Pensions

Restricting pensions tax relief

Summary

On 14 October 2010, the Government announced its proposed changes to the taxation of pension savings due to be introduced from April 2011. The legislation covering these changes is contained in the Finance Act 2011, which achieved Royal Assent on 19 July 2011, together with accompanying regulations.

The changes are: 

  • Annual Allowance ("AA") has reduced from £255,000 to £50,000 from April 2011 
  • The single valuation factor has been increased from 10 to 16 
  • Indexation of accrued benefits is in line with the Consumer Prices Index (CPI) ("inflation proofing") 
  • Unused AA from up to three previous years can be "carried forward" and offset against excess pension savings made in a particular year. For this purpose, the AA in previous years is assumed to be £50,000.

In addition, the Lifetime Allowance (LTA) has been reduced from £1.8m to £1.5m with effect from April 2012. The reason this change was delayed until April 2012 was in order to allow sufficient time to design a protection regime, known as Fixed Protection.

Fixed protection allows you to take benefits worth up to £1.8 million without paying the lifetime allowance charge, although your ability to accrue benefits in the future is limited. HM Revenue & Customs (HMRC) must have received your application before 6 April 2012. Those who were previously protected by either Primary or Enhanced Protection were not eligible to apply for Fixed Protection and so will continue to receive the protection previously in place. 

(Additional note: Information about changes to the annual allowance announced by the government for the 2014 period)

Who is exempt?

Deferred members are exempt from the AA regime. In addition, the AA test will not be applied in the year of death or for someone satisfying the severe ill health condition. A severe ill health condition covers people who are either:

  • suffering from ill health and as a consequence are unlikely to be able (otherwise than to an insignificant extent) to undertake gainful work (in any capacity) before reaching State Pension Age ("SPA") – this is determined by the NHS pensions agency's medical advisers when ill health retirement has been applied for; or 
  • entitled to a serious ill health lump sum commutation.

However, it has been confirmed that exemptions from the AA test will not be granted in the year that benefits come into payment, on redundancy or for individuals with Enhanced Protection.

 

Who is most likely to be affected?

The following members are most likely to be affected:

  1. members with long service and or significant promotional or pay rises
  2. high-earners and members with Enhanced Protection
  3. members retiring on redundancy grounds where some of the redundancy money is diverted into the pension scheme to provide additional benefits;
  4. members buying "Added Years" or "Additional Pension".

 

Examples

Please note: example calculations are intended to illustrate the method for calculating the annual allowance. This guidance does not provide exhaustive examples or illustrate all types of pension growth and in the case of the GP examples it has not taken into account the 'flexibility tests' which will be undertaken when the pensions agency tests for the annual allowance (AA).

The examples below demonstrate the potential tax charges for doctors, MHOs and GPs – including those buying "Added Years" or "Additional Pension". In all of the examples, CPI over the relevant period is assumed to be 2%. Actual CPI figures will need to be used in each appropriate year's test.

Where a tax charge is illustrated which exceeds £2000 the individual can elect that the 'scheme pays' the charge by actuarially reducing the pension payable at retirement. A charge of less than £2000 would need to be paid at the following tax assessment.

Examples have been shown for the following sections of the NHS Pension Scheme - the impact will be similar for other schemes offering benefits similar to those shown.

Hospital and Community doctors (1995 Section) provides benefits on a 1/80ths basis and cash at retirement of 3 times pension.

MHOs (1995 Section) receive benefits as for Hospital/Community doctors but each whole year in excess of 20 years as an MHO counts "double" when calculating pensionable service.

GPs (1995 Section) provides benefits based on career earnings and a retirement lump sum of 3 times pension. Pension is based on 1.4% of "dynamised earnings". Pensionable earnings are recorded each year and a revaluation factor is applied. The revaluation factor used to re-value earnings each year is 1.5% above CPI. The resulting figure is known as "dynamised earnings".

 

Example 1a – Promotion from specialist registrar to consultant

Andy is promoted from specialist registrar (SpR) to consultant and his pensionable salary increases from £46,708 to £75,994. He is accruing benefits in the NHS Pension Scheme (1995 Section) and has completed 10 years’ membership at the end of the Pension Input Period prior to the current one.

Step 1: Calculate pension benefit value at the end of the previous Pension Input Period and "inflation proof":
Pension = (£46,708 x 10/80) = £5,839
"Inflation proof" = £5,839 x 1.02 = £5,956
Lump sum = 3 x £5,956 = £17,868

Step 2: Calculate pension benefit at end of the current Pension input Period:
Pension = (£75,994 x 11/80) = £10,449
Lump sum = 3 x £10,449 = £31,347

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£10,449 - £5,956) x 16 = £71,888
Lump sum = (£31,347 - £17,868) = £13,479

Step 4: Test against Annual Allowance:
Annual Allowance exceeded by: (£71,888 + £13,479) - £50,000 = £85,367 - £50,000 = £35,367.
So, need to look at any unused allowances over previous 3 years.

Step 5: Carried forward Annual Allowance from previous 3 years*:
Year X – 1 unused Annual Allowance: £34,933
Year X – 2 unused Annual Allowance: £36,111
Year X – 3 unused Annual Allowance: £37,232
Total unused allowance: (£34,933 + £36,111 + £37,232) = £108,276

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus £108,276 = £158,276
Therefore, as £85,367 is less than £158,276, Andy will not be subject to any tax charge.

Note: Assuming Andy progressed through the Trainee pay points at a rate of one per year.

 

Example 1b – As per Example 1a, but also buys £5,000 of Additional Pension ("AP")

Let’s now assume that Andy wants to buy £5,000 of Additional Pension (i) by making a single lump sum payment, or (ii) by funding the Additional Pension via the payment of regular additional contributions over a period of 20 years.

(i) Paid for by a single lump sum
Step 1: As above.

Step 2: Calculate pension benefit at the end of the current Pension Input Period:
Pension = £10,449 + £5,000 = £15,449
Lump sum = 3 x £10,449 = £31,347 [Note: AP does not include an automatic lump sum]

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£15,449 - £5,956) x 16 = £151,888
Lump sum = (£31,347 - £17,868) = £13,479

Step 4: Test against Annual Allowance:
Annual Allowance exceeded by: (£151,888 + £13,479) - £50,000 = £165,367 - £50,000 = £115,367. So, need to look at any unused allowances over Pension Input Periods ending in previous 3 tax years.

Step 5: Carried forward Annual Allowance from previous 3 tax years (as above): £108,276

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus £108,276 = £158,276
Andy will therefore be liable for an AA charge of 40%* of (£165,367 - £158,276) = £2,836.

Note: Assuming that Andy’s marginal income tax rate is 40%. Some of this may in fact attract a higher income tax rate.

(ii) Paid for by regular additional contributions over a period of 20 years
Step 1: As above.

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Pension = £10,449 + (£5,000 x 1/20) = £10,699
Lump sum = 3 x £10,449 = £31,347 [Note: AP does not include an automatic lump sum]

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£10,699 - £5,956) x 16 = £75,888
Lump sum = (£31,347 - £17,868) = £13,479

Step 4: Test against Annual Allowance:
Annual Allowance exceeded by: (£75,888 + £13,479) - £50,000 = £89,367 - £50,000 = £39,367.
So, need to look at any unused allowances over Pension Input Periods in previous 3 tax years.

Step 5: Carried forward Annual Allowance from previous 3 tax years (as above): £108,276

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus £108,276 = £158,276
Therefore, as £89,367 is less than £158,276, Andy will not be subject to any tax charge.

 

Example 2a – Salaried GP, pensionable salary of £70,000 and £2.0m dynamised earnings

Belinda is a salaried GP with a pensionable salary of £70,000 and £2.0m dynamised earnings. She is accruing benefits in the NHS Pension Scheme (1995 Section).

Step 1: Calculate pension benefit value at end of the previous Pension Input Period and "inflation proof":
Pension = £2.0m x 1.4% = £28,000
"Inflation proof" = £28,000 x 1.02 = £28,560
Lump sum = 3 x £28,560 = £85,680

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Dynamised earnings: [£2.0m x (1 + (2% + 1.5%)) + £70,000] = £2.140m
Pension = £2.140m x 1.4% = £29,960
Lump sum = 3 x £29,960 = £89,880

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£29,960 - £28,560) x 16 = £22,400
Lump sum = (£89,880 - £85,680) = £4,200
Total = £26,600

Step 4: Test against Annual Allowance:
As £26,600 is less than £50,000, Belinda will not be subject to any tax charge.

 

Example 2b – As per Example 2a, but has also been building up "Added years"

Let’s now assume that Belinda has been buying four years of "Added Years" over a period of 25 years from her 35th birthday. At the start of the relevant year she is aged 55 and has been paying for these Added Years for 20 years – her average earnings over this time was £70,000.

Step 1: Calculate pension benefit value at end of the previous Pension Input Period and "inflation proof":
Pension = £2.0m x 1.4% = £28,000
"Added Years" pension = [4 x (20/25) x £70,000] x 1.4% = £3,136
"Inflation proof" = (£28,000 + £3,136) x 1.02 = £31,759
Lump sum = 3 x £31,759 = £95,277

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Dynamised earnings: [£2.0m x (1 + (2% + 1.5%)) + £70,000] = £2.140m
Pension = £2.140m x 1.4% = £29,960
"Added Years" pension = [4 x (21/25) x £70,000] x 1.4% = £3,293
Total pension = £29,960 + £3,293 = £33,253
Lump sum = 3 x £33,253 = £99,759

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£33,253 - £31,759) x 16 = £23,904
Lump sum = (£99,759 - £95,277) = £4,482
Total = £28,386

Step 4: Test against Annual Allowance:
As £28,386 is less than £50,000, Belinda will not be subject to any tax charge.

 

Example 3a – Self-employed GP, pensionable salary of £150,000 and £2.7m dynamised earnings

Colin is a self-employed GP with a pensionable salary of £150,000 and £2.7m dynamised earnings. He is accruing benefits in the NHS Pension Scheme (1995 Section).

Step 1: Calculate pension benefit value at end of the previous Pension Input Period and "inflation proof":
Pension = £2.7m x 1.4% = £37,800
"Inflation proof" = £37,800 x 1.02 = £38,556
Lump sum = 3 x £38,556 = £115,668

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Dynamised earnings: [£2.7m x (1 + (2% + 1.5%)) + £150,000] = £2,944,500
Pension = £2,944,500 x 1.4% = £41,223
Lump sum = 3 x £41,223 = £123,669

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£41,223 - £38,556) x 16 = £42,672
Lump sum = (£123,669 - £115,668) = £8,001
Total = £50,673

Step 4: Test against Annual Allowance:
Annual Allowance exceeded by: £50,673 - £50,000 = £673
So, need to look at any unused allowances over previous Pension Input Periods ending in 3 previous tax years.

Step 5: Carried forward Annual Allowance from previous 3 tax years:
Year X – 1 unused Annual Allowance: £1,041
Year X – 2 unused Annual Allowance: £2,696
Year X – 3 unused Annual Allowance: £4,296
Total unused allowance: (£1,041 + £2,696 + £4,296) = £8,033

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus £8,033 = £58,033
Therefore, as £50,673 is less than £58,033, Colin will not be subject to any tax charge.

 

Example 3b – As per Example 3a, but has also been building up "Added years"

Let’s now assume that Colin has been buying four years of "Added Years" over a period of 25 years from his 35th birthday. At the start of the relevant year he is aged 55 and has been paying for these added years for 20 years – his average earnings over this time was £150,000.

Step 1: Calculate pension benefit value at end of the previous Pension Input Period and "inflation proof":
Pension = £2.7m x 1.4% = £37,800
"Added Years" pension = [4 x (20/25) x £150,000] x 1.4% = £6,720
"Inflation proof" = (£37,800 + £6,720) x 1.02 = £45,410
Lump sum = 3 x £45,410 = £136,230

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Dynamised earnings: [£2.7m x (1 + (2% + 1.5%)) + £150,000] = £2,944,500
Pension = £2,944,500 x 1.4% = £41,223
"Added Years" pension = [(4 x (21/25) x £150,000] x 1.4% = £7,056
Total pension = £41,223 + £7,056 = £48,279
Lump sum = 3 x £48,279 = £144,837

Step 3: Calculate increase in pension benefit value over the Pension Input Period:
Pension = (£48,279 - £45,410) x 16 = £45,904
Lump sum = (£144,837 - £136,230) = £8,607
Total = £54,511

Step 4: Test against Annual Allowance:
Annual Allowance exceeded by: £54,511 - £50,000 = £4,511
So, need to look at any unused allowances over Pension Input Periods ending in previous 3 tax years.

Step 5: Carried forward Annual Allowance from previous 3 years: Nil.

Payment of the additional contributions towards Added Years has meant that he has no unused Annual Allowance in any of the 3 previous years to carry forward.

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus Nil = £50,000
Colin will therefore be liable for an AA charge of 40%* of (£54,511 - £50,000) = £1,804

Note: Assuming that Colin’s marginal income tax rate is 40%. Some of this may in fact attract a higher income tax rate.

 

Example 4a – Consultant on £100,446, no pay rise, moving from Level 10 (Silver) CEA to Level 11 (Gold) CEA

Qamar is a senior Consultant accruing benefits in the NHS Pension Scheme (1995 Section).

At the beginning of the period, Qamar has completed 28 years’ pensionable service. His pensionable salary for that year is £100,446 and he has received a Level 10 (Silver) Clinical Excellence Award (CEA) of £46,644.

By the end of the period, Qamar remains on £100,446 and receives a Level 11 (Gold) CEA of £58,305.

Step 1: Calculate pension benefit value at end of the previous Pension Input Period and "inflation proof":
Pension = [£100,446 + £46,644] x 28/80 = £51,482
"Inflation proof" = £51,482 x 1.02 = £52,512
Lump sum = 3 x £52,512 = £157,536

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Pension = [£100,446 + £58,305] x 29/80 = £57,547
Lump sum = 3 x £57,547 = £172,641

Step 3: Calculate increase in pension benefit value over the Pension Input Period (which runs from 6th April to 5th April):
Pension = (£57,547 - £52,512) x 16 = £80,560
Lump sum = (£172,641 - £157,536) = £15,105

Step 4: Test against annual allowance:
Annual Allowance exceeded by: (£80,560 + £15,105) - £50,000 = £95,665 - £50,000 = £45,665
So, need to look at any unused allowances over Pension Input Periods ending in previous 3 tax years.

Step 5: Carried forward Annual Allowance from previous 3 tax years: Nil.

Qamar has exceeded the annual allowance in each of the previous 3 tax years and therefore has no unused allowance to carry forward.

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus Nil = £50,000
Qamar will therefore be subject to a tax charge of 40%* of (£95,665 - £50,000) = £18,266

Note: Assuming that Qamar’s marginal income tax rate is 40%. Some of this may in fact attract a higher income tax rate.

 

Example 4b – As per Example 4a, but Qamar chooses to take early retirement at the end of the year

Let’s now assume that Qamar chooses to take early retirement at the end of the Pension Input Period, three years before his Normal Pension Age. His pension and lump sum will be reduced to take into account that it will be paid from an earlier age. The early retirement factor applied to his pension is 86.5% and to his lump sum is 91.0%.

Step 1: As above.

Step 2: Calculate pension benefit at end of the current Pension Input Period:
The calculation at the end of the Pension Input Period takes into account actual events that have occurred over the Pension Input Period, such as retirement.

Pension = [£100,446 + £58,305] x 29/80 = £57,547 x 86.5% = £49,778
Lump sum = 3 x £57,547 = £172,641 x 91.0% = £157,103

Step 3: Calculate increase in pension benefit value over the Pension Input Period (which runs from 6th April to 5th April):
Pension = (£49,778 - £52,512) x 16 = - £43,744
Lump sum = (£157,103 - £157,536) = - £433
Total = - £44,177 (i.e. negative)

Step 4: Test against annual allowance:
The total Pension Input Amount (ie the value of the pension benefits built up over the Pension Input Period) is subject to a minimum of £0. The amount of Annual Allowance that Qamar has used is therefore £0, and he will not be subject to a tax charge.

 

Example 5a – Consultant psychiatrist, Mental Health Officer (MHO)

Natalie is a consultant psychiatrist accruing benefits in the NHS Pension Scheme (1995 Section). She spent one year in a non-MHO post before becoming an MHO. Natalie then remained as an MHO for a period of 20 years, so has worked a total of 21 years at the beginning of the Pension Input Period.

Each whole year in excess of 20 years as an MHO counts "double" when calculating her pension.

At the start of the period, her pensionable salary is £83,829. She has worked 1 year as a non-MHO and 20 years as an MHO. At the end of the period, her pensionable salary has increased to £89,370 and a Level 1 Clinical Excellence Award (CEA) of £2,957 has fully worked through into her pension. She has worked 1 year as a non-MHO and 21 years as an MHO.

Step 1: Calculate pension benefit value at end of the previous Pension Input Period and "inflation proof":
Pension = £83,829 x (20 + 1)/80 = £22,005
"Inflation proof" = £22,005 x 1.02 = £22,445
Lump sum = 3 x £22,445 = £67,335

Step 2: Calculate pension benefit at end of the current Pension Input Period:
Pension = (£89,370 + £2,957) x (22 + 1)/80 = £26,544
Lump sum = 3 x £26,544 = £79,632

Step 3: Calculate increase in pension benefit value over the year:
Pension = (£26,544 - £22,445) x 16 = £65,584
Lump sum = (£79,632 - £67,335) = £12,297
Total = £65,584 + £12,297 = £77,881

Step 4: Test against Annual Allowance:
Annual Allowance exceeded by: £77,881 - £50,000 = £27,881
So, need to look at any unused allowances over Pension Input Periods ending in the previous 3 tax years.

Step 5: Carried forward Annual Allowance from previous 3 years:
Year X – 1 unused Annual Allowance: £35,579
Year X – 2 unused Annual Allowance: £37,137
Year X – 3 unused Annual Allowance: £34,686
Total unused allowance: £35,579 + £37,137 + £34,686 = £107,402

Step 6: Calculate any tax charge payable:
Total Annual Allowance: £50,000 plus £107,402 = £157,402
Therefore, as £77,881 is less than £157,402, Natalie will not be subject to any tax charge.

 

Example 5b – As per Example 5a, but looking at the next year

Let’s now look at the calculation for the following Period Input Period assuming that Natalie has not received any pay increase since the end of the previous Pension Input Period

Step 1: Calculate pension benefit value at the end of the previous Pension Input Period and "inflation proof":
Pension = (£89,370 + £2,957) x (22 + 1)/80 = £26,544
"Inflation proof" = £26,544 x 1.02 = £27,075
Lump sum = 3 x £27,075 = £81,225

Step 2: Calculate pension benefit at the end of the current Pension Input Period:
Pension = (£89,370 + £2,957) x (24 + 1)/80 = £28,852
Lump sum = 3 x £28,852 = £86,556

Step 3: Calculate increase in pension benefit value over the year:
Pension = (£28,852- £27,075) x 16 = £28,432
Lump sum = (£86,556 - £81,225) = £5,331
Total = £28,432 + £5,331 = £33,763

Step 4: Test against Annual Allowance:
As £33,763 is less than £50,000, Natalie will still not be subject to any tax charge.

 

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