Pension tax update: the NHS pension scheme

In the spring Budget 2023, the Chancellor announced an increase in the limits for the annual allowance, and the abolition of the lifetime allowance to “help ensure that NHS clinicians are not disincentivised from remaining in the workforce”. The changes come after years of campaigning by professional bodies, such as the British Medical Association, who have seen a significant number of senior doctors retire early or reduce their working hours, due to the amount of tax suffered on benefits accrued within their pension funds.

Below is an insight into the recent changes to the pension tax system and their effect on members of the NHS pension scheme.

What is the NHS pension scheme?

The NHS pension scheme comprises three sections; 1995, 2008 and 2015.

A member of the scheme may have accrued benefits under one or more sections throughout their career.

The 1995 and 2008 sections, which together form the 1995/2008 NHS pension scheme, are the most generous, as pensions are based on members’ salary in the later years of their career. This scheme was closed on 31 March 2022. Benefits accrued within the 1995/2008 scheme are protected but all future benefits will now accrue within the 2015 NHS pension scheme. This scheme is slightly less generous in that pensions are based on members’ pensionable earnings throughout their career.

What is the annual allowance?

The annual allowance is a limit on the amount of pensions savings that an individual can make each year without incurring a tax charge.

The basic annual allowance has been increased from £40,000 to £60,000 from 6 April 2023.

Any unused annual allowance can be carried forward for three tax years, provided the individual has been a member of a registered pension scheme in the tax year.

What is the tapered annual allowance?

The annual allowance may be tapered for individuals with high incomes.

For tax years 2020/21 to 2022/23, the tapering rules affected individuals with “threshold income” over £200,000 and “adjusted income” over £240,000. However, concerns over their effect on the delivery of public services such as the NHS, led to an increase in the limit for adjusted income to £260,000 from 6 April 2023.

The taper reduces the annual allowance by £1 for every £2 of adjusted income above £260,000, subject to a minimum allowance of £10,000. This means that an individual with adjusted income of £360,000 or more will only receive tax relief on pension savings of £10,000.

For tax years 2020/21 to 2022/23, the minimum allowance was £4,000.

What is threshold income?

The calculation for threshold income differs for individuals who are employed by the NHS and those who are self-employed and providing NHS services to the public.

The starting point for both calculations is to determine the individual’s total income for the tax year. Total income includes both pensionable and non-pensionable earnings from the NHS, as well as other sources of income (for example, investment income, pension income, etc.). The individual is then allowed a deduction for certain tax reliefs, such as ‘qualifying loan interest.’

An individual who is employed by the NHS will then receives a deduction for their employee superannuation contributions.

Self-employed individuals are liable for both “employee” and “employer” superannuation contributions on their profits. These are both deductible in the calculation of their threshold income.

If the individual’s threshold income exceeds £200,000, it will be necessary to calculate their adjusted income to determine whether the annual allowance is tapered, and if so the amount of their tapered annual allowance.

What is adjusted income?

Again, the calculation of adjusted income depends on whether an individual is employed or self-employed.

To determine the adjusted income of an individual who is employed by the NHS, their ‘pension input amount’ is added to their threshold income. The pension input amount is the growth in value of their NHS pension benefits over the tax year, as stated in their annual allowance pension savings statement for each section of the NHS pension scheme.

To determine the adjusted income of an individual who is self-employed, the difference between their ‘pension input amount’ and superannuation contributions (both “employee” and “employer” contributions) is added to their ‘net income.’ Net income is their total income for the tax year, minus certain tax reliefs. Their pension input amount is the same as that for NHS employees, i.e. the growth in value of their NHS pension benefits over the tax year, as stated in their annual allowance pension savings statement for each section of the NHS pension scheme.

How does the NHS pension calculate the pension input amount?

The calculation of the pension input amount is complex, but essentially it is the difference between the value of the individual’s pension benefits at the start and end of the year, adjusted for inflation.

What is the annual allowance charge?

The annual allowance charge restricts tax relief on pension savings in excess of an individual’s available allowance.

To calculate the amount of the charge, the pension input amount for all NHS schemes is compared to the individual’s available allowance.

Any excess pension savings will be taxed at the individual’s marginal rate of income tax which, in most cases, will be the additional rate of 45%.

What is ‘scheme pays’?

It can be difficult for members of the NHS pension scheme to avoid an annual allowance charge as the growth in their pension scheme is not known until after the end of the relevant tax year.

If they have an unexpected charge, they could elect for it to be settled from their pension pots in return for a reduction in their future pension benefits.

Where the individual has an annual allowance charge of £2,000 or more, and their pension savings exceed the annual allowance of £60,000, NHS pensions will become jointly liable for the charge under ‘mandatory scheme pays’.

If these conditions are not met, the individual will remain liable for the charge but it may be possible for the scheme to settle the charge on a voluntary basis.

The deadline for scheme pay elections is 31 July following the anniversary of the end of the tax year. This means that those affected by the charge in 2023/24 would need to notify the NHS pension scheme by 31 July 2025.

Abolition of the lifetime allowance

For pensions taken on or after 6 April 2023, there is no tax charge on the value of benefits in excess of the lifetime allowance of £1,073,100.

Conclusion

It is hoped that the changes to the pension tax system will improve staff shortages and waiting lists. Although this remains to be seen, the changes do present opportunities for members of the NHS pension scheme to enhance their pension benefits at retirement.

For example, if an individual ceased contributions to the NHS Pension Scheme because they were approaching or in breach of the annual or lifetime allowance, it may be beneficial for them to re-join the scheme and re-start their contributions.

Help from the experts

Moore Kingston Smith has a wealth of experience in advising healthcare professionals on their personal tax affairs. If you are impacted by the recent changes to the pension tax system and would like advice on pension tax charges, please do not hesitate to contact us. Our tax advisers work closely with Moore Kingston Smith Financial Advisers to ensure that our advice is tailored to your circumstances and maximise your benefits at retirement.