance charge
The lifetime allowance charge is applied at retirement and NHS Pensions will carry out the necessary calculations. Some will have pension protection from when the limits reduced and it is important that you have details of this when preparing your paperwork.
Where the lifetime allowance is exceeded, a tax charge on the excess is applied at 25% if taken as income.
The tax payable is automatically deducted from your pension which applies for life. Often the reduction in the pension is modest, as the pension forgone would have been taxed at 40%.
Following the Hutton report in 2011, new pension schemes were proposed across the public sector to move away from schemes based on final salary to being career earnings-based.
The way in which these were forced onto members was based on age and, following a legal challenge, this was deemed to be illegal by the courts due to age discrimination. The ‘fix’ for this is what is known as the McCloud remedy.
The McCloud remedy has many elements to it, but is basically giving members a choice for the period 1 April 2015 to 31 March 2022 whether they want to be in the 2015 scheme or go back to their legacy scheme, usually the 1995 scheme. From 1 April 2022, every NHS Pension Scheme member will be in the 2015 scheme.
The implications of this in the context of this article are that previous calculations of pension annual allowance will need to be revised and the value of a member’s pension will be different depending on which scheme is adopted.
Your actual choice will be made at retirement, so, for most, this is not an immediate consideration but many will want to know their position in advance.
Pension annual allowance charges have been particularly punitive over recent years and have acted as a disincentive to work.
Thankfully, the landscape is now fairer for most members, with reduced exposure to annual allowance charges and more pension options. It is refreshing to be writing at last about positive changes to pensions.
Ian Tongue (right) is a partner with Sandison Easson accountants