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Watch out for annual allowance increases in 2022/23

As a member of the NHS pension scheme, you are likely to be familiar or at least aware, to some level, of annual allowance charges. One of the key questions our clients ask us is whether there is likely to be an annual allowance charge this year? And, if so, what can be done to mitigate this?  As annual allowance charges are linked to inflation and inflation is currently at exceptional levels, we are expecting a significant number of charges in 2022/23 and for some members with long service and/or high earnings, these charges may be significant.

What are annual allowance charges?

Put simply, everybody has an “annual allowance” of £40,000 for their pension input. For members of defined contribution schemes, this will refer to the level of contributions that can be paid into schemes in the tax year. For members of defined benefit schemes though, (which includes the NHS Pension scheme), the annual allowance is assessed on the growth in pension benefits in the tax year. If the growth or contributions in the tax year exceeds £40,000, then the excess over this amount will crystallise into an annual allowance charge, taxable at your marginal tax rate, (usually 40% or 45%). NHS pension scheme members have the option to make a “Scheme Pays Election” (where the cost is charged to the pension scheme) or to pay the charge as part of their annual personal tax bill.

Why are a lot of annual allowance charges expected to crystallise in tax year 2022/23?

One of the key attractive features of the NHS pension scheme is its design to be inflation proof.

For GPs, benefits accrued to date are uplifted by CPI from September of the previous year, (this is effectively “allowed growth” as growth in the year is compared to this figure). Growth in the year is also inflated by CPI + 1.5% – but CPI from September in the year is applied to this figure.

There is therefore a mismatch in the CPI rates applied to growth.

For example, for 2021/22, opening accrued benefits are inflated by 0.5% (September 2020 CPI) whereas in year growth is inflated by 4.6% (September 2021 CPI + 1.5%).

It follows then that we are expecting significant growth in 2022/23 as opening accrued benefits will be inflated by 3.1% (September 2021 CPI) and in year growth will be inflated by September 2022 CPI + 1.5% – which, could be c.11.5% (10% CPI + 1.5%).  This is potentially 8.4% growth on accrued earnings before pensionable earnings from the year are added into the equation.

To put that into context, an individual with 20 years of service and accrued benefits of c. £38,000, earning £100,000 of pensionable income in the 2015 scheme in the year ending 31/3/23, would be expected to generate pension growth of c.£94k, £54k over the annual allowance. In turn, this would create a charge of c.£22k, assuming a 40% tax rate.

Furthermore, beyond immediate annual allowance issues, the strong growth may also have a bearing on exceeding the lifetime allowance, particularly for higher earners with long service.

On the flip side, if inflation drops to more normalised levels in September 2023, then very low growth (possibly even negative growth) may eventuate in the 2023/24 tax year but there is currently no way of carrying this back to offset against the likely excesses in 2022/23.

The position is slightly different for consultants as benefits in the 1995/2008 Scheme are linked to final salary, rather than inflation. This means that pension growth won’t be as high. Benefits in the 2015 Scheme are calculated in the same manner as for GPs so there will be high growth for these benefits.

What can I do?

First of all, we’d recommend taking a proactive rather than reactive approach to managing your NHS pension. Given the complexity of the scheme, the potential pitfalls and the errors that can be made, we feel that it is better to have full sight of what may lie ahead.

When you know what lies ahead, we can lay out various options for you to consider in how you would like to proceed. Unfortunately, there are no simple solutions as actions to mitigate charges can also reduce pension benefits – and so the action to take is a very individual decision.

Are there any positives to this?

Let’s not forget that the NHS Pension scheme is an excellent, inflation proof scheme that provides members with very attractive retirement benefits – which, with the current volatility in the markets, is extremely valuable.

A key point to note is that a high annual allowance charge is driven from high pension growth; you can’t have one without the other.  Furthermore, our experience is that, generally speaking, even after making a Scheme Pays Election, members should still be in net pension growth position.  Indeed, making a Scheme Pays Election can also help to mitigate Lifetime Allowance charges.  The default position of doing nothing is therefore not necessarily the worst strategy to take but depends on each individual’s position of whether they would prefer to have cash in their pocket now or higher retirement benefits, assuming a long life.

Is anything likely to change?

In the background, there are various groups that are currently lobbying the government for reform. This includes on (i) the mismatch in inflation rates applied to opening accrued benefits and in year growth (ii) a possible compensation scheme for 2022/23 – as was seen for 2019/20 (iii) an increase in the annual allowance – which has been static at £40,000 since 2014 and (iv) a more equitable scheme where losses or unutilised allowances can be carried backwards as well as forwards.

Therese Coffey, during her brief tenure as Secretary of State for Health, announced on 22 September 2022 in the policy paper ‘Our plan for patients’ that “We will incentivise our most experienced GPs to stay in practice by correcting pension rules regarding inflation.”  We wait to her further detail of these corrections.

If you would like a review of your NHS pension figures, please get in touch with you usual PKF Francis Clark contact or alternatively, please contact Katie Skea (Katie.Skea@pkf-francisclark.co.uk) or alternatively call 01872 276477.

FEATURING: Katie Skea
Katie Skea, ACA BSC (Hons), is a partner working in the Healthcare team of the Truro office. Katie looks after a large number of our… read more
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