The new pension lifetime allowance of £1.25m will mean that generally, any GP retiring from the 1995 section of the NHS pension scheme with a pension of over £54,347 will have to pay a lifetime allowance (LTA) tax charge.
As a GP, you might be reluctant to pay superannuation contributions at a rate of up to 28.5% to build up a pension pot that is going to be partly taxed away. The LTA charge grows with the size of your pension, so working fewer hours to reduce your earnings, pension and LTA tax charge might appear to be the solution.
Intentionally cutting your profits and pension to avoid an LTA tax charge is a fairly extreme course of action.
Before deciding to get off the treadmill, or at least slow it down, there are four key tasks you need to do, with the help of your specialist medical accountant and IFA:
- Make sure you have fully explored alternative ways of mitigating an LTA tax charge, such as fixed or individual protection, or deferring membership of the pension scheme.
- Work out how much you will need to live on in retirement. Will an NHS pension of £54,437 a year be enough?
- Calculate the effect on your profits, tax and drawings, and decide whether you will need another non-pensionable income source to maintain your standard of living.
- Speak to your partners at an early stage to discuss the terms of your reduction in sessions
This article covers five steps to take to make a good decision about whether to cut your hours.
1. Check you understand how the LTA works
The LTA tax charge will normally be paid by deduction from your annual pension, not by writing a cheque to HMRC. If you are a member of the 1995 section of the scheme, and retire in May 2014 with an annual pension of £63,000, you might expect an LTA tax charge of £49,750. You would pay this by having your annual pension reduced by £2,487.50. If you had received the extra £2,487.50 of pension, 40% of it would have disappeared in income tax anyway. So in reality, the actual cost of the LTA tax charge to you would be £1,492.50 a year, or just under £125 per month.
2. Ask an IFA whether reducing your hours will help
Evaluating the effect of reducing your hours on your final pension and your death in service benefits is a complex business. The reduction in your final pension depends on a whole host of factors, such as when and at what age you will take your pension, and your earnings and career history.
It is essential to ask an IFA who specialises in the NHS scheme to work the figures through, but a fairly large reduction in income is needed to generate LTA tax charge savings. As a very simple indication, ignoring dynamisation and pension flexibilities, you may need to reduce your pensionable earnings by £10,000, your final pension by £140 pa and your lump sum by £420 to save just £805 in LTA tax charges.
3. Assess the short-term implications
The more immediate implications of reducing your hours need to be considered, particularly, whether your reduced earnings will deliver the standard of living you require.
You can’t assume that halving your hours will halve your profits and drawings. For instance, if you currently receive full seniority, dropping just one session could put your earnings beneath two thirds of the national average and cut your seniority by 40%.
On the other hand, a reduction in profits may sometimes feed through to a smaller than expected reduction in drawings. You may move into a lower superannuation tier, which dampens the effect of your reduced profits on bottom line drawings. Similarly, if your previous earnings level meant you lost your personal allowance, you could save tax at 60% by reducing your profits.
4. Factor in capital gains tax on the sale of property
Some other implications are often forgotten about. If you are a property-owning GP, you need to decide whether you want to keep your full share of the surgery ownership and notional rent, and whether your partners will allow this. If you choose or are obliged to reduce your ownership, you will effectively have sold part of your share of the surgery to the other partners and this could trigger an unexpected capital gains tax charge. Your gain may be covered by your annual CGT exemption, and the excess may be taxed at 10%, but it is important to work the numbers through.
5. See if non-NHS earnings can patch the gap
If you wish to reduce your pensionable profits but not your overall income, you could try to replace practice profits with non-pensionable income such as private medical work or a non-NHS, non-CCG post.
This could leave you with a fairly similar level of take home pay, but slow down the growth of your pension and your exposure to an LTA tax charge.
Faye Armstrong is a partner at Dodd & Co, a member of the Association of Independent Specialist Medical Accountants