This year we will see an unprecedented attack on the pension provision of higher earners. With the government putting in place austerity measures the NHS pension scheme is directly in the firing line only four years after it was last changed. As individuals there is little we can do to influence government policy however there is another even more pressing issue estimated to affect at least 100,000 and possibly up to 500,000 higher earners retiring over the next few years that you can plan for.
Currently anyone retiring in the current tax year can accrue pension benefits equivalent to £1.8million. This figure is calculated as the current value of any personal pension with the NHS being valued as the annual pension entitlement multiplied by 20 with tax free cash entitlement added.
From April 2012 this current pension allowance is reducing to £1.5million. The government has announced it will remain at this level at least for the lifetime of the current parliament, after the 2015/16 tax years there is no indication of what is likely to happen however with the expectation of a continued financial squeeze there may be little appetite amongst politicians or the general public to increase pension tax benefits for high earners.
While this allowance may still seem generous, any doctor retiring with an NHS pension of £50,000 will have utilised £1.15million of the allowance leaving scope for £350,000 of private pension arrangements. Increase the NHS pension to £60,000 and the level of permissible private pension fund reduces to £120,000. NHS pension increases have been significant in the last few years and coupled with private arrangements means that a significant number will breach the new limit. Some consultants are losing their enhanced protection as many have breached the terms of the agreement due to these increases over the past few years.
If allowances are exceeded the penalties are harsh. Pension accrued above the allowance is returned either as a lump sum or as a pension. If returned as a lump sum it is subject to a 55% tax penalty, if taken as income there is an immediate penalty of 25% plus taxation at marginal rate making a tax rate of up to 75%. This change means anyone planning their retirement around the higher allowance of £1.8million is now sitting on a tax penalty of up to £165,000.
There are a number of things that can be done in order to mitigate these penalties but time is short. Firstly it is possible to seek from the revenue a protected allowance. This is called fixed protection and preserves the individual’s higher allowance of £1.8million. The significant downside to this is that in order for the protection to remain valid it is necessary to cease all contributions to pensions including the NHS scheme. Leaving the NHS pension scheme is a significant step and I would strongly urge taking professional advice prior to making this decision. The nomination for fixed protection must take place before April 2012.
A more drastic measure is to draw retirement benefits before the new limits apply in April. This may not be practical due to the timescale; however it is possible to draw retirement benefits without ceasing work.
It makes sense to review private pension contributions being made if likely to be close to the lifetime allowance, as the tax penalties for exceeding the limits are significantly greater than the reliefs received for making the contributions. It also makes little sense investing in high risk pension funds if the outcome is pension growth that will be heavily taxed when benefits are taken.
The reduced lifetime allowance has the most immediate impact upon those retiring within the next three years. However, with uncertainty over how much - if at all - allowances will rise in years to come, more and more doctors will find themselves breaching this limit especially those with high NHS incomes.
It is always sensible to review pension arrangements and with legislative changes affecting the NHS pension and market forces playing havoc with private arrangements, it is more important than ever to ensure retirement planning is appropriate.
Justine Roberts is a director of Medical & Financial Ltd who are an Independent Financial Consultancy Service, specialising with doctors and dentists. She has over 12 years experience working with the medical community providing pension, investment and general financial planning advice. For further information email Justine on justine@medicalandfinancial.com
Tags: Pensions
