Understanding your pension - and how it's taxed - isn't always straightforward. But getting it right can make a big difference to your future plans.

Arrangements around the pensions of healthcare professionals can be extremely complex and can lead to excess tax charges for some.

Constant changes to the annual allowance since its introduction, coupled with lifetime allowance charges and protections, are ample reasons why those working in healthcare would be wise to seek professional advice when it comes to their finances.

Annual allowance

Annual allowance (AA), also referred to as pension input, is the maximum amount of pension savings an individual can make each year with the benefit of tax relief. This includes pension contributions made by the individual, their employer or a third party.

The NHS Pension scheme is a defined benefit scheme. This means the level of contributions made within a fiscal year is irrelevant, as it is the annual growth within the fund(s) that is used as the pension input. Any pension input above the available AA is subject to tax at the individual's marginal tax rate.

The government introduced AA in 2006 with an initial limit of £215,000. This rose over the following four years to £255,000 before being significantly cut to £50,000 in 2010/11 and reduced again in 2014 to the current standard level of £40,000. In 2016/17, the potential to 'taper' AA for high earners was introduced, effectively restricting the amount of tax relief available on pension input even further.

In 2016/17, the 'threshold income' and 'adjusted income' levels were set at £110,000 and £150,000 respectively, which resulted in many senior clinicians, general practitioners and dental practitioners being subject to tapered annual allowance, with many suffering additional tax liabilities as a result. The higher an individual's earnings, the lower the level of annual allowance; in 2016/17 the minimum was £10,000 where adjusted income levels exceeded £210,000.

Members of the NHS Pension Scheme must include all NHS superannuable income in the determination of their contributions. Employee tier rates range between 5% and 14.5% alongside a flat rate employer's contribution of 14.38% (with NHS England and NHS Improvement (NHSEI) contributing a further 6.3% employer's contribution in 2021/22 as part of the transition to the higher employer's rate of 20.68%).

Pensionable pay is defined by the rules of the NHS pension scheme. For employed clinicians, pensionable pay is primarily basic salary, excluding elements of earnings such as commission, bonuses and overtime. For GP partners, superannuable income is broadly based on the profit share which relates to NHS income and expenses plus any NHS income.

A more detailed explanation can be found on the NHS Business Services Authority website.

Knock-on effects

The consequence to the healthcare sector of senior personnel being subject to AA excess tax charges has been massively detrimental to the government's waiting list targets, as many individuals impacted by this rule decided to cut their working hours to reduce their income.

This in turn resulted in reduced primary and secondary care capacity for healthcare service to meet ever-increasing demands and has resulted in an ever-increasing backlog of patients and lengthening waiting list times.

The government's action to address this was twofold.

  1. From 2020/21, the threshold income and adjusted income levels were raised by £90,000 each to £200,000 and £240,000 respectively, with a minimum tapered AA reduced to £4,000 for those with adjusted income in excess of £312,000.
  2. NHS England confirmed that clinicians and dental practitioners who are active members of the NHS Pension Scheme, and, "who as a result of work undertaken in this tax year (2019/20) incurred a tax charge in respect of the growth of their NHS pension benefits above their pension savings annual allowance threshold, will have this charge reimbursed by their NHS employer at the point of retirement, ensuring that they are fully compensated for the effect of the 2019/20 Scheme Pays deduction on their income from the NHS Pension Scheme".

The one-year fix for 2019/20 requires a 'scheme pays election' (submission of form SPE2 to NHS Pensions) along with a declaration by the individual confirming entitlement to 'compensation', which in turn has to be certified by the employer. The deadline for both submissions is 31 March 2022.

The raising of the threshold and adjusted income limits in 2020/21 has reduced the volume of individuals subjected to tapered AA. But if the input pension (fund growth) exceeds the individual's available AA (standard AA level is £40,000) in any given year, an AA excess tax charge will still be levied by HMRC.

As in the past, this tax charge can be paid directly or a scheme pays election can be made, in which case the pension fund will cover the tax payable.

The higher an individual's earnings, the lower the level of annual allowance.

Lifetime allowance

For pensions, the lifetime allowance (LTA) is the overall limit that can be amassed in an individual's pension savings without incurring a tax charge. The current standard LTA is £1,073,100, which is frozen until April 2026.

It is the capital value of a pension and benefits that determine what percentage of the LTA is used. If the capital value exceeds the LTA, a lifetime allowance tax charge will be levied as follows:

  • 25% of the capital value where the excess is being taken as a pension income, plus your marginal rate of income tax when income is drawn; or
  • 55% of the excess if it is to be taken as a lump sum. Any pension lump sum in excess of 25% of the LTA value will also be taxed at a rate of 55%.

The pension administrator and the individual are jointly liable to ensure the LTA tax is settled.

The capital value of a fund is calculated as follows:

  • Capital value = (annual pension amount x 20) + lump sum

Introduced in 2006, the LTA has changed annually, going up in value as well as down. Throughout this time, there have been various fixed and individual protections members could initiate to minimise the impact of the LTA at the point of benefit 'crystallisation', but the uptake of these has remained comparatively low.

A recent freedom of information request by wealth management company Quilter identified more than 400 NHS doctors had paid in excess of £11 million in LTA tax charges.

Fixed protection

Fixed protection (FP) secures the member's lifetime allowance at a certain level, depending on what version the member holds. There are three different levels:

  • fixed protection 2012 (FP12) provides LTA of £1.8 million
  • fixed protection 2014 (FP14) provides LTA of £1.5 million
  • fixed protection 2016 (FP16) provides LTA of £1.25 million.

FP12 and FP14 are closed, but FP16 remains open. Under FP16, the LTA is adjusted to £1.25 million.

There is also individual protection 2016 (IP16), which along with FP16 has the same entitlement parameters - namely a minimum pension fund of £1m as at 5 April 2016. With individual protection, the LTA is set as the fund value as at 5 April 2016.

It is possible to elect for both FP16 and IP16. With IP16, a member can continue to contribute to their fund and any capital value in excess of the personalised LTA will be subject to LTA tax. But if a member continues to contribute with FP16, their fixed protection will be lost.

Here to help

If you're an MDU member, you can discuss your pension and tax liabilities, as well as other financial issues, by accessing Armstrong Watson's services through your MDU membership.

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This page was correct at publication on 04/03/2022. Any guidance is intended as general guidance for members only. If you are a member and need specific advice relating to your own circumstances, please contact one of our advisers.