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Neil MacGillivray: Just how ‘unfair’ is doctors’ annual allowance hit?

neill macgillivrayCampaigners should tread carefully in calling for reforms for those in the NHS pension scheme

Recent articles reporting the furore around the annual allowance and how it “unfairly” impacts individuals in public sector defined benefit schemes have piqued my interest.

Adding fuel to the fire was news the British Medical Association is calling on the government to reform both the AA and the tapered AA for doctors in the NHS pension scheme. It has also been suggested doctors and other public sector workers are taking early retirement to avoid the lifetime allowance charge.

Regarding the latter, the LTA should be scrapped for other money purchase arrangements for the simple reason the individual carries all the investment risk in their pension. However, I do not believe in such action for public sector DB arrangements, as the member carries no investment risk whatsoever and, indeed, many of these schemes are underpinned by the taxpayer universe.

Annual allowance breaches double with taper introduction

Back to the AA, though, given the number of comments made on some of these articles, it got me thinking what all the fuss was about.

Pension input amounts
In the case of a DB arrangement, calculating the pension input amount (the pension savings figure measured against the individual’s AA) is slightly more complicated than that for other money purchase arrangements.

It is not, as may be envisaged, a case of using the percentages for employer and employee contributions and applying these to the member’s pensionable earnings. Rather, the PIA for a DB arrangement is a notional contribution based on the increase in the member’s benefits accrued over the pension input period.

Taking the NHS scheme as the basis for an example to work through, for someone with pensionable income of £111,377 or more, personal contributions are set at 14.5 per cent and employer contributions at 14.3 per cent, with an additional levy of 0.08 per cent for the latter.

A recent Department of Health and Social Care consultation recommended employer contributions be increased to 20.6 per cent from 1 April, though member contributions are to stay the same.

Keeping things simple, we will presume the individual in question – let us call him Dr Strangelove – is a member of the 1995 Section of the NHS pension scheme and will remain so until retirement.

Rachel Vahey: Tackling the tapered annual allowance

He is accruing pension income benefits on the basis of 1/80th for each year of service, with 3/80ths for his pension commencement lump sum.

At the start of the PIP, his NHS pensionable income was £137,931 and he had 34 years’ pensionable service. At the end of the current PIP, it is presumed he has 35 years’ service and his NHS pensionable income is £140,000. CPI in September 2017 was 3 per cent. His PIA calculation would be as follows:

1. Opening value of pension rights:

  • Income – £137,931 x 34/80 = £58,621 – £58,621 x 16 = £937,936
  • PCLS – 3 x £58,621 = £175,863
  • Add together and up rate by CPI – (£937,936 + £175,863) x 1.03 = £1,147,213

2. Closing value of pension rights:

  • Income – £140,000 x 35/80 = £61,250 – £61,250 x 16 = £980,000
  • PCLS – 3 x £61,250 = £183,750
  • Add together: £980,000 + £183,750 = £1,163,750

3. PIA 2018/19:

  • £1,163,750 – £1,147,213 = £16,537

Let us also presume Dr Strangelove has private practice income of £20,000 and so has threshold income of £139,700 (£160,000 – £20,300), and adjusted income of £160,000 (for the purposes of tapering, due to the methodology, there is deemed to be no employer contribution in this scenario, i.e. £16,537 PIA minus personal contribution of £20,300).

His tapered AA is therefore £35,000 (£40,000 – £5,000), leaving him with £18,463 to carry forward.

Dr Strangelove has accrued uplift on his index-linked pension benefits worth £2,629 (ignoring the uplift in PCLS) for a PIA amount of £16,537.

Let’s presume this accrual is for an individual in the year they take benefits, and contrast this with the significantly lower benefits another money purchase arrangement PIA of £16,537 would secure through the immediate purchase of an RPI-linked annuity with 50 per cent of the spouse’s pension.

Just to compound this issue, the actual capital value of the contributions made to a DB arrangement can be significantly higher than the calculated PIA. Assuming a total contribution of 28.8 per cent of NHS pensionable income, Dr Strangelove’s contribution in monetary terms would be £40,320 (28.8 per cent of £140,000), £23,783 higher than the actual PIA for AA purposes.

Many would call this “unfair” and it is probably one bomb the BMA should avoid setting off.

Neil MacGillivray is head of technical support at James Hay



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There are 11 comments at the moment, we would love to hear your opinion too.

  1. Graham Ponting 4th April 2019 at 9:53 am

    An extremely cogent argument Neil.

    I particularly like your rationale re the LTA and the investment risk taken by those on DC.

    I am tired of highly paid Public Sector employees bemoaning their unfair treatment over pensions, they have no idea how lucky they are!

  2. Mark Belchamber 4th April 2019 at 11:56 am

    I don;t agree your adjusted income value and think this should be £156,237 which gives a higher AA and more carry-forward. However, your example shows the PIA in a year when pensionable pay increases at a lower rate than the inflation index used to uplift the opening balance. In a year like 2016/17 where the CPI was zero the PIA in your example would be nearly c£50,000, the Adjusted Income would be c£190,000 and the tapered AA would be c£20,000 so a tax charge on the excess (assuming no prior carry-forward) of c£30,000 would be incurred. For the same increase in pension Dr Strangelove would pay a further c£13,000 AA tax charge, for the same growth in pension. If he decided that his £20,000 non-pensionable income should stop his pension is the same but his Adjusted Income is £20,000 lower, his AA is £10,000 higher and he pays £4,500 less tax charge. It’s when this non-pensionable income is delivered to the benefit of the NHS that the issue gets concerning as many doctors are [seemingly]reducing the extra work they do to control the pension tax charges. Its not about fairness.

    • Neil MacGillivray 8th April 2019 at 2:49 pm

      Dr Strangelove’s scenario makes certain assumptions, which if altered will naturally impact the outcome (such as the rate of CPI – it has been negative and therefore zero in the past, however, it has also previously exceeded 3% ). In the piece you’ll see that Dr Stranglove’s income is £160,000, it is presumed he has no other source of income such as dividend income, bank or building society interest etc. His NHS income is £140,000 and his private practice is £20,000 meaning he loses £5,000 of AA through tapering. In your calculations you appear to have added the PIA to the NHS income and ignored the private practice income to determine his adjusted income. For someone in a defined benefit arrangement to calculate the employer contribution for the purposes of determining the individual’s adjusted income you firstly calculate the pension input amount and then deduct the personal contributions from this figure. In Dr Stranglove’s scenario the PIA is £16,537 but his personal contribution is £20,300 meaning there is nothing to add to the £160,000.

      • Mark Belchamber 11th April 2019 at 3:58 pm

        No I didn’t. His Threshold Incone I agree. I then added his contributions, then added the PIA, then subtracted his contributions as per the legislation, to get his Adjusted income figure. I rounded the numbers in the rest of the comment for ease of reading.

        The “employer contribution” for DB schemes is the PIA less the members contributions. Not how much the employer has paid.

        • Neil MacGillivray 16th April 2019 at 4:24 pm

          Thanks for your response. We have gone back and looked at the specific legislation and our thoughts are it could be interpreted in different ways.

          Determining adjusted income is arrived at under s228ZA(4) of FA 2004. This includes adding the value derived from the following:

          (i) the total pension input amount calculated in accordance with section 229(1), less
          (ii) the amount of any contributions paid by or on behalf of the individual during the year under registered pension schemes of which the individual is a member,

          Strictly speaking, in the case of a DB arrangement this does not rule out the possibility of a negative result, however the stance we adopted in treating it as a zero vale, rather than negative one, was derived from other parts of legislation around the annual allowance, namely s234 and s235 FA 2004. Although these sections do not specifically refer to negative values, it is clear that the PIA under a DB arrangement can never be less than zero. On this basis, and given that a negative CPI is assumed to be zero when uprating the opening value for PIA purposes, we determined that it would be treated as zero. It does though beg the question as to whether HMRC envisaged that there could be scenarios in which there was a negative value.

          Pension tax legislation is not always explicit and relies on interpretation at times, therefore if you have had your interpretation confirmed by HMRC, we would very much appreciate it if you could let us know.

          In the meantime we will check with some of our external reference sources to see if anyone has an opinion on this matter, or had confirmation from HMRC.

  3. Re the Life Time Allowance (LTA), this issue could be resolved so easily. Instead of the valuation being 20 times Defined Benefit income plus PCLS, it should be the cost to purchase the annuity, plus PCLS.

    Twenty times income was originally applied by HMRC some three decades ago, when annuity rates were much higher. If you apply the annuity rates today you need between 35-40 times income to purchase.

    If this calculation was introduced maybe individuals would start to understand the true value of their DB Pension Scheme. It would also be a more accurate way of applying the Life Time Allowance. We all know the LTA would double over night once the MP’s received their bills.

  4. Whilst I have no arguments with other posters the larger picture has to be considered. I recently spoke with a doctor who is being asked to do many saturday clinics and this is pushing up her salary to the point that he is considering reducing his hours to avoid the pension cap and the extra taxation.

    The losers are those who will have to wait even longer to be seen by this specialist. Additionally he is considering retiring earlier.

    In the private sector he would be able to increase his renummeration and have less paid into his pension arrangement.

    Therefore I suspect the way forward should be to allow NHS professionals at a certain income level to have a similar arrangement. According to nhS england they are 100,000 staff short and we can not afford to have those that we have working shorter hours

  5. Simon Albright 5th April 2019 at 4:02 pm

    I agree with the thrust here but a typical practitioner’s input is far higher because it is not calculated on n/80ths but through career average earnings.

    The dynamisation factors are determined by CPI+3% and they rarely have £30K of TAA.

    A member with £1m (which is low) of CARE in the above example would have an input amount of £94,240 (1.4% of £140K + £1m*0.03 – all multiplied by 19 (16 for pen and 3 for lump sum).

    The NHS will not permit scheme pays for the excess TAA between £10K and £40K so many Practitioners are having to find £13,500 p.a.

    Bear in mind also that practitioners are actually paying the employer contribution too.

    That said I would happily swap!

  6. Neil, I think perhaps you have failed to take the time to fully understand the complexities here.

    Many medical consultants are, as a result of pension reform, members of two pension schemes, the 1995 final salary scheme and the 2015 career average scheme, which succeeded it, and thus accrue benefits annually in both.

    This is not a problem in many tax years as pay increases have been sub-inflationary in the public sector (unlike the private sector) and thus there is little or no growth in the final salary component of the pension scheme.

    However, the pensionable salary for medical consultants includes supplements for bonus awards for unpaid quality improvement work (which are paid for five years and then removed) and also for increased frequency of on call duties, which can lead to sudden increases in the value of the final salary pension component and large tax bills. Fair enough you may say, increased salary = increased pension = increased tax.

    However, these pensionable supplements are often temporary. For example, If a consultant finds themselves covering on call duties for a sick colleague for a year they may move up to a higher pensionable on call supplement and thus have a higher pensionable salary and thus a big tax bill for that year as the final salary pension growth is significant (a problem compounded when added to the more mundane career average scheme growth). However when the consultants colleague returns from illness the folllowing year, the same consultant has a reduction in their pensionable salary back to the previous level, the final salary pension component now loses value in that year. This loss can not be offset – only recorded as zero growth. In essence the consultant has paid a pension tax charge ( in some cases of tens of thousands of pounds) the previous year for what be becomes no actual increase in pensionable benefit.

    The complexities are such that some consultants have agreed to do overtime to reduce waiting lists, have breached the £110k threshold income by a few pounds and as a result have landed tax bills of £15k that they would not have had if they had stayed below the £110k.

    This is because if their earnings are below £110k their annual pension allowance remains set at £40k. If however their earnings are over £110k by a few pounds their adjusted income is now calculated as income + pension growth . If pension growth is £90k (because of a temporary salary fluctuation discussed previously) their adjusted income would now be £200K and their annual pension allowance reduced to £15k. They will have an 45% tax charge on £25k of pension growth that they would not have had if their earnings were less than £110k.

    This is therefore an incredibly complex tax on a theoretical future gain that is often not realised. In essence fluctuations in salary can generate wild swings in pension value from year to year, where increases are taxable at 45% but losses are not recoverable.

    The NHS scheme is generous but I would argue that a taxation system where consultants can literally end up paying (sometimes thousands of pounds) to come to work is not equitable or given the pressures on the NHS sensible.

    • Neil MacGillivray 9th April 2019 at 3:56 pm

      Pension tax legislation is seldom straightforward and subtle little nuances mean there will be winners and losers when the legislation is applied to particular scenarios. It is always possible to come up with a worst case scenario to paint the bleakest picture, but for the vast majority of individuals who are saving into their pension these issues are meaningless, as they are unlikely to have an issue with the AA or the LTA. However, the purpose of the article was to attempt to show that in certain situations an individual in a DB scheme gains relatively sizeable benefits without breaching the AA or having a material impact on their tapered AA, which runs contrary to a number of recent articles that have only highlighted the worst outcomes.

      In your comment, you mentioned that an individual having “breached the £110k threshold income by a few pounds and as a result have landed tax bills of £15k that they would not have had if they had stayed below the £110k”. If, an individual in such a situation had threshold income of say £111,000, and adjusted income such that they are impacted by tapering, then by simply paying a gross contribution of £1,000 into a personal pension, they would reduce their threshold income to £110,000. Their adjusted income then becomes irrelevant and more importantly they retain the full £40,000 AA. Such a positive outcome is why it is imperative to seek appropriate financial advice before deciding on any action.

      Lastly, there are many scenarios where it could be argued that the AA and LTA favours DB schemes, but on the other hand the treatment of death benefits are potentially more favourable for other money purchase arrangements.

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