A freeze in the lifetime allowance for pension savings will result in more doctors being caught by the lifetime allowance limit, but there may be ways to mitigate the issue.
The Chancellor’s decision in last month’s budget to freeze the Lifetime Allowance (LTA) will inevitably have implications for senior doctors who are members of the NHS Pension Scheme. More doctors will be at risk of breaching the LTA than would have been the case had the allowance been increased in line with inflation, as has been the practice in recent years.
Broadly speaking, the LTA is the total amount of pension savings you accrue across all your pensions without facing additional tax charges when you begin to take retirement benefits. The current LTA, £1,073,100, will now remain in place until April 2026.
With defined contribution pensions, including stakeholder and personal pensions, it is the actual value of your pension fund that is tested against the LTA. In defined benefit schemes such as the NHS Pension Scheme, there is no pension fund and instead there is a formula for converting the value of your pension into a ‘cash value’ for assessment against the LTA. This assessment is done at the time of retirement and is after any ‘scheme pays’ deductions that were used to pay annual allowance tax charges and any reductions made to take into account tiering before the relevant pension age. It is important to remember that it is the total value of all your pension savings that count, i.e you need to add any personal pension to your NHS pension when assessing against the LTA.
This is not the first time that the Treasury has tinkered with the LTA. First introduced in the 2006-07 tax year, the LTA was set at £1.5m; it was then raised to £1.8m in 2010-11, but reduced back to £1.5m in 2012-13 and then to £1.25m in 2014-15, and to £1m in 2016-17. Since April 2018, successive Chancellors have raised the allowance in line with the CPI measure of inflation each year, until Rishi Sunak announced the freeze from April 2021.
For the new 2021-22 tax year, the freeze means savers miss out on what would have been an increase of around £5,800, had the LTA continued to rise in line with CPI inflation, which stood at 0.5% when the test was applied. For a member of the 1995 section of the NHS Pension Scheme, this would have been the equivalent of being able to receive additional pension income and lump sum cash of £252 a year and £756 respectively while staying within the LTA.
That sounds relatively modest, but over the next five years, the cost of the repeated LTA freezes will add up, with increasing numbers of Doctors being affected. Assuming that CPI inflation returns to a more typical 2.5% over the next couple of years, the LTA would rise to around £1.2m by April 2026 without the freeze, almost £127,000 above today’s threshold. Tax is applied at a rate of 55% for pension savings above the LTA taken as a lump sum or 25% if taken as income so this freeze will potentially cost senior doctors additional tax charges. Alternatively, this could potentially lead to them considering early retirement or opting out of the scheme.
However, in practice, the tests for assessing whether you have breached the LTA can get quite complicated, particularly if you are taking benefits from both the NHS Pension Scheme and a separate defined contribution plan. It is therefore important to seek advice on your potential exposure to the LTA – and any steps you can take to mitigate the tax charges that might result before you make any decisions.
One option may be to take advantage of Individual Protection 2016 (IP2016). If your pensions from all sources were worth more than £1m on 5th April 2016, when the Lifetime allowance was reduced to £1m, you are able to protect them from LTA charges, up to a maximum value of £1.25m, which was the previous LTA.
For example, if your pension rights were worth £1.2m on 5 April 2016, IP2016 would enable you to claim an LTA of £1.2m; if your pension rights were worth £1.3m on the same date, you would be entitled to apply for an LTA of £1.25m.
The key is to understand your position and what you might be able to do about it today. A Chase de Vere Medical financial adviser can help you understand your position against the LTA and advise you on the most appropriate action to mitigate this while also providing you with the retirement income a doctor would expect. While last month’s budget freeze will have alarmed many Doctors, the lower-than-expected LTA does not necessarily mean you should opt out of the NHS pension scheme. But it certainly is a factor of which you need to take account as you continue to plan your retirement finances.
Content correct at the time of writing and is intended for general information only and should not be construed as advice.