The Chancellor’s Spring Budget included pension reforms designed to support doctors who want to work for longer and to re-join the workforce. Here’s how they will work in practice.
Jeremy Hunt’s Spring Budget included proposals designed specifically to address some of the concerns of the British Medical Association. It has consistently highlighted how pension tax allowances are making it difficult for doctors to carry on working as they get closer to retirement age, or to re-join the workforce if they’ve already stopped practicing. But has the Budget dealt with the entire issue of pension tax in order to retain doctors in the NHS?
Two reforms in one budget
The main problem highlighted by the BMA has been the annual allowance which, if exceeded, imposes a tax on the excess amount. The annual allowance test is based on pension contributions for defined contribution schemes or the rise in the value of benefits in defined benefit schemes such as the NHS pension. The annual allowance has in recent years been frozen at a maximum of £40,000. The complicated formula used to calculate the value of benefits in defined benefit pension schemes such as the NHS Pension has seen many doctors inadvertently exceed this allowance, incurring a significant tax charge.
From 6 April , 2023, the annual allowance will increase by half, reaching £60,000. This positive development is expected to benefit many doctors by significantly reducing the number who receive large pension tax bills and eliminating the incentive to reduce working hours. However, although the numbers affected should decrease and the tax charge for those who breach the limit will be smaller, it may still impact those doctors at top of their profession. Therefore, while a step in the right direction, it may not provide a complete solution for senior doctors working for the NHS, who will still need to carefully plan their work schedule. The second problem facing doctors has been the lifetime allowance. This caps the value of pension benefits that any one individual can build up; benefits above the allowance, reduced in recent years to a little over £1m, are then taxable at rates of 25% if the excess is taken as income and 55% if taken as a lump sum.
Here, the Chancellor appears to have gone the extra mile. From 6 April, there will no longer be any tax to pay on excess benefits above the lifetime allowance; and from April 2024, the lifetime allowance is being scrapped altogether.
Both changes are good news for doctors, who have been disproportionately adversely affected by these allowances and tax changes. Pensions Expert, published by the Financial Times, recently used a freedom of information request to reveal that 34% of all taxpayers who exceeded the annual allowance in 2019-20 were members of the NHS Pension Scheme. More recently, it has become very clear that some doctors are restricting their hours, or not working at all, to avoid such traps; given the challenges facing the NHS, that has been disastrous.
Devil in the detail
It’s important to stress that the small print of the reforms reveals some issues where doctors will still need to take care – and not only those who may still fall foul of the increased annual allowance.
One issue is that while the general rule on pensions is that you can take up to a quarter of your fund as tax-free cash up to a maximum of 25% of the lifetime allowance, this perk will be limited to a quarter of the lifetime allowance of £1,073,100. Therefore, even after the lifetime allowance has been abolished, you won’t usually be allowed to take a tax-free lump sum – known as the pension commencement lump sum in the jargon – of more than £268,275, no matter how large your fund grows except if you hold some form of lifetime allowance protection entitling you to a higher level of tax free cash.
More disappointing is the Chancellor’s decision to retain the tapered annual allowance, albeit with a slightly more generous set-up. This allowance affects particularly high earners – currently those whose income, NHS pension growth and private pension contributions add up to £240,000 or more and this is known as the adjusted income limit. If you’re affected, your annual allowance shrinks by £1 for every £2 that you’re over this sum; those with adjusted income of £312,000 or more have an annual allowance of just £4,000.
From 6 April 2023, the adjusted income limit will increase to £260,000 and the minimum annual allowance will rise to £10,000 (for people with adjusted income of £360,000 or more). Nevertheless, keeping the taper makes for a more complicated pension system – and as mentioned earlier hardly reflects the Chancellor’s rhetoric about wanting to encourage senior doctors to keep working.
The reality is that in a defined benefit scheme such as the NHS Pension Scheme, members have less control over the amounts deemed to have been added to their pension each year. So, the tapered annual allowance may still be a disincentive for doctors to work.
Planning for change
The reforms announced by Mr Hunt will begin to take effect on 6 April, when the 2023-24 tax year begins. Given the complexity of the pensions system, it may be a good idea to get independent financial advice on how the reforms will affect you.
That advice may be able to identify opportunities as well as managing risk. For example, the Chancellor has retained the carry forward rules, which allow pension savers to bring forward unused annual allowance from the past three tax years to the current tax year. Another important change that the BMA has been campaigning for will be applied from 6 April is in respect of negative growth within the 1995/2008 Scheme. This is where an annual pay award is less than inflation from the previous year and the effect of a higher opening value can lead to a negative pension input amount which previously would have shown as zero. However, from 2023/24 any negative growth in the 1995/2008 scheme can now be used to offset any positive growth in the 2015 Scheme.
So, from April at the extreme, for doctors who haven’t used any of their annual allowance in the past three years, the £60,000 allowance in 2023-24, combined with the £40,000 allowance in each of the previous three years, would make for a total annual allowance of £180,000 in the tax year to come. Most doctors won’t be in that position – but many will be in a position to make at least some use of the carry forward system.
Content correct at time of writing and is intended for general information only and should not be construed as advice.