Doctors nearing retirement and senior public sector workers facing big tax hit to their pensions from lifetime allowance cut

18th March 2015

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NHS doctors nearing retirement are set to suffer big reductions in their pension payments following the reduction in the lifetime allowance says a leading financial planner.

David Smith, financial planning director at Tilney Bestinvest says the reduction of the lifetime allowance is effectively a stealth tax on the NHS.

He points out that cuts to the lifetime allowance is effectively a 40% reduction during the term of this government.

READ MORE: Pensions lifetime allowance cut

However Smith says that while members of defined contribution schemes can apply for ‘protection’ in return for not making further contributions, the position of those in defined benefit schemes such as the NHS scheme is significantly more complicated.

“Active members of defined benefit arrangements; including NHS workers, teachers and the police etc. will effectively be subject to the £1m ‘annual allowance’ if they remain active members of their respective schemes, which is something that ultimately they should do”.

“A further issue is that many members of defined benefit pension schemes are unaware of how their retirement benefits will be valued for ‘lifetime allowance’ purposes, as it is actually calculated as twenty times the pension they will receive, plus any additional tax-free lump sum,” he says.

He adds that members of public sector pension schemes will no longer be permitted to transfer their benefits into defined contribution arrangements from next month, preventing them from accessing the Freedom and Choice reforms.

“Many of the public sector pension scheme members will be trapped within these schemes, whilst building up an unknown tax liability that will have to be paid when they take their retirement benefits, and this will ultimately reduce the pension they could receive,” he adds.

Smith gives an example of two NHS consultants, one who will reach their retirement age on 7th April 2015 and the second who will retire a year later on 7th April 2016.

“Both of these consultants will have accrued the same level of years’ membership of the scheme by their respective retirement dates, and both will be entitled to a pension of £62,500.

“For the consultant who reaches their retirement date on 7th April 2015, they will receive their full pension entitlement as the value of their pension benefits would be £1.25m (i.e. £62,500 x 20) and this would not exceed the ‘lifetime allowance’ of £1.25m.

However, the second consultant is not so lucky, as his pension benefits will also have a value of £1.25m, but the ‘lifetime allowance’ would then be £1m, resulting in an excess of £250,000, which is unfortunately going to be subject to tax.

As the excess will be taken as income, the total tax due will be £62,500 and this will be paid from the pension scheme in lieu of a reduction in the pension income the consultant receives.

“In this instance the consultant would face a reduction in their pension of £3,125 and would only actually receive a pension of £59,375, a 5% reduction from the pension their colleague would receive.

“When the ‘lifetime allowance’ was £1.5m, a Consultant could have received a pension of £75,000 per annum without any tax charge being applied, but a consultant with this level pension benefit retiring after 6th April 2016 would face a reduction in their pension entitlement of £6,250 or 8.3%.”

Smith adds this is not the end of the potential bad news for members of final salary arrangements, as the continuing fall in the rate of inflation (as measured by Consumer Prices Index – CPI) could result in potential tax charges for those who remain active members of such schemes.

“This is due to the role that CPI plays in revaluing final salary pension values for the purposes of the ‘Annual Allowance’ check, with the lower the CPI figure the greater the potential for the ‘Annual Allowance’ of £40,000 being exceeded.

“For the purposes of the ‘Annual Allowance’ check, the CPI figure from the preceding September will be used for calculating the pension value, so we already know that the CPI figure for the 2015/16 tax-year will be 1.2%. However, given that the CPI figure for January 2015 was only 0.3% there is the real possibility that the CPI figure for the 2016/17 tax-year will be well below the 1.2% figure recorded in September 2014.”

Smith says that looking at members of the NHS Pension scheme (1995 membership) the CPI figure of 1.2% will mean that someone receiving a pay increase and/or an incremental award of more than 2% will potentially exceed their ‘Annual Allowance’ figure of £40,000.

He says that in the case of an NHS Consultant who has 30 years membership of the NHS Pension scheme and who earns a pensionable salary of £130,000, they would exceed their annual allowance by £3,688 and face a potential tax charge of 40% if they had no available unused ‘annual allowances’ to carry forward. If the CPI rate was 0.3%, then under the same criteria they would exceed the ‘annual allowance’ by £12,024, which again would be subject to a 40% tax charge.

“At a time when NHS members have experienced, for a number of years, little or no salary increases, coupled with increased pension contribution limits, a potential reduction in their pension entitlements is unlikely to boost staff moral and attract new staff to join.

“Indeed, it was only yesterday that it was reported that there is now a shortage of GPs, with the proposal to introduce Pharmacists within GP Practices to try to alleviate the pressure, and the expectation of a far lower pension at retirement is unlikely to attract new staff to this profession.”

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