Act now on pensions
Dentists with NHS pensions valued close to the Lifetime (pension) Allowance may need to act now to avoid a tax penalty from April 2014.
The current pension limit of £1.5 million allows a dentist to take NHS pension benefits of up to £65,000pa without a tax penalty.
However, with the limit set to reduce to £1.2 million next year, those taking an annual NHS pension of £54,000pa or more, may be caught out.
Dentists with personal pensions together with NHS pensions lower than £54,000pa may also suffer a penalty.
There are options available for those seeking to avoid or minimise the potential penalty. Here’s my opinion on these:
Action 1 – Take your NHS pension before April 2014
My comments: Effective but drastic. This will ‘crystalise’ the value of your NHS pension and trigger an immediate assessment against the current pension allowance of £1.5m. This action is likely to be of use to dentists with NHS pension benefits forecasted to be between £54,000 and £65,000pa. Those with personal pensions will need to include their value as part of the decision making process.
Taking NHS pension benefits before the standard NHS retirement age of 60 will incur an actuarial reduction of your pension, so a careful assessment should be made before doing this. Beware, applying for your NHS pension can take up to four months, so don’t leave it until the last minute.
Action 2 – Increase your NHS tax-free lump sum
My comments: Not effective enough. Swapping NHS pension income for a larger tax-free lump could reduce your liability to a tax penalty. For every £60,000 of additional lump sum taken you will lose £5,000pa of pension income but at the same time reduce the deemed total pension value by £55,000. In simple terms you avoid a tax penalty amounting to only £700pa. This isn’t a significant enough saving to appeal to most, unless you have a real need for additional tax-free cash.
Action 3 – Apply for the official HMRC pension ‘protection’
My comments: Not as simple as it sounds. There are five forms of HMRC protection, some of which are no longer available or don’t apply in certain situations. Fixed protection 2014 and Individual protection are the ones to focus on. Firstly, you can’t have these if you already have an existing protection certificate in place. The outcome would be to retain the Lifetime Allowance of £1.5m beyond 2014, avoiding the drop to £1.2 million.
Rules prevent those with Fixed protection from further pension accrual. In effect you lose this protection if you continue to actively accrue pension benefits (NHS or personal).
This may be appropriate for some individuals and Fixed Protection will need to be applied for and accepted before April 2014.
Action 4 – Accept a tax penalty
My comments: Worth considering. A tax penalty for breaching the Lifetime Allowance may not be as punitive as you think. For example, if you breach the allowance by £100,000 the tax penalty is applied by deducting £1,250 from your NHS Pension annually. The key here is to assess whether taking your pension benefits early and/or applying for HMRC protection puts you in a better financial position than simply paying the penalty.
This requires some detailed analysis and calculations involving your NHS pension, personal pensions and existing annuity income. A competent adviser with specialist NHS knowledge will do this for you.
Action 5 – Cap the growth of personal pension funds
My comments: Effective damage limitation. This is most likely to be suitable for dentists with pensions close to the Lifetime Allowance and with personal pension funds in excess of £100,000. Pension drawdown can be used to avoid a ‘second test’ of the Lifetime Allowance in future years. This strategy involves crystallising your personal pension and drawing out sufficient income annually, to freeze the value. This needs to be well managed and can only be achieved through a SIPP (self-invested personal pension). Independent advice is needed to ensure investment risk meets your objectives.
I strongly recommend dentists seek independent advice on the value of their pensions compared to the Lifetime Allowance. Start by requesting a forecast of NHS pension benefits and obtaining personal pension valuations. The advice you receive must be tailored to your individual circumstances.
The comments in this article are based on current legislation and pension rules, which are subject to change. This article is not intended as individual advice.
Jon Drysdale is an independent financial adviser and director of PFM Dental (Financial Advice). PFM Dental offers wealth management services exclusively for dentists. Please contact the author to discuss your individual situation. Jon can be contacted at www.pfmdental.co.uk or on 0845 241 4480.