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Tax impact of NHS pension holders due to inflation

The long-standing pay-as-you-go NHS Pension Scheme underwent reform in 2015 and part of that included a change to the way pensions for general practitioners and NHS dentists are calculated.

This does not constitute advice and advice should be sought in all instances before acting on it. The Financial Conduct Authority does not regulate tax advice. 

Pensions are now based on your ‘dyanamised’ earnings, which means the government keeps a record of an individual’s income and adds each subsequent year’s earnings together, resulting in your total career earnings. When it comes time to retirement, a percentage of this sum is calculated as your pension.

Effect of inflation

To keep your annual salary relevant, a calculation is applied each year to bring it in line with inflation. This is known as dynamising. This figure is your Career Average Revalued Earnings (CARE). The factor used in the dynamisation calculation is the Consumer Price index (CPI), which is set in September of the current tax year, plus 1.5%.

In September 2017, the CPI rate was 3%, boosting the earnings value for the 2017/18 tax year to 4.5%. On the surface, this sounds like it would be great, but it actually may result in an unwanted tax bill at the end of year.

To grasp why this may happen, you must understand the different factors involved in the pension calculations.

Pension Allowance

A pension allowance is how much one can contribute to a pension annually without the possibility of being subject to an additional tax charge. As members of the NHS Pension scheme, the annual allowance is based on how much your pension has grown that year, not how much you actually contributed. Although inflation is part of the calculation, the CPI from the previous tax year is also taken into account.

In September 2016, the CPI rate was 1%, so while the value of your earnings for 2017/18 increased by 4.5%, the pension allowance only increased by 1%.

Higher earners more affected

The danger of an unwelcome tax bill comes into play when you go over your pension allowance for the year. This is of particular concern for general practitioners and NHS dentists since the 2017/18 increase of 4.5% in the value of your earnings could mean that you surpass the £150,000 maximum income, reducing your pension allowance from as much as £40,000 to as little as £10,000.

However, if the 2018 CPI rate comes in under 3%, higher earners would get a welcome reprieve for the 2018/19 tax year.

What are your options?

One route for dealing with this situation is to utilise the NHS Pensions’ Scheme Pays. In order to take advantage of this option, your annual allowance must be more than the standard £40,000, your bill for going over your allowance must be £2,000 or more, and you must apply before 31st July of the following year.

If you are a higher earner with a decreased pension allowance and your tax burden is between your allowance and the standard £40,000 allowance, you will be responsible for paying the bill yourself.

If you do have a reduced allowance but your contributions haven’t reached the £40,000 maximum, you will only find out if or when you do exceed the allowance when you receive your Total Rewards Statement.

Unfortunately, these statements are only available after the NHS Pensions’ Scheme Pays deadline but luckily, you can use estimates during your application and once you receive your statement you can add in actual contribution numbers.

Planning for the future

Pension planning is an extremely convoluted process, but extremely important. And the earlier you start contributing to your retirement and pension plans, the better of you’ll be.

It’s also best practice to invest in private pensions to supplement your NHS pension plan.

Learn more about ways to save and make sure you are ready for retirement by working with a Dental & Medical Financial Services pension planning expert.

Discuss your pension with a specialist

Dental & Medical Financial Services have been helping doctors and dentists with pension planning for over 25 years. Call Darren to discuss your options.

Tel: 01403 780 770


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