The reduction of the lifetime allowance is effectively a stealth tax on the NHS

Comment from David Smith, Financial Planning Director at Tilney Bestinvest

The Chancellor has today announced that a further reduction in the ‘lifetime allowance’ for pension funding will be introduced from 6th April 2016. This will see the ‘lifetime allowance’ decrease to £1m from the current £1.25m - an overall reduction of 40% during the term of this Government, as it was £1.8m during 2011.

Coupled with this has been the associated slashing of the amount of pension funding that can be made on behalf of an individual during a tax-year from £255,000 during 2011 to £40,000 now; a quite staggering reduction of 84%! Unfortunately this is unlikely to the be the end of the attack on pension funding as both Labour and the Liberals have suggested reducing the ‘annual allowance’ further and/or altering the tax relief available.

Many pension savers have benefited from applying for protection to preserve ‘lifetime allowances’ above the £1m proposed limit, although there is often a trade-off for securing these allowances of not making future pension contributions as this would result in some protections being lost. Whilst the loss of these protections can be easily avoided by members of defined contribution schemes, (they simply cease making any further contributions) it is very rare that a member of a defined benefit scheme can remain an active member of these schemes and still retain this protection.

Therefore, active members of defined benefit arrangements; including NHS works, teachers and the police etc. will effectively be subject to the £1m ‘annual allowance’ if they remain active members of their respective schemes, which is something that ultimately they should do. A further issue is that many members of defined benefit pension schemes are unaware of how their retirement benefits will be valued for ‘lifetime allowance’ purposes, as it is actually calculated as twenty times the pension they will receive, plus any additional tax-free lump sum.

This is yet another attack on members of public sector pension schemes who, with effect from 5th April 2015, will no longer be permitted to transfer their benefits into defined contribution arrangements where they could benefit from flexible pension income and have the ability for their beneficiaries to inherit their pension funds on death. Instead, many of the public sector pension scheme members will be trapped within these schemes, whilst building up an unknown tax liability that will have to be paid when they take their retirement benefits, and this will ultimately reduce the pension they could receive.

Let us take the example of two NHS Consultants; one who will reach their retirement age on 7th April 2015 and the second who will retire a year later on 7th April 2016. Both of these consultants will have accrued the same level of years’ membership of the scheme by their respective retirement dates, and both will be entitled to a pension of £54,300.

For the Consultant who reaches their retirement date on 7th April 2015, they will receive their full pension entitlement as the value of their pension benefits would be £1.25m (i.e. £54,300 x 20 {plus their tax-free lump sum entitlement of £162,900}) and this would not exceed the ‘lifetime allowance’ of £1.25m. However, the second Consultant is not so lucky, as his pension benefits will also have a value of £1.25m, but the ‘lifetime allowance’ would then be £1m, resulting in an excess of £250,000, which is unfortunately going to be subject to tax. As the excess will be taken as income, the total tax due will be £62,500 and this will be paid from the pension scheme in lieu of a reduction in the pension income the Consultant receives. In this instance the Consultant would face a reduction in their pension entitlement of £3,125 and would only actually receive a pension of £51,175, a 5.75% reduction from the pension their colleague would receive. There would be no reduction to the pension lump sum that they would receive, as it is the excess above £1.25m that is taxable, and in this instance the excess will be taken as income.

When the ‘lifetime allowance’ was £1.5m, a Consultant could have received a pension of £65,000 per annum and a tax-free lump sum of £195,000 without any tax charge being applied, but a Consultant with this level pension benefit retiring after 6th April 2016 would face a reduction in their pension entitlement of £6,250 or 9.6%.

Unfortunately this is not the end of the potential bad news for members of final salary arrangements, as the continuing fall in the rate of inflation (as measured by Consumer Prices Index – CPI), whilst welcomed by most, could result in potential tax charges for those who remain active members of such schemes. This is due to the role that CPI plays in revaluing final salary pension values for the purposes of the ‘Annual Allowance’ check, with the lower the CPI figure the greater the potential for the ‘Annual Allowance’ of £40,000 being exceeded.

For the purposes of the ‘Annual Allowance’ check, the CPI figure from the preceding September will be used for calculating the pension value, so we already know that the CPI figure for the 2015/16 tax-year will be 1.2%. However, given that the CPI figure for January 2015 was only 0.3% there is the real possibility that the CPI figure for the 2016/17 tax-year will be well below the 1.2% figure recorded in September 2014.

If we look at members of the NHS Pension scheme (1995 membership) the CPI figure of 1.2% will mean that someone receiving a pay increase and/or an incremental award of more than 2% will potentially exceed their ‘Annual Allowance’ figure of £40,000. In the case of an NHS Consultant who has 30 years membership of the NHS Pension scheme and who earns a pensionable salary of £130,000, they would exceed their annual allowance by £3,688 and face a potential tax charge of 40% if they had no available unused ‘annual allowances’ to carry forward. If the CPI rate was 0.3%, then under the same criteria they would exceed the ‘annual allowance’ by £12,024, which again would be subject to a 40% tax charge, although tax would not have been paid on this money previously.

At a time when NHS members have experienced, for a number of years, little or no salary increases, coupled with increased pension contribution limits, a potential reduction in their pension entitlements is unlikely to boost staff moral and attract new staff to join. Indeed, it was only yesterday that it was reported that there is now a shortage of GPs, with the proposal to introduce Pharmacists within GP Practices to try to alleviate the pressure, and the expectation of a far lower pension at retirement is unlikely to attract new staff to this profession.

If, as anticipated, future Governments are going to continue to attack pension funding through the reduction in both the ‘lifetime’ and ‘annual’ allowances, then surely it would be fairer to new entrants to public sector defined benefit members to offer them a maximum pension entitlement and, once this has been achieved, permit them to cease making contributions.

- ENDS -

Important Information:

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. The above article is based on our interpretation of the Budget 2015 and related legislation; it is not intended as advice, and the impact of any changes to tax rates or allowances will depend on your personal circumstances. Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change.

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Roisin Hynes
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roisin.hynes@tilneybestinvest.co.uk

Matthew Gray
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matthew.gray@tilneybestinvest.co.uk

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