Many GPs and dentists in the NHS Pension Scheme may have an unpleasant tax bill coming, merely because CPI inflation in September 2017 was 3%. How can that be and what should you do if this applies to you?
How your pension is calculated
If you’re a General Practitioner or NHS Dentist in the NHS Pension Scheme, your pension is based on your ‘dynamised earnings’.
In effect, a record of your earnings each year is kept and added to all your previous years’ earnings to give you a whopping great figure which equals your total career earnings. Your pension at retirement is a percentage of this sum.
Keeping the value of your pension in line with inflation
In order to make sure that all your previous years’ earnings mean something in today’s terms, a factor is applied to them each year to ‘uprate them’ and bring them in line with inflation. This is known as dynamising. The resultant sum is referred to as your Career Average Revalued Earnings (CARE).
The effect of inflation on GPs and NHS Dentists’ career earnings and pension benefits
The factor used by the NHS Pension Scheme for dynamising your earnings is the Consumer Price Index (CPI) figure that is set in September of the current tax year, plus 1.5%.
The CPI rate in September 2017 was 3% which means that your earnings will be increased by 4.5% for the 2017/18 tax year. That’s a significant increase in the value of your pension benefits which all sounds great, but (and it’s a big but!)…
The effect of inflation on GPs and NHS Dentists’ annual pension allowance
Everybody has an annual pension allowance. It is how much you can contribute tax efficiently to a pension each year without potentially incurring an extra tax charge.
For NHS Pension Scheme members, your annual pension allowance is calculated using your deemed pension contribution ie the amount that your pension has grown in that year, not your actual pension contribution. NHS medics: Calculating your annual pension allowance >
Whilst inflationary increases are also taken into account when your annual pension allowance is calculated, it is the CPI figure of the previous tax year (not the current tax year) that is used. The CPI rate in September 2016 was 1%.
So, the value of your earnings has increased by 4.5% for the 2017/2018 tax year yet your annual pension allowance has only increased by 1%…and there lies the issue.
GPs and NHS Dentists earning more than £110,000 are likely to be the most affected
For higher earning GPs and NHS dentists in particular, the 4.5% inflationary increase in the value of your pension for 2017/18 could alone cause you to exceed the £150,000 adjusted income limit. If you do exceed this limit, your annual pension allowance is reduced from £40,000 to potentially as little as £10,000.
If you breach your annual pension allowance, a nasty tax bill could well be coming your way!
So what should GPs and NHS Dentists do?
If your annual pension allowance is the standard £40,000 and your tax bill for exceeding this allowance is £2,000 or more, you can normally elect for NHS Pensions’ Scheme Pays (as long as you apply before July 31st of the following year).
However, only any excess above the standard £40,000 annual allowance limit can be paid by the Scheme Pays election. You cannot elect for NHS Pensions’ Scheme Pays if:
- Your tax bill for exceeding the standard £40,000 allowance is less than £2,000, or
- You are a high earner with a reduced annual allowance and have incurred a tax liability between your reduced allowance and the standard £40,000 allowance.
In both the above cases, your unexpected tax bill is your personal responsibility. You will have to find the money to settle the tax liability yourself.
The second, albeit slightly less painful, sting
The NHS Pensions Agency will only let you know if you have breached your annual allowance if your annual allowance is over £40,000.
If you’re a GP or NHS Dentist who has a reduced pension allowance but hasn’t breached the £40,000 limit, you will not know if/when you exceed your allowance. You will only find out when your Total Rewards Statement for that year is available which is often after the July 31st NHS Pensions’ Scheme Pays deadline!
Thankfully, the Scheme Pays application form does allow you to apply with an estimate which can be adjusted once you know what your actual deemed pension contribution for the year is.
Whilst there is also the normal scope to utilise unused relief from the last 3 years, many GPs and full time NHS Dentists will have had fairly substantial pension inputs in that period which likely takes this out of the equation.
What if inflation goes down next September?
If the CPI figure in September 2018 is less than 3%, there could be some relief for high earners for the tax year 2018/19.
Your deemed pension contributions will be dynamised by less than 4.5% and the inflationary increase factored in your annual pension allowance calculation will be 3%. Still, that’s no comfort for those GPs and NHS Dentists facing a tax bill this tax year.
Forewarned is forearmed
Calculating your deemed pension contributions and your annual pension allowance is complicated, to put it mildly! There are many other factors at play and, of course, everyone’s circumstances are different. Rules also change.
We recommend that you speak to an NHS pension specialist financial adviser or accountant sooner rather than later to understand your own personal situation and get an idea of whether or not you are likely to be unpleasantly stung this 2017/18 tax year!
Were you aware that inflation rising to 3% in September 2017 has had such an impact on your NHS pension? Let us know by adding a comment below.