Taking the unfairness out of pension taxation

Recent announcements have been made about the actions doctors will need to take as part of the long talked about ‘McCloud remedy’ to solve anomalies in different pension tax schemes. Alec James explains 

Reading this article will be crucial if you have been required to pay annual pension saving tax charges in the past or retired from the NHS Pension Scheme with both a 1995/2008 – now referred to as the legacy schemes – and 2015 pension.

Sit back in a comfy chair with a cuppa as Alec James looks at the McCloud remedy complexities and gives a roadmap of the years ahead.

On 1 April 2015, new pension schemes were created for public sector workers. For the NHS, this was aptly named the 2015 scheme. It brought a significant change to the way the pension was calculated for hospital doctors. 

The 2015 scheme is not based on your pensionable pay on the years leading up to your retirement like the legacy schemes were. Instead it is calculated using your ‘Career Average Revalued Earnings’ or CARE. 

In layman’s terms, each year a percentage of your career earnings contributed to the 2015 scheme. So that the earnings are not time eroded by inflation, each year the historic earnings are uplifted by the Consumer Price Index (CPI) + 1.5%.

Unlike when the 2008 scheme was introduced, members were not given a choice as to whether to transition from the legacy schemes to the 2015 scheme. Instead, they were transitioned to the new scheme based on their age.

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Age discrimination 

Those closer to retirement were either given full protection to remain in their legacy scheme or had a deferred transition date. Those who were not eligible for any form of protection were transferred to the 2015 scheme on 1 April 2015.

In 2018, the Court of Appeal found that offering levels of protection to those closer to retirement was discriminatory to other members and so we now have the McCloud remedy, which looks to put right the age discrimination. 

To do this, from 1 April 2022 all members of the NHS Pension Scheme are now contributing to the 2015 scheme. The period of 1 April 2015 – or whatever date you transitioned to the 2015 scheme –  to 31 March 2022 is called the reform period.

For pension purposes, you will be given the choice as to which pension scheme you would like the reform period to be included in. This decision does not need to be made until you are retiring.

However, for annual allowance purposes, the reform period will be recalculated as if the 2015 scheme never existed.

Annual allowance tax charges

Many of you will have received the dreaded envelopes over the last few years. In these envelopes, you would have received two statements from NHS Pensions, one showing the growth figures from your 1995/2008 pension scheme(s) and the other showing the growth from your 2015 scheme. 

The two growth figures are then totalled and compared to your annual pension savings allowance in the tax year. For tax years up to 2022-23, the pension savings allowance was £40,000, but it 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 – referred to as adjusted income.

Your threshold income is effectively your total taxable income from all sources in the year and is not limited to your NHS income. 

It is only if you exceed both limits that you will be subject to tapering of the annual allowance. 

The effect of this is similar to those of losing your personal allowance. For every £2 your adjusted income goes over £240,000, your pension savings annual allowance for the tax year reduces by £1 to a minimum allowance of £4,000 for some years. 

If you exceeded the annual allowance in a tax year and it gave rise to a tax charge, then this would need to be declared on your personal tax return form.

The tax due would either be paid personally or you could opt to use ‘scheme pay elections’ whereby the pension pays the tax and your pension when you come to retire is reduced to reflect the liabilities paid on your behalf.  

McCloud remedy actions

As mentioned earlier, the reform period will be recalculated with the growth being attributed to your legacy schemes rather than the 2015 scheme.  

This requires NHS Pensions to update all its members’ records. NHS Pensions had initially said that the recalculations for members would be available by October 2023 and therefore this article would be more specific about the actions that would be required. 

However, earlier this year, this was extended until 6 October 2024 for the active and deferred NHS pension members. 

For those of you already receiving your NHS pension and who are affected by the McCloud remedy, it is expected you will be provided with the information in October 2023.

Once the information has been released, it will be entered, together with the original annual allowance information, into a new HM Revenue and Customs (HMRC) calculator. 

Details of the calculator will be released shortly before October 2023, but the calculator will look at your annual allowance position before and after the McCloud remedy. 

Calculate tax adjustments

It will then calculate any annual allowance tax adjustments, splitting these into ‘in scope’ and ‘out of scope’ adjustments. Here, we are talking about HMRC’s rules in respect of amending tax returns. 

‘In scope’ years are where HMRC will accept a revision to your tax position and any refunds or additional tax due will be recovered from or paid to HMRC. 

Any corrections outside of this period becomes ‘outside the scope’ and therefore is no longer the responsibility of HMRC. 

If you are due a refund from the ‘outside the scope’ years, you will have suffered a taxation loss that you cannot recover from HMRC. 

As the tax paid was due to the move to the 2015 scheme, as part of the McCloud remedy, you will be able to recover the tax refund via the NHS pension compensation scheme. 

Compensation scheme applications

Compensation scheme applications will need to be made to the scheme manager together with evidence of the taxation losses incurred. 

The scheme manager will then be able to make either direct compensation to you – if you paid any annual allowance tax personally – or indirect compensation by way of increased annual pension benefits if you opted for scheme pays elections.

NHS Pensions has confirmed that it will not seek to recover any additional tax that would be due on any ‘out of scope’ years which would have ordinarily been due to HMRC – good news for the taxpayer.

If you are already in receipt of your NHS pension and retired with both a legacy scheme and 2015 scheme, you will be able to make elections to receive all the pension based on your legacy scheme. 

The information regarding this should be available in October 2023.

For those members who opted out of the NHS Pension Scheme between 1 April 2015 and 31 March 2022 as a result of the changes to the scheme, you will be able to reinstate your pension for those years if you apply before 1 October 2023. 

To do this you must confirm that your original decision to opt of the scheme would have been different had it not been for the age discrimination impact of the 2015 scheme transitions. 

If you choose to do this, the pension contributions due on the amounts will become payable again. You should always seek the advice of specialist medical independent financial advisors and accountants before making any decisions regarding this. 

Looking into the future…

2022-23 annual allowance position

With the McCloud remedy statements not being issued until October 2024, many doctors will be considering what they need to do for their 2022-23 tax returns. 

As the McCloud remedy work will not have been completed, NHS Pensions will be unable to provide statements for 2022-23. 

While you may breathe a sigh of relief that you do not need to make entries on this year’s return, unfortunately it is not quite that simple.

To help minimise any interest and surcharges that could be imposed by HMRC, you should include an estimate of your annual allowance position for 2022-23. 

This can then be updated once the annual allowance statements are available from NHS Pensions in October 2024. The appointment of an accountant with specialist knowledge of the NHS pension will be invaluable in calculating an estimated annual allowance growth figure.

Post-Budget changes 

In spring 2023, three key announcements were made about NHS pensions:

1. The annual pensions savings allowance was increased to £60,000 for 2023-24;

2. Lifetime allowance tax would not be charged for 2023-24 – providing certain criteria are met – and will be abolished from 6 April 2024 

3. Alignment of the CPI figures used by NHS Pensions and HMRC (2015 scheme) and allowing in-year negative pension input amounts incurred on the legacy schemes to be offset against growth on the 2015 – which has previously not been allowed.

The £60,000 annual pension savings allowance should help many doctors avoid hefty tax charges on their NHS pension. This also helps alleviate the pressure of annual allowance tapering, because the adjusted income has been increased to £260,000. The minimum allowance has also been increased from £4,000 to £10,000. 

CPI alignment was a pressing issue which was addressed outside of the Budget. As mentioned earlier, the 2015 scheme is a Career Average Revalued Earnings scheme. This means that each year, the NHS revalued historic earnings by CPI + 1.5%. 

Historically, this was done on 1 April each year using the September prior figure. HMRC allows for such increases; however, it uses the CPI figure prior to the start of the tax year and there has always been a disparity between the two rates used. 

Many Independent Practitioner Today readers will have seen the impact of this on their 2021-22 annual allowance statement when the 2015 scheme growth was considerably more than it has been in previous years, despite doctors’ circumstances remaining similar. This was likely to be a result of the CPI uplift. 

From 2022-23, NHS Pensions will now revalue on the 6 April, meaning that the CPI rates used by both NHS Pensions and HMRC will be aligned. 

Therefore, the only inflationary increase which will be included in the calculation against your annual pension savings allowance will be the 1.5% given each year.

Common misconception

Finally, in the past, many of you will have received a 1995/2008 statement which show nil growth in a particular tax year. There is a common misconception that this means your pension has not grown within the tax year. 

But what this actually means is that your pension grew by less than the allowable inflationary amount applied by HMRC. In some cases, this may have been a negative figure. Rather than showing the negative figure, this was historically shown as a zero. 

This meant that the taxpayer was missing out on relief that could be offset against the growth seen on the 2015 scheme. In the Spring Budget it was announced that, from April 2023, members of the NHS pension will be able to offset these in-year negative figures from their legacy schemes against the 2015 growth figures.

The McCloud remedy and pension annual allowance matters in general is a very complex area and ensuring you make the correct disclosures will be imperative. 

You should seek the advice of a medical specialist accountant to ensure you have declared the correct annual allowance tax charges.

Alec James (right) is a partner at Sandison Easson and Co, specialist medical accountants