Government initiatives to help doctors avoid substantial tax bills on pension benefits are welcome, but there is more work to do.
Rapid rises in inflation can cause all sorts of unexpected difficulties. It is therefore good news that the Government has intervened to protect members of the NHS Pension Scheme from one potentially expensive trap caused by this year’s spike – even if other problems remain to be resolved.
This is the so-called “CPI disconnect” issue, which threatened to disadvantage members of career average revalued earnings (CARE) occupational pension schemes such as the 2015 NHS Pension Scheme. It could have left many members facing a nasty tax bill because of the way the rules on the annual allowance work.
The CPI disconnect explained
Members of CARE schemes, like all pension savers, are subject to strict annual allowances on pension contributions and benefit increases each year; if they exceed the caps, they pay tax penalties. In a CARE scheme, you are judged against your annual allowance on the basis of how much your pension benefits rise in value over the course of the year; there is a set formula to work this out.
Crucially, however, adjustments for inflation have to be made, so that savers aren’t penalised just for having some inflation protection built into their schemes. The way this has previously worked in a CARE scheme is that your previously accrued pension benefits were revalued each year according to the prevailing rate of CPI inflation in September. However, for the purposes of working out what increase in benefits reflected inflation for the annual allowance, the rate of inflation from the previous September was used.
In the past, this hasn’t been problematic since inflation hasn’t changed significantly from one year to the next. However, between September 2021 and 2022, the CPI inflation measure rose from 3.1% to 10.1%. So, using the latter figure to revalue your pension, but the former for annual allowance purposes would have been disastrous for many doctors; they’d have breached their annual allowance and faced a tax penalty just because of this anomaly.
Solving the problem
Following lobbying from the British Medical Association (BMA) the good news is that the Government has finally listened and has put in a proposal to amend the rules accordingly. It is moving the effective date of the revaluation of CARE schemes in line with inflation from 31 March to the first Monday of the new tax year, which starts on 6 April. The effect will be to ensure annual allowance tests and benefit revaluations make reference to the same inflation figure.
It’s not totally plain sailing, in that revaluations are actually made on the basis of inflation plus 1.5 percentage points. This additional amount will still eat into a doctor’s annual allowance. However, the critical danger of soaring inflation counting towards the annual allowance has been averted, with the rules due to be introduced in time to apply to the current 2022-23 tax year.
The intervention is really important for NHS Pension Scheme members, particularly GPs, who were facing potentially enormous annual allowance tax bills because all their pension entitlements, including those from the legacy 1995/2008 NHS Pension Scheme, are held in CARE schemes.
It’s worth noting that this plan currently only applies to England and Wales, though the BMA expects Scotland and Northern Ireland to follow. But it doesn’t automatically apply to doctors in alternative schemes such as those offered by the armed forces, local government or universities.
Negative growth still an issue
Less happily, the Government’s solution does not address the issue of “negative growth”, an issue that has arisen following the public sector pension reforms that led to the introduction of the 2015 NHS Pension Scheme. This scheme is, for tax purposes, considered to be completely separate to the 1995/2008 scheme. The result is that if your benefits fall in value in one scheme for the purposes of the annual allowance, you can’t offset this fall against a rise in the other; the fall is simply counted as zero against your annual allowance.
For some doctors, this problem is now a pressing one. It could see them hit with an annual allowance charge even though they wouldn’t have exceeded the annual allowance if they had been able to take into account the negative growth in the 1995/2008 benefits. Closing the CPI disconnect makes it more likely that there will be negative growth for annual allowance purposes from this legacy scheme – but that won’t help reduce any annual allowance liability in the 2015 scheme.
Better news on pension recycling
Finally, there is more encouraging news for doctors who have decided to opt out of the NHS Pension Scheme to avoid annual allowance and lifetime allowance problems. A growing number of trusts are now adopting “pensions recycling” – that is paying the employer’s contribution they would have made to the opted out doctor’s pension pot directly to the doctor instead, as part of their total reward.
The Government is encouraging all trusts to introduce pension recycling by April 2023. It’s a potentially valuable move – the employer’s contribution to the NHS Pension Scheme is 20.6% of pensionable salary in England and Wales. 6.3% of this comes directly from the NHS, rather than from the trust as the employer which has led to some Trusts limiting recycling to 14.3% of pensionable pay. Most Trusts are also paying this net of employer’s national insurance contributions at a rate of 13.8% therefore limiting pension recycling to 12.4%. However, many employed dentists have said that irrespective of the 6.3% employer contribution being funded centrally that it is part of the pay package, and they expect that this should be included in the amount reimbursed if opted out.
In Wales, every health board has now agreed to introduce pension recycling, albeit limited to 12.4% of pensionable pay (14.38% of pensionable pay net of employer’s national insurance contributions at a rate of 13.8%. In England, trusts are considering this option one by one – and although more are now adopting it, many are offering significantly less than the full 20.6%. It’s worth pointing out that the employer will suffer an increase of approximately equal to 13.8 per cent of the value of any additional salary payments and most Trusts will take this into consideration when calculating the amount paid to an employee in order to keep this cost neutral. From 01.04.2019 this is 17.75% of your pensionable pay (20.6% of pensionable pay net of employer’s national insurance contributions at a payable rate of 13.8%).
In Scotland pension recycling has also been introduced which has also been limited to 12.4% of pensionable pay. However, the start date of this policy is the 1st October 2022, the date when the power to introduce such a scheme was devolved to NHS Boards in Scotland and applications can be backdated to this date. The scheme will run initially until 31st March 2023 and will be reviewed at the start of each financial year with consideration given to whether the policy is still required.
Finally it’s essential that anyone thinking about opting out of the NHS Pension Scheme receives financial advice as pension recycling is only financially beneficial to a small number of doctors who expect to have significant ongoing pension taxation issues
All information is accurate as of the 16th January 2023.
Content correct at time of writing and is intended for general information only and should not be construed as advice.