Mitigating NHS pension threats
This article by Jon Drysdale, an independent financial adviser for PFM Dental, was first published in The Dentist magazine December 2016.
Headline statistics on the NHS pension don’t make great reading. Within the last three years government legislation on employer pension schemes has increased the retirement age by eight years and, for most dentists, at least doubled the cost of contributions.
In this article I identify three key areas which threaten to devalue your NHS pension and weaken your financial position on retirement. The good news is I suggest some solutions which may help to mitigate the threats.
Threat 1: ‘Retire later and pay more’
This was the slogan adopted by teachers’ unions to describe the then Chancellor George Osborne’s wholesale changes to public sector pensions. The changes were largely effective from April 2015, although modifications were afoot as far back as 2008.
So what does ‘retire later’ mean for dentists and what has changed? First, a dentist qualifying before 1 April 2008 would have typically expected to retire at age 60 and pay 8.5% of their pensionable pay by way of annual contributions. Second, for those qualifying after 31 March 2008 the retirement age moved from 60 to 65. Most recently, in 2015 changes to the NHS pension were imposed on all dentists except those aged over 53 (but see note one below). This was unprecedented as previously changes to the scheme affected just new joiners and not existing members.
Which scheme(s) are you in?
There can be confusion as to which scheme you are a member of and how your previously accrued NHS pension benefits are treated. This is because some NHS practitioners will have a combination of three pension schemes: 1995 section, 2008 Section and 2015 section. The following will tell you which scheme or schemes you are a member of.
If you qualified (see note two below) before 1 April 2008. You will have built up pension benefits in the 1995 pension scheme, which have a normal retirement age (NRD) of 60. From 2015 your pension will be building up within the 2015 section, which has an NRD equivalent to the State Pension age. However, if you were within 10 years of normal retirement age (60) as at April 2012 you will continue to build up pension benefits in the 1995 section. You may also have elected to move your 1995 section benefits to the 2008 section through the NHS Choice exercise.
If you qualified after 31 March 2008. You will have built up pension benefits in the 2008 pension scheme, with an NRD of 65. From 2015 your pension will be building up within the 2015 section, which has an NRD of the State Pension age. However, if you were within 10 years of normal retirement age (65) as at April 2012 you will continue to build up pension benefits in the 2008 section.
If you qualified after 31 March 2015. Your pension will be building up within the 2015 section, which has an NRD of the State Pension age.
How much more are you paying?
The ‘pay more’ element of this threat is straightforward: present contributions rates mean the cost of contributions for some has risen to 14.5% of pensionable pay – a huge rise from the flat rate of 6% they paid before April 2008.
Table 1 shows the contribution rates from 1 April 2015. Worryingly, the rates are only set until March 2019, so we might expect a review then and I think it unlikely they will be reduced.
Pensionable pay tiers — Contribution rate
Up to £15,431.99 — 5.0%
to £21,477.99 — 5.6%
to £26,823.99 — 7.1%
to £47,845.99 — 9.3%
to £70,630.99 — 12.5%
to £111,376.99 — 13.5%
over £111,376.99 — 14.5%
Many (full-time NHS) dentists will be in the tier to £111,376.99. NHS practice owners are more likely to fall into the £111,376.99 and over. Table 2 compare the cost of the scheme now with 2008 for these two groups.
Pensionable pay — Actual contribution (before tax relief) 2008 — Actual contribution (before tax relief) 2016
£70,631.00 — £4,238 — £9,535
£111,376.99 — £6,683 — £16,150
Can I mitigate ‘retire later and pay more’?
Changes to public sector pensions are set in legislation and probably won’t be reversed. Mitigation will therefore require additional planning and I advise you start as soon as possible. For those qualifying after 2015 I view this as essential, not least because you are unlikely to want to work to the current (latest) State Pension age of 68 and, secondly, because the State Pension age may rise further.
Dentists who are most financially secure at retirement tend to be those who have made additional plans early in their career. Simply put, the later you leave it, the more it will cost. Starting early with a modest investment is often the best strategy. Additional planning comes in many forms, including personal pension provision which allows for access to additional income from age 55 without retiring. Another form of saving, which is often underutilised, is the annual ISA allowance. Each year you can pay £15,240 into an ISA and later withdraw funds or an income stream tax free.
Threat 2: Loss of tax relief
Further attacks on pensions, not necessarily related to the NHS, will see some high earners being stripped of valuable tax relief from the 2016/17 tax year onwards. Those with taxable income over £150,000 will lose £1 of relief for every £2 of income over £150,000. This effectively reduces the maximum (tax relievable) pension contribution from £40,000 of £10,000. Tax relief rules can be complex and those with taxable income of over £110,000 will also need to calculate whether they can claim tax relief on their pension contributions as they may breach the annual pension saving allowance of £40,000.
Unfortunately calculating ‘deemed’ NHS pension contributions, which count towards the £40,000 is not that straightforward and the relevant figures are not available until well after the end of the financial year. This means that you could be unwittingly making contributions to a pension without the ability to claim tax relief. This new rule bites in the current tax year (2016/17) so will affect the tax return due in January 2018. Your accountant will need to be up to speed with this otherwise you could be heading for a larger than expected tax bill.
Can I mitigate the loss of tax relief?
Yes – although some careful planning is required to achieve this. Reducing taxable income should be a priority, especially if your taxable income is currently in excess of £150,000 as described above. To achieve this, rather than reduce your working output you may wish to consider employing your spouse. Assuming they can contribute to your business in some way this is a legitimate business expense and will reduce your taxable profits. This has dual benefits: first you will pay less income tax and second the loss of tax relief will be limited. You should speak to your accountant about the level of income that you can pay your spouse.
A further option, also involving your spouse, is to pay them an employer’s pension contribution. Again this should be a legitimate business expense and have a similar effect on mitigating the loss of tax relief. Furthermore, the pension they build up will not contribute to your Lifetime Allowance position (see next section).
A final option to consider is trading through a limited company structure. It should be noted that this is not necessarily achievable if you currently hold an NHS contract in your own name or in a partnership as it risks the loss of the contract. It may be possible if you have fully private income or a separate source of private fee income. I advise you seek the advice of a dental accountant on this matter. With a limited company structure, you only pay income tax on income you draw out of the company. You can control this to ensure your income is below the £150,000 threshold. You may also consider making your spouse a director to make use of the dividend tax regime and reduce your exposure to income tax/loss of tax relief.
Threat 3: Lifetime Allowance charge
You may be relatively unscathed by the 2015 change to the retirement age because you fall within the exempt age group (see note one below). Consequently, you might be forgiven for thinking that your retirement planning is home and dry. However, dentists are increasingly breaching the HMRC Lifetime Allowance (LTA), which is a limit on pension values and has fallen from a high of £1.8m (2012) to the present £1.0m.
To make a comparison meaningful, consider a dentist retiring in 2012 with pension income of £78,000. This incurred no liability to the LTA charge. In 2016 the same dentist would face a charge of circa £10,000pa based on the reduced limit. The charge is paid by way of deduction from the NHS pension in retirement. Table 3 shows how the charge is calculated.
NHS pension at retirement — LTA calculation — 2016/17 LTA — Excess over LTA — LTA charge calculation — Annual NHS pension after charge
£78,000pa — (£78,000 × 20 + tax-free cash of £234,000) = £1,794,000 — £1,000,000 — £794,000 — (£794,000 × 25%/20) = £9925 — £68,075
If you have a personal pension(s) the value will need to be taken into account in the calculation and added to the figure in column two. The LTA calculation is only tested when you draw pension benefits and not before (unless in the case of premature death or transfer overseas). This means that many dentists may be unwittingly building up a future LTA charge.
Can I mitigate the Lifetime Allowance charge?
For several years various forms of LTA protection have been introduced by HMRC. Beware – for some of these you have a limited time to apply and others are no longer available. It remains possible to apply for Individual Protection 2014 which could give you a personalised LTA of up to £1.5m. Eligibility for this should be calculated and an application submitted by April 2017, so time is running out. Individual Protection 2016 could give you a personalised LTA of up to £1.25m. Again eligibility needs to be calculated, with reference to the NHS pension and personal pensions. Fixed Protection 2016 may also be appropriate but if you made pension contributions after 5 April 2016 this is no longer an option. Fixed Protection 2012, Fixed Protection 2014, Primary and Enhanced Protection (2006) are no longer available unless you have already applied. The key point here is to investigate the options that remain before they too become obsolete.
It is possible to reduce the total LTA value by increasing your NHS pension lump sum. The effect of doing so is shown in Table 4.
NHS pension — Tax-free cash — LTA calculation — Excess over £1m LTA — LTA charge
£50,000pa — £150,000 — (£50,000 × 20 + £150,000) = £1,150,000 — £150,000 — (£150,000 × 25%/20) = £1875pa
Reduced pension — Increased lump sum
£39,214pa — *£261,428 — (£39,214 × 20 + £261,428) = £1,045,708 — £45,708 — (£45,708 × 25%/20) = £571pa
*Maximum lump sum calculated from www.nhsbsa.nhs.uk November 2016
The example above shows how the LTA charge can be reduced. However, you should seek advice on the decision to increase your lump sum as this will result in a permanently reduced annual pension payment.
Summary and conclusions
The devaluation of NHS pensions and wider pension legislation changes are likely to affect all dentists. As demonstrated, there are a number of areas where careful planning can specifically mitigate the loss of tax relief and the LTA charge. Some mitigation, especially HMRC protection, has deadlines so now is the time to consider your position. The NHS pension age is now linked to the State Retirement age and thus retiring earlier requires additional long-term saving strategies.
The legislation and tax rules referred to in this article are correct as at November 2016 and are subject to change.
1. More specifically, those within 10 years of normal retirement age as at April 2012 are exempted from changes. Normal retirement age for 1995 section members is 60 and for 2008 section members is 65.
2. This refers to when you joined the NHS pension scheme which is usually related to when you qualified although could be when you started NHS work, if later.