What does the increased CPI inflation rate mean for my NHS pension and tax?

Our healthcare team examine the impact increased CPI inflation may have on your future NHS pension and tax contributions.

Why may I have an Annual Allowance tax charge this year?

The September 2021 CPI rate has been announced as 3.1%, this is a significant increase as it was only 0.5% in September 2020. Due to the way the NHS pension scheme is linked to the CPI rate, this will result in increased growth in your pension. Even if your income remains the same as it was in 2021 your pension growth will be higher because of the increased CPI. This higher growth will result in more individuals exceeding the annual allowance and having tax charges to pay.

What impact does CPI have on my NHS pension?

Along with adding your pensionable earnings, each year your pension is uplifted by the September CPI plus 1.5%. Depending on the size of your pension, then, movement in CPI can have a significant impact on the growth of your pension. On the plus side a higher CPI rate results in a higher potential pension but the increased growth can cause there to be annual allowance tax charges.

Do recent changes to the annual allowance calculation help me?

In April 2020, the government increased the threshold income for tapered annual allowances from £110k to £200k. This was done as a large portion of medical practitioners were being caught by this tapering and incurring large annual allowance tax charges. With the increase to £200k, fewer people are suffering a tapered annual allowance, however, it does not solve all of the problems. If an individual’s threshold income is over £200k then they may still have a reduced annual allowance.

With the higher CPI rate more individuals pension growth will exceed the standard allowance of £40k and may have tax charges. Those already above £40K will see significantly higher annual allowance charges in 2021/22.

How do I pay any annual allowance tax charge?

If your pension growth results in you having an annual allowance tax charge then there are two options for paying this.

  • You can pay it through your tax return along with your normal January tax liability. As well as paying the charge for the current year, your payments on account in January and July for the next year may be increased.
  • You can opt for the pension scheme to pay the tax charge by reducing your future pension entitlement. At the time of retirement, the pension provider will calculate the total tax charge paid and using actuarial factors will reduce your gross annual pension and any lump sum due. The pension provider will charge interest on any tax payment made up to your retirement date. (Calculations and factors differ between Scotland and, England and Wales)

What can I do to mitigate any annual allowance tax charge?

The growth in your NHS pension each year is based on the CPI inflation rate and your pensionable earnings. There is nothing that can be done about the CPI rate, so the only flexibility is in your pensionable earnings. The two ways that this can be changed are by reducing your taxable income through dropping sessions or stopping additional work, or by opting out of the pension scheme for part of the year. Both options can have a significant impact on your take-home earnings, tax liabilities, and future pension entitlement. In some cases, using Limited Companies can help but that depends on whether income can be paid into a company. In many NHS GP contracts, there are restrictions, so it is not straightforward.

If reducing taxable income is not an option, then, of course, you can always use the Scheme Pays Election, to pay the charge, although electing for this potentially has an impact on future pension benefits.  We therefore strongly recommend that independent financial advice is taken before making any decision.

What about the Lifetime Allowance?

A higher gross annual pension results in a higher total pension pot and increases the likelihood of you breaching the lifetime allowance and suffering a tax charge. The current lifetime allowance is £1,073,100 and this is fixed until 2026. If at the time of drawing your pension you exceed this, then a tax charge is assessed on the pension scheme. Any tax paid by them will reduce the benefits paid to you in retirement. Some protections still exist for higher amounts of allowance.

What is the McCloud Judgement?

It was judged that the way some scheme members were moved to the 2015 pension scheme depending upon their age was discriminatory. Scheme members are therefore going to remain or be returned to their legacy scheme (1995 or 2008) until 31 March 2022. At the time of retirement, each individual will have the choice of leaving this period in the legacy scheme or moving it to the new scheme. As each scheme has a different pension accrual rate, this choice will impact your pension and annual allowance tax charges.

How we can help

The NHS pension and the interaction with pension taxation are complex and only going to get more complicated over the next few years.

Our specialised Healthcare team deal with the tax affairs of medical professionals across Scotland and England. Along with our independent financial advisors, we can provide you with more information and estimates to enable you to make an informed decision for your future. We can do this through cash flow planning, tax estimates, and scenario reports.

If you would like more information on any of this or to discuss your position, please contact us through the form below.

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