Confused about how much you’re allowed to contribute to your pension and what to do if you’ve been hit with an unexpected tax bill? If you are, you’re not alone amongst doctors and dentists. This summary will hopefully help answer your questions.
How much can you pay into your pension each year without incurring a tax charge?
There is a limit to how much you can pay into your pension each year and still receive tax relief on the contributions. This limit is set by the Government and is called your annual pension allowance.
The standard annual pension allowance is £40,000 but, under the Tapered Annual Allowance rules, this can be reduced to as low as £10,000 for “high earning” doctors and dentists.
Is your annual pension allowance less than £40,000?
Calculating whether or not your annual allowance is tapered all depends on the total amount you have earned, and what your deemed pension contributions across all your pensions are.
You also need to take into account any “unused allowance” from the previous 3 years and use ‘carry forward’ to bring them into play.
Calculating your deemed pension contributions (also called your pension input) can be complex, particularly for members of the NHS Pension Scheme.
- If you have a personal pension, your pension input in any given year is simply how much in total was added – by you and your employer – to your pension in that year.
- For NHS Pension Scheme members, it isn’t as simple as that. The HMRC takes the value of your NHS pension pot at the start and end of the tax year and “calculates” the deemed increase in benefits – this is referred to as the pension input.
- If you have both a personal pension and an NHS pension, you need to add your two pension input figures together. Knowing the difference between the two methods is vital.
The final figure is different for everybody and calculating it is something you should, in truth, do with your financial adviser and/or tax accountant.
What if your pension contributions are more than your annual allowance?
If your pension contributions exceed your annual allowance, you are likely to be stung with a hefty, unwanted tax bill as many unaware doctors and dentists have recently found out!
It’s as simple as that.
Paying your unwanted pension tax bill
What many medics and dentists are also unaware of is that there are two ways to pay this nasty tax bill.
Option 1: Pay your bill with cold hard cash in the here and now
Or
Option 2: Pay your bill via the NHS Scheme Pays facility.
What is NHS Scheme Pays?
NHS Scheme Pays is effectively a loan from the NHS to pay for tax charges you have incurred as a result of exceeding your annual allowance. The ‘loan’ is repaid when you retire; your NHS pension is reduced by a fixed amount on an annual basis from when the pension comes into payment. In essence, NHS Scheme Pays allows you to defer your tax bill.
An election to use Scheme Pays for a particular tax year must be received by the NHS Pensions Agency by the 31st of July 2019 in the following tax year. So beware, this is fast approaching!
For example
If you want to use Scheme Pays for the 2017-2018 tax year, you:
- Must make your election by the end of July 2019
- Should have told HMRC that you are going to use Scheme Pays (and by how much) in your 2017-2018 tax return that was due by the 31st January 2019. If you didn’t, you may need to re-submit your tax return.
Since 2017/18 you can use the NHS Pension Scheme Pays, to pay 100% of your annual allowance charge that relates to your NHS benefits. However, the NHS Pension Agency must receive your election before the end of July deadline.
What if you have an annual allowance charge for tax year 2016/17, or earlier?
I’m afraid it isn’t such good news. The NHS may accept an application for Scheme Pays retrospectively, however, as we move away from the 2016-2017 year, then it becomes less and less likely.
In addition, for the 2016-2017 year, you can only ask the NHS pension scheme to pay an annual allowance charge that is attributable to the part of the pension input amount that is over the standard annual allowance. If you had a tapered allowance, for instance, the NHS will not pay the tax associated with the “contribution” between the personal tapered allowance and the standard allowance.
Examples of the “2016-2017” approach are as follows:
Example 1
Dr. Jones is a high earning Consultant. Her tapered annual pension allowance is £15,000 and she has just found out that her deemed pension contributions total £60,000.
She has exceeded her tapered annual allowance by £45,000, all of which will be liable for tax and likely at 45%. That’s a tax bill of £20,250!
Even if Dr. Jones elects for NHS Scheme Pays, only her tax liability on the £20,000 above the standard £40,000 annual allowance limit (£60,000 – £40,000 = £20,000) will be paid by the NHS. That’s just £9,000 of the £20,250 she owes.
Not only will Dr. Jones have to pay the remaining £11,250 herself, but she will also probably have to pay a higher amount on account for the following tax year too!
Example 2
Dr. Sayad has a tapered annual allowance of £27,000 but his deemed annual pension contributions total £43,000. That’s a difference of £16,000. His overall tax liability is therefore £7,200 (£16,000 x 45%).
Only £1,350 of this tax bill is eligible for NHS Scheme Pays (the tax on the £3,000 over the standard £40,000 limit).
Normally Dr. Sayad would have to pay this himself because it is lower than the £2,000 Scheme Pays minimum limit. This limit is still relevant as it’s relating to a pre 2017/18 liability. However, because Dr. Sayad’s overall tax liability for breaching his annual allowance is £7,200, NHS Scheme Pays will consider paying the £1,350.
To defer or not to defer paying your additional pension tax bill
Using NHS Scheme Pays to defer paying the additional tax you owe is not for everyone. Some prefer to just pay the bill and know that their retirement income is untouched. Others come out in a rash at the thought of paying more tax now!
For me, the main points to think through are:
1. How do you feel about deferment of tax? An additional tax bill of thousands of pounds is always hard to take, but you aren’t making it go away with NHS Scheme Pays…just “kicking the tax can down the road” and paying the compound interest that will be added along the way!
Take caution, this rate could be punitive, as for what starts as a seemingly small amount could grow to a large amount. For medics/dentists close to retirement, NHS Scheme Pays may be a good option. For younger doctors, then a career’s worth of annual NHS Scheme Pays elections could really mount up and needs to be seriously considered.
2. Make sure you are fully up to date with all the nitty-gritty details that will help you make a decision. For instance, when you retire, you will pay an annual NHS Scheme Pays fixed charge through a reduction of your pension income. However, each year your pension will increase by inflation (CPI) but the fixed charge remains static. In other words, the fixed charge, in real terms, becomes less and less meaningful for each year that goes by.
3. Do you have a lifetime allowance issue with benefits in excess of the prevailing lifetime allowance? If you do, this may actually reduce your liability as it reduces your NHS pension pot’s deemed value.
A little known fact is that “To defer or not to defer – that is the question” is what Shakespeare’s Hamlet actually asked himself. OK so that is slight poetic licence, but ask yourself the same question when discussing it with your financial adviser.
Of course, calculating your annual pension allowance is a very complex area. This article is designed to provide an overview for members of the NHS Pension Scheme. It is to help ensure that those potentially affected, are aware of the rules and options available to them, to pay any associated tax due. It isn’t designed to provide advice or enable you to self-diagnose.
If you’re a doctor or dentist and you think you are impacted by the tapered annual allowance rules, we strongly recommend you seek professional guidance from a specialist IFA.
If you exceed your annual allowance, will you opt to defer paying the tax bill you’ll very likely get? Let us know by adding a comment below.
Sources: NHS Pensions’ Scheme Pays FAQs; NHS Pensions’ Scheme Pays