Should you opt out of the NHS pension scheme?

Specialist medical account Paul Samrah outlines what to consider before opting out of your NHS pension

A combination of factors is leading many GP partners to consider opting out of the NHS pension scheme.

The tax-free annual allowance has been reduced since 2014/2015 while the lifetime allowance was reduced between 2008 and 2018. With the introduction of the tapered annual allowance in 2016 and the fact that many GPs will have exhausted all available carry-forward allowances, these restrictions are beginning to bite.

If you are a GP who has exceeded your annual or lifetime allowance within the NHS pension scheme, you will doubtless be anxious to know whether you should stay in or opt out. You are not alone. The number of GPs now facing annual allowance/lifetime allowance tax charges has grown exponentially. You might instinctively want to mitigate your tax charge by leaving the scheme.

However, it is important to weigh up your options carefully before taking the leap. There are ways to mitigate these charges and it may be better to remain in the scheme in the long run. This will depend on a number of factors including your age, income and length of existing scheme membership.

The annual allowance charge and lifetime allowance charge are not HMRC fines or penalties for having contravened tax law. Both charges are simply mechanisms by which HMRC can claw back any tax relief that exceeds your annual and lifetime limits.

There’s nothing inherently wrong in paying one of these charges but you should consider whether:

• the prospective benefits that you will receive over your retirement are likely to have a greater value than the cost of remaining in the scheme;

• payment of one or more of these charges alters this.

Use of ‘scheme pays’

If you do not have sufficient available funds to pay the charge from your own pocket, you might wish to consider whether ‘scheme pays’ might be appropriate or advantageous. This allows you to pay the charge out of your pension scheme, direct to HMRC, with the tax charge taken out of your pension savings. There are certain conditions that need to be met for an individual to have the right to use this facility.​ Requesting the scheme to pay the benefits, or paying the charge from own funds, means the charge is paid from post-tax income.

In order to prevent financial hardship in such cases, a facility has been introduced which allows individuals meeting certain conditions to ask their scheme to pay some or all of the charge on their behalf in return for a corresponding reduction to their benefits. The pension scheme is only obliged to facilitate the payment of the charge if certain conditions are met.

‘Scheme pays’ has the benefit of allowing the charge to be settled using monies on which tax relief has been granted however paying the charge from own funds could reduce the amount of benefits tested against the lifetime allowance. ‘Scheme pays’ may therefore be advantageous for individuals with an actual or potential lifetime allowance issue.

Calculating your long-term benefits

The manner of the actuarial adjustments made to benefits may be favourable depending on circumstances – they may affect just your own benefits or also contingent beneficiary benefits. In the public sector, the approach taken by each scheme and the adjustment factors are typically set out in statutory guidance which is in the public domain. It may be worth asking for a copy or visiting the scheme’s website.

No two scenarios are the same. Each will have different circumstances, different pension rights from different schemes and different objectives, so planning will vary. However, the calculation process for working out whether you are better off in or out of the scheme is the same.

In particular, the value of employer contributions should not be overlooked. The factors relevant to the calculations will vary depending on whether the issue is with the annual allowance, the lifetime allowance or both.

Factors you should consider include the direct financial implications of you opting out/ceasing contributions and thereby becoming a paid-up member or staying in your scheme and paying the tax charge. There are also potentially wider implications of deferral you should consider, such as:

• Dependants’ benefits

On what basis will any dependants’ pensions/lump sum benefit be calculated if you leave the scheme? The calculation basis may be less generous if you have preserved benefits potentially requiring mitigating actions.

• Beneficiary nominations/expression of wishes

Do scheme arrangements for distribution of death benefits change on deferral?

Some employer schemes may allow scheme discretion where you die in active service, but benefits may be paid under direction where the individual has left the scheme. This can have an impact on the inheritance treatment of the benefits.

• Ill-health benefits

On what basis will these be calculated if you leave the scheme? The calculation basis may be less generous and/or there may be no option for serious ill-health commutation.     

Summary

Regardless of whether the issue is with your annual allowance or lifetime allowance or both, there is no easy route to deciding whether opting out or ceasing contributions will be your best course of action. This will often need to be considered on an annual basis, by calculating the relative value of being in or out.

Alternative suitable strategies could include you paying into alternative pensions or the pensions of others, venture capital trusts, enterprise investment schemes and variations on these themes. What doesn’t vary is that your alternative strategy will need to reasonably project a better member (or beneficiary, if that is important to you) outcome than continuing scheme membership and contributions.

Paul Samrah is a partner at chartered accountants Kingston Smith LLP