Pension Annual Allowance and what this means for you

Working out pension annual allowanceNadia Khan explains what your Pension Annual Allowance is, how it could impact your final retirement income and how to ensure you don’t breach it.

It might surprise you to hear most dentists have no idea what their Annual Allowance is. You could easily exceed this through your NHS contributions alone and not even realise it. 

The NHS pensions crisis is well publicised recently. Pension tax rules have over the last several years impacted on high earning dentists and in some cases, this has resulted in those dentists reducing their commitment to the NHS so that they avoid breaching the Annual Allowance tax charge. 

Many believe they have escaped any additional tax penalties.

Unfortunately, this is not the case. You may still receive an Annual Allowance charge even if you are mindful of your contributions because of pension growth.

If you don’t receive a letter from the NHS Business Authority, you may think you are in the clear. But the NHS BSA is not privy to your total taxable income.

Still with me…

The Annual Allowance is the maximum amount of tax-free growth an individual’s pension can grow by in one year.

Based on your earnings and normally capped at £40,000, this allows you to pay the maximum possible towards your pension while still receiving tax relief. The allowance applies across any pension scheme you may belong to. It includes both individual and employer contributions. 

If, over the course of the tax year, the value of your pension exceeds £40,000, you pay income tax on the difference.

For 2020-2021, the Annual Allowance is £40,000 for most people. But it can be lower if your annual income is more than £110,000. 

Example

Your Annual Allowance is £40,000. If the value of your pension increases by £40,000 or less in that year, there is no additional tax to pay.

But, if the value of your pension increases by £50,000, then you would pay income tax on the extra £10,000. 

The Annual Allowance is applied each tax year. So you must consider it on an ongoing basis.

It represents a limit on how much pension growth you are allowed to see each year before you start to lose the tax relief on pension contributions.

This means that increases in NHS earnings can serve to both increase the level of NHS pension built up (and therefore result in higher levels of pension growth) and to reduce the Allowance available for tax free growth. 

The majority of members should not be affected by the Annual Allowance. But there are a number of circumstances where members could see significant growth in their NHS Pension Scheme benefits that takes them over the Annual Allowance.

What do you need to do? 

You need to check and review your pension statements to confirm whether you have breached the pension Annual Allowance.

The pensions statements are usually sent out every October. From speaking to many dentists, most of them are not aware of the information they should receive with respect to the Annual Allowance.

Restricting NHS income is unfortunately, the only true course of action dentists can take to immediately avoid astronomical Annual Allowance charges.

Apart from simply doing less work, there are other ways to reduce your taxable income. This includes some charitable donations.

It’s also important to claim any tax-deductible expenses through BDA. The BDA can help you get under key thresholds.

If you do private work, you may need to consider the most tax efficient way to remunerate yourself. 

What happens when you are in breach of the Annual Allowance? 

If you are in breach of the Annual Allowance and receive a bill, there are options available as to how you pay it. You can pay out of your own savings, or you can choose the option of ‘scheme pays’. 

Scheme pays is essentially a loan secured against your pension savings. It has a rate equal to the Consumer Prices Index. Plus the scheme discount rate, currently hovering around 3.9%, making it higher than the standard mortgage rate.

Electing to use scheme pays to pay your Annual Allowance charge will only reduce your pension pot.

Scheme Pays is an initiative whereby you can pay the charge directly to HMRC or ask the NHS Pension Scheme to pay your Annual Allowance tax charge. 

Effectively, this is a loan which you pay back, with interest, when you retire. The amount you owe is ultimately debited from your NHS pension benefits, reducing your final retirement income. 

It won’t be the right option for everyone. Some members are better off paying the Annual Allowance charges themselves if they can afford it. This allows you to continue taking your full pension benefits when you retire. 

Providing your tax charge 

Many GDPs will not have the information required to accurately state what their Annual Allowance tax charge is. So include an estimate if final accounts are not been agreed before 31 July 2021. 

It is sensible to do this well in advance and to submit a realistic estimate in order to avoid any interest charges.

However, if you are uncertain whether you will incur an Annual Allowance tax charge, you can consider declaring a small charge (eg £1) and electing to use scheme pays. 

You may wish to discuss this with your accountant prior to making a declaration.

You can amend the scheme pays amount up to four years later. But unfortunately if you do not make a scheme pays election, you cannot do this retrospectively after the deadline. 

Conclusion

Dentists working under the NHS Pensions Scheme can face large tax charges due to the complexity of the current system.

However, despite all of the problems with pensions tax, it is important to remember that saving into a pension scheme is generally the most tax efficient way to provide financial security for old age.

The NHS Pension Scheme still remains the best vehicles around. It offers guaranteed incomes and generous contributions from the government. 

Where can I get NHS pension advice? 

Look for an independent financial adviser who specialises in NHS and public sector pension schemes.


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