Last month a number of my clients were worried about the impact of the recent Chancellor’s Autumn Statement and the implications for their NHS pension, and it’s not just those GPs approaching retirement who are starting to worry about their long-term future.
In this article I’ll introduce a case study of one of my company’s clients, explain the changes to GPs’ pensions, suggest some ways to deal with the changes, and explain what action plan the client will take in light of the changes.
A prime example of one of the clients worried by the changes is James, a GP in his early thirties, and a general practitioner member of the 1995 section of the NHS pension scheme.
James is currently buying added years (at a rate of 6%) and paying £150 net per month into a personal pension. James was previously working as a locum and has recently taken up a post within a rural dispensing practice; he has the potential for his earnings to increase from very little to pensionable profits in excess of £150,000 per annum – clearly this has significant implications for both his annual allowance and, over time, his lifetime allowance.
Changes to the pension
We spent some time discussing the two main changes that have been introduced by George Osborne as part of the austerity measures that public sector workers will once again be hit with:
- a further reduction in the annual allowance, from £50,000 to £40,000,
- and a cut in the lifetime allowance to £1.25 million.
So those who apply for fixed protection for 2014 will not be allowed to carry on saving into their pension without losing their protection. Any pension savings above the individual’s lifetime allowance will be subject to a lifetime allowance charge when benefits are taken. It will mean individuals who apply for fixed protection 2014 will have a lifetime allowance of the greater of £1.5 million or the standard lifetime allowance (£1.25 million from April 2014).
HMRC will be discussing the feasibility of a personalised protection regime with interested parties in the next few months. It is anticipated that personalised protection will be available to those with pension pots over £1.25 million on 5 April 2014. It is anticipated that personalised protection could give individuals a lifetime allowance equal to the greater of their pension rights on 5 April 2014, up to £1.5 million or the standard lifetime allowance (£1.25 million effective from April 2014). However unlike fixed protection 2014, individuals with personalised protection may be able to continue saving in their pension schemes without losing the protection. The question of whether individuals will be able to apply for both fixed protection 2014 and personalised protection will form part of the discussions HMRC will be having with interested parties in the next few months.
James still has an ongoing annual allowance tax liability remaining after offsetting his carry forward allowance, and believes that he is likely to have a lifetime allowance tax liability at his retirement age of 60.
So there are two main risks to James’ pension.
Firstly we are unable to predict future legislation or to know what the lifetime allowance limit will be in the next 30 years. Therefore, it is unlikely that applying for fixed protection 2014 is in James’ best interests.
Secondly, future earnings and dynamising factors are as yet unknown to us and therefore, opting for personalised protection could be a gamble, which may or may not pay off. We also need to await further guidance from HMRC on the transitional protection arrangements before we can advise on its suitability.
Ways to deal with the changes
At this stage the priority is to address the reduction or mitigation of the annual allowance tax liability. Lifetime allowance strategies are of secondary importance, as James does not intend to draw his pension for the next 30 years. James can elect to pay the annual allowance tax in one of two ways:
- By Self Assessment – It would be James’ responsibility to calculate the tax charge. NHS Pensions will issue Pension Savings Statements with effect from October 2013 in relation to the NHS Pension Scheme only. Therefore, relying upon NHS Pensions to advise of James overall Annual Allowance liability is not achievable, nor does it allow James to take any preventative measures. Should James outsource this work to an accountant, he should ensure that they specialise in this type of calculation and that they are preferably a member of AISMA.
- Scheme pays – There are three conditions that must be met; the member must exceed the annual allowance in the NHS pension scheme in the relevant tax year 11/12 onwards; the overall tax charge is more than £2,000 in the same relevant year; the member has not taken all of their benefits in the NHS pension scheme. James could become a deferred member, opt out of the NHS pension scheme and contribute to a money purchase scheme, but it is unlikely that this is in the best interests of James and his family. Given James’ age and the benefits lost on deferral, he puts himself and his family at risk. Money purchase pensions do not provide guaranteed index linked pension benefits, adversely; they expose clients to the risk of stockmarkets and potential losses. Should James apply for Tier 2 Ill Health Retirement in the future, no enhancement (representing two thirds of prospective service) would be granted. Thus, any decision to opt out should be viewed as the exception and not the norm.
Alternatively James could become a deferred member, opt out of the NHS Pension Scheme and cease all contributions to his personal pension. The NHS now take a more lenient view towards the cancellation of these contracts, since the reduction in annual allowance has had a significant impact on many doctors. As a result, it is no longer essential to prove financial hardship. Any Added Years bought prior to the cancellation of the Added Years contract would be credited to James at retirement by increasing his total calendar membership.
James could also cease contributions to his personal pension arrangement, which would remain paid up and invested until James is age 60. Normally, it is advisable to first cease contributions to any private arrangements, such as money purchase personal pension schemes, FSAVCs, AVCs, before cancelling added years or additional pension contracts, as private arrangements do not provide guaranteed index linked or survivor benefits.
Tip: James could reduce his income tax liability by investing in Venture Capital Trusts or Enterprise Investment Schemes. But James is a cautious risk investor so these investments are not suitable on the basis that he does not have the appetite for risk. Note: tax relief from VCT/EIS does not directly reduce or mitigate annual allowance tax.
Whilst we are looking to reduce and save tax, the reality is that the NHS pension is still one of the best pension schemes available today.
We need to ensure that we do not ‘let the tail wag the dog’ and we should prioritise how much income James needs in retirement, and whether he is on track to attain his goals.
A range of preliminary calculations will be carried out to ascertain the impact of ceasing on-going contributions to the purchase of added years, and his personal pension plan; the latter being the most favoured out of the two options, as they do not provide any guaranteed benefits and are subject to investment risk.
There are often situations where paying some tax could still prove to be a sensible strategy – so long as the on-going contributions remain both affordable and realistic. With a sound financial plan in place and with regular annual reviews, we can monitor James’ situation and tailor our advice to suit his changing needs.
Rachael Hall is a medical specialist independent financial adviser at Rutherford Wilkinson. She has previously worked for BMA Services.