Medical finance expert Parminder Gill explains how cuts and tapering of the annual allowance are leading to unexpected tax bills for GP partners – and what they can do about it
The NHS Pension Scheme (NHSPS) is known for being one of the best pension schemes in any sector – public or private – but it has been making headlines for all the wrong reasons recently, as many doctors and GPs find themselves faced with punitive tax charges.
When the annual allowance was introduced in 2006 it was designed to limit the amount of tax-free savings that could be put into a pension in any year. The current limit is £40,000 and this is increasingly being breached by many middle and higher earners.
In 2016 the government introduced a tapered annual allowance, which has further complicated the pension tax system for many. This taper applies to earnings over £150,000, reducing the allowance by up to £30,000 – down from £40,000 to a minimum annual allowance of £10,000 at an income of £210,000.
While the reduction in the annual allowance threshold has seen many more GPs being hit by a tax bill, it’s the tapered annual allowance that has really caused a stir, with the #ScrapTheTaper hashtag on Twitter developing a growing fan-base.
Tapering was introduced to restrict the amount of pension tax relief available for high earners. As a result, it’s led to a growing number of doctors facing unexpected tax bills. Consequently, some healthcare professionals have considered leaving – or have left – the NHSPS or reduced their practice hours to avoid breaching the tax threshold.
In recognition of this situation, the government has announced a consultation that would allow clinicians to control their level of pension accrual. If applied this would mean clinicians could choose to make, for example, 30% contributions for a 30% accrual rate, ‘or any other percentage in 10% increments depending on their financial situation’.
The change would mean that a typical NHS pension pot would build more gradually over a consultant’s or GP’s working life and could mean savers avoid tax charges from exceeding their annual allowance.
As part of the same announcement the government also stated that guidance will be given to help those who may be affected by tax charges to opt out of the NHSPS this year.
Crucially, the government also promised a review of the tapered annual allowance, however no time frame has been set for when the review into the taper will be complete, and so for now, it remains in place.
Tapering is complicated.
One of the many issues that makes tapering complicated is the definition of income. There are two definitions – one is called ‘threshold income’ and the other is ‘adjusted income’. In its simplest form, threshold income is all your gross income (including investment income) less tax deductibles such as gross pension contributions or charitable donations (employer pension contributions do not count).
Adjusted income is effectively your threshold income plus the value of all your pension savings for the tax year.
If your adjusted income is greater than £150,000 your annual allowance will be reduced by £1 for every £2 of income over £150,000. Here’s the twist – this tapering only applies if your threshold income is over £110,000. In other words, if your threshold income is below £110,000 it doesn’t matter about your adjusted income, you will not be subject to tapering. This can get complicated, so an example will help to illustrate the situation.
If your salary was £130,000 and your NHS pension employee contributions are £18,850 (£130,000 x 14.5%), assuming you have no other tax relievable payments, your threshold income would be £111,150 (£130,000 – £18,850). If the growth in your NHS pension benefits was valued at £40,000, your adjusted income would £151,150 (£111,150 + £40,000).
It is difficult to accurately predict the value of the growth in NHS pension benefits because it depends on a number of factors such as actual earnings for the year, total earnings to date and the rate of inflation.
So in practice, if you earn anywhere near £130,000, it’s worth taking action sooner rather than later, as you may be liable to an unexpected tax bill.
Similarly, if you’ve had a substantial increase in salary over the past year, the way that HMRC values the increase in NHS pension benefits you receive might also leave you liable to a charge, something which could be exacerbated if the taper leaves you with an annual allowance that is lower than £40,000.
The first thing to do if you think you’re affected is to ask the NHSPS for a pension saving statement, which shows the amount you have saved into your pension over previous tax years. If you exceed the annual allowance threshold, you will need to declare this on your next annual tax return, otherwise you could be faced with a penalty from HMRC for late payment.
GPs can work out their threshold income by adding together their gross income from all sources and deducting their pension contributions to establish if they exceed the £110,000 limit.
Many have taken advice or worked out for themselves – using online resources provided by the NHS Business Services Authority, for example – that if their threshold income is below £110,000 they are unlikely to be subject to annual allowance tapering.
If your pension savings exceed the annual allowance limit, the excess may be subject to a tax charge. The tax rate will depend on your tax banding – any excess that falls within the higher rate tax banding will be taxed at 40% and any that falls into the additional rate banding will be taxed at 45%.
For example, if you are a higher rate tax payer and your pension excess is £20,000, this will be taxed at 40% so the annual allowance tax charge would be £8,000 (£20,000 x 40%). If part of the excess fell into the additional tax rate banding, this would be taxed at 45%.
It is worth noting that if you have any unused annual allowance from the previous three tax years, this can be used to offset the tax charge.
If you have exceeded the threshold there is some support to help you meet your tax bill. You can ask NHS Pensions to pay some or all of your annual allowance charge for you. This option is known as Scheme Pays. It is like the NHS loaning you the money now to pay your tax bill which you pay back with interest when you retire. It works by creating a debt against your pension benefits, which is then used to reduce your NHS benefits before they are paid to you.
If you have been impacted by the annual allowance tax charge, it’s worth reviewing your overall pension situation.
For example, if you are contributing to a separate personal pension plan, perhaps paying additional voluntary contributions for Added Years or Additional Pension under the NHSPS, it is worth considering if this is still worth doing.
It is also advisable, if you believe you will keep hitting the tax threshold, to build a healthy cash reserve throughout the year to help pay for these charges.
While it may be tempting to pull out of the NHSPS altogether, this isn’t usually the best solution. Overall, the benefits offered by the scheme are still particularly attractive in comparison with others.
However, everyone’s circumstances are different and if you’re considering opting out, you should seek independent financial advice to ensure you are aware of all the facts before you make such an important decision.
Case study: A 46-year old GP with a modest increase in NHS and private earnings
A GP with NHS earnings of £118,000 and private earnings of £10,000 had a modest increase in earnings resulting in NHS earnings of £120,000 and private earnings of £15,000.
The growth in their NHS pension benefits was valued at £43,000 for the tax year. They were subject to the tapered annual allowance, and their annual allowance for the year was £35,000. This meant they had an excess input of £8,000 (£43,000 – £35,000).
They had used all their annual allowance in every one of the previous three tax years, so there was no annual allowance to carry over.
As a higher rate taxpayer, this meant the entire excess was subject to tax at 40%, so the annual allowance bill was £3,200 (£8,000 x 40%).
Unknown to the GP in previous years, they had been able to carry across the unused annual allowance from previous tax years. Since this was the first year the GP was unable to carry across unused annual allowance it resulted in a surprise tax charge, even though the change to their working pattern was modest.
Parminder Gill is advice policy consultant at Wesleyan, a specialist financial services mutual for GPs.
The information contained in this article is does not constitute financial advice. This information is based on our current understanding of legislation. Legislation and tax treatment can change in the future.
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