Pensions - are you over your allowance?

05 March 2020
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Claims that NHS doctors and other public servants are quitting their jobs because of recent tax changes are worrying. Jill Insley finds out what’s going on
 
Recent changes to pension rules have resulted in doctors, judges, army officers and other senior public servants quitting their pension schemes, cutting work hours or even retiring early for fear that further pension contributions could trigger huge tax bills.

The amount of tax-free earnings that you can save into your pension on both an annual and lifetime basis have been drastically reduced over the past eight years, and if you exceed the new limits you will face hefty tax charges. Government figures show that hundreds of thousands of people have already fallen victim to the new rules, with some reportedly having to remortgage their homes to pay five-figure tax bills. High earners in the private sector have been affected to a lesser degree, because their schemes are often more flexible and tend to have significantly lower contribution rates than public sector pensions.

Problems started when the government cut the annual allowance – the maximum amount you can pay into your pension each year – from £255,000 to £40,000. It also reduced the lifetime allowance – the maximum amount you can hold in all your pensions without triggering a tax charge when you withdraw cash – from £1.8m to £1m, although the allowance has now crept back up to £1.055m in the current tax year.

 

Exceeding limits


While allowances of £40,000 a year and £1.055m over a working lifetime might sound generous, if you are a high earner and belong to a pension scheme that allows you no control over how much you contribute, it is all too easy to exceed the limits in the final years of your career. Kevin Walker, a wealth director at Sanlam, specialises in financial planning advice for medical professionals and regularly lectures on NHS pension changes. He says: “For a lot of people working full time in the NHS, it’s not a matter of if you are going to breach the lifetime allowance, but when.”


The issue became even more serious for high earners in 2016, when Chancellor George Osborne introduced a tapered annual allowance to limit the amount of tax relief for those earning £150,000 and above. The taper means that for every £2 of ‘adjusted’ income earned above a £150,000 threshold each year, £1 of annual allowance will be lost. The maximum reduction is £30,000, so those earning £210,000 or more will have their annual allowance capped at £10,000. However, the metrics used to calculate the taper mean that you could be hit even if you are earning £110,000 a year. This is because the annual allowance pension growth as well as all private and investment income is taken into account.


Calculating whether you have exceeded your allowance is mind-bogglingly complex, and most people will need professional help, both to calculate what they may already owe in tax and to avoid further bills.
 

Axing the taper

The British Medical Association is among the critics that have called for the taper to be axed. But although the government is desperate to stop an exodus of experienced staff from the NHS and other public services, Walker believes financial constraints could prevent politicians from taking this step. He points out that many of the final salary schemes are ‘pay as you go’ – the money being paid in now by working members is being used to fund the pensions of those already retired. “Increasing longevity has made funding such schemes increasingly expensive, and the government recently lost a court case relating to public sector pensions which will result in it having to find a further £4bn a year in funding,” he says. “In these circumstances I think it unlikely that the government would do anything that increases its pension costs.”


The government has proposed new rules to allow NHS staff flexibility around how much they contribute to their pensions from April 2020, enabling them to set exactly how much they contribute and accrue at the start of each financial year. But Walker says the trouble with this approach is that you have to make that decision before you even know what you will earn over the course of the year.


Don’t panic Walker does not think it necessary or sensible for everyone caught by the allowances and taper to reduce their working hours or stop making pension contributions, adding that there are measures to mitigate the impact of both lifetime and annual allowance cuts. Some working doctors may have the option not to pay tax upfront on excess pension contributions. Instead they can opt for the NHS pension scheme to pay the tax bill now and recoup the tax plus interest from their pension pots at retirement.


Although this process, known as ‘scheme pays’, means the doctor is still effectively paying the tax bill, Walker says they will often end up with a bigger pension income on retirement. He cites the example of one client who wanted to opt out of the scheme due to the tax charges. Even after ‘scheme pays’ charges, his pension was still about £16,000 a year bigger than if he had opted out.


Walker says: “If you take into account the savings this client would have made by not being in the scheme, he had to live less than 10 years after retirement to be in profit by staying in and opting for ‘scheme pays’. With a potential life expectancy of up to 30 years I know what I would choose. It’s not just about paying the tax, it is what you are getting for it.”
 

The impact of pension changes

  • 290,000 people already have pension savings above the lifetime allowance Royal London, April 2019

  • 33% of NHS consultants are considering early retirement NHS Employers research, June 2019

  • 19% of GPs in England have quit the NHS pension scheme GP Online, August 2019

  • 25% Nearly 25% of judges in the UK went over the annual allowance in 2017/18Your Money, July 2019

“For a lot of people working in the NHS, it’s not a matter of if you are going to breach the lifetime allowance, but when."

Tax rules are subject to change and based on our understanding as at November 2019. The information provided should not be taken as fi nancial advice, and you should always seek professional advice.

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