Annual allowance – don’t you just hate the restrictions? Alec James gives an update on the tax charges on your pensions.
Many readers may not be aware that when the pension savings annual allowance was first introduced in April 2006, the allowance was £215,000 rising in successive years to £255,000.
This meant that considering the annual allowance position was rarely an issue for doctors.
However, when the markets took a downturn in 2008, it was seen by successive governments as a mechanism to generate more tax by reductions in the allowance. The allowance is now normally £40,000, but can decrease down to £4,000 if tapering is applied.
In this article is a summary of the rules and the upcoming changes.
A recap on pension savings
The annual allowance for each taxpayer is currently £40,000. The type of pension scheme you are contributing to determines what amounts are assessed against the annual allowance.
For defined contribution schemes – such as private pension schemes and many employment schemes – the annual allowance is applied to the total contributions from both the taxpayer and employer contributions made during the year.
For defined benefit schemes, such as the NHS Pension Scheme, the taxpayer is assessed not on the contributions paid during the tax year, but instead by how much the pension pot has grown by. This makes annual allowance tax planning much more complicated.
If you are an active member of the NHS scheme and you contribute to a private pension or you also contribute to a non-NHS workplace pension scheme, you have to consider the combined implication of all the pension schemes.
NHS Pension Schemes
Many Independent Practitioner Today readers will have been members of either the 1995 or the 2008 scheme – now often referred to as the ‘legacy schemes’ – and the 2015 scheme.
It is the combined growth across the schemes that will be assessed against the annual allowance each year.
Although what is known as the McCloud remedy may eventually alter the growth figures, legislation dictates that the figures up to 2021-22 will be assessed on the current rules.
As you would expect with different schemes, the legacy and 2015 schemes all grow at different rates. This is due to the way the pension is calculated in each of the schemes:
The 1995 scheme is based on the best pensionable earnings of the last three years prior to your retirement;
The 2008 scheme is based on the best average consecutive three years pensionable earnings out of the last ten years prior to your retirement;
The 2015 Scheme is a Career Average Revalued Earnings (or CARE) scheme.
In the CARE scheme, each year your historic earnings are revalued by the Consumer Price Index (CPI) to bring them in line with current monetary values. The CPI rate used for the 2015 scheme is from September within the tax year.
As an active member of the NHS Pension Scheme, you are also given a 1.5% inflationary increase.
The 1995 and 2008 schemes as detailed above are linked one way or another to final salary and that is an important distinction between these two schemes and the 2015 scheme.
In the three schemes, the annual allowance growth is determined by the value of the pension at the start compared to the end of the year, adjusted by certain arithmetical factors and the CPI.
In determining growth for annual allowance purposes, inflationary influences were intended to be discounted in calculating any annual allowance growth.
This is done by using the CPI figure of the September preceding the tax year that it relates to. For example, in calculating the annual allowance growth for 2021-22, HM Revenue and Customs (HMRC) would use the September 2020 CPI figure.
In some years, the CPI can have the opposite effect to that which it was intended.
Former Health and Social Services Secretary Thérèse Coffey has highlighted the impact the difference in the CPI rates used by NHS Pensions, and HMRC is looking to correct the rules.
At the time of writing this article, there has been no further updates, but hopefully there will be more formal announcements in the near future.
In addition, although you are not actively contributing to the legacy schemes, they are subject to growth when there is a change to your pensionable pay.
This could include:
Any inflationary pay;
National Clinical Excellence Awards;
Salary sacrifice scheme such as a NHS Fleet Car.
National Clinical Impact Awards (NCIA)
From April 2022, the historic National Clinical Excellence Award (NCEA) scheme was replaced by the NCIA. With the change in name comes a change to the level of funding available and also a change in the pension status.
The NCIA is now non-pensionable, whereas the NCEA was pensionable. This means that if you were to have been granted a bronze award or similar, you would likely have seen a significant growth in your legacy scheme as a result of the award.
Similarly, if you cease to be in receipt of a NCEA, you may well see a reduction in your legacy scheme’s pension pot.
It is possible to protect the pension benefit of the award and any other additional pensionable pay over and above the normal ten pensionable programmed activities.
If a loss of this income arises or is anticipated to occur, then advice must be sought.
Going forwards, any NCIA received will not impact your annual allowance growth. It may, however, cause tapering of annual allowance issues.
Tapering of annual allowance
As stated at the beginning of this article, each taxpayer is currently entitled to a £40,000 annual allowance.
This allowance is reduced if the following limits are exceeded:
- If your threshold income is more than £200,000;
- If your threshold income together with your pension savings are more than £240,000.
Your threshold income is effectively your total taxable income in the year and is not limited to your NHS income.
If both limits are exceeded, you will be subject to a tapering of annual allowance. This means that for every £2 your adjusted income goes over £240,000, your annual allowance for the current tax year reduces by £1.
The minimum reduced annual allowance you can have in the current tax year is £4,000. If you have self-employed income, you may wish to consider incorporating the self-employed business into a separate legal entity such as a limited company, even if the income levels are modest.
Annual allowance tax charges
If you believe you may have an annual allowance tax charge or you have received a statement from NHS Pensions, you should always seek the advice of a specialist medical accountant.
It is important to identify the assessable annual allowance growth. It may be possible for you to utilise unused relief from previous years against growth in the current year, if this is in excess of £40,000. This could either reduce or remove an annual allowance tax charge.
If you do have a liability, this can either be paid personally or by opting for a Scheme Pays Election or a mixture of the two options. If you opt to pay the tax personally, it follows the usual tax system and is included on your personal tax return.
A Scheme Pays Election is effectively asking your pension pot to pay the tax liability on your behalf. The tax paid is treated like a loan secured against your pension pot and is therefore subject to interest and charges by NHS Pensions.
On retirement, the Scheme Pays Elections are crystalised before your pension is calculated. There are deadlines for submitting these forms.
Whichever option you choose, disclosures will need to be included on your personal tax return and, if necessary, a Scheme Pays Election needs to be submitted. An incorrect disclosure can prove to be very costly.
Many consultants have opted for an NHS fleet car over the past few years, particularly since the benefit-in-kind rates on electric cars have been low.
Salary sacrifices are deducted from your pensionable pay and therefore can have an impact on either the pension you receive when you come to retire or cause significant pension growth when you return the vehicle.
There can be tax-planning opportunities in respect of the timing of taking out and returning an NHS fleet car and this should be discussed with a specialist medical accountant prior to making any decisions.
Your annual allowance positions for 2021-22 will be based on being in the two pension schemes.
As part of the remedy, for the purpose of assessment of your annual allowance position and depending on when you joined the NHS Pension Schemes, the seven-year period covering 1 April 2015 to 31 March 2022 is likely to be recalculated as if the transition to 2015 scheme had never taken place.
This means that the annual allowance positions for 2015-16 onwards will be recalculated in the legacy scheme relevant to you. This will mean that the annual allowance positions in these years will change, which could result in tax refunds or a tax liability.
When you come to retire, you will be given a choice as to which scheme benefits you wish to receive. This is known as the Deferred Choice Underpin (DCU).
If you are due to retire before 1 October 2023 or are already in receipt of your NHS pension and you will be party to the McCloud remedy, you will continue to receive benefits based on both the legacy scheme and the 2015 scheme, but you will be given the option of making a retrospective choice.
The annual allowance is a complex area for doctors and careful planning should be taken if your circumstances within the NHS are changing.
Many of you will have received a letter from NHS Pensions in the last few months. If you have received statements, you should seek the advice of a medical specialist accountant to review whether you have any hidden tax liabilities.
Alec James (right) is a partner at Sandison Easson & Co, specialist medical accountants