NHS Pension - Annual Allowance issues

In my first post I explained how the NHS pension is calculated and it's more obvious benefits - I suggest reading that first otherwise it this may not make too much sense. The main reason I actually wanted to look into it was to calculate the annual allowance and to see if it was worth topping up a personal allowance. What I found was, that it was very complicated so hopefully I will be able to break it down for you in a easy to follow manner. Again, I am only talking about the 2015 NHS pension.

Annual Allowance

Currently everyone is entitled to put away up to £40,000 tax free into a pension as long as you earn below a certain amount. This amount is called the threshold income. For this year, it is £200,000 annually. Previously it was £110,000, but due to covid (and politics), it was increased by £90,000 to get more doctors to work without worrying about tax bills from pension contributions. A good explanation can be found here but essentially, the threshold income is all taxable income (wage, dividends, bonuses) minus all deductible expenses and pension contributions. 

If after that, your threshold income is above £200,000, then your adjusted income is calculated which is your threshold income plus your pension contributions (employer included). If your adjusted income is above £240,000 then you lose £1 of your annual allowance for every £2 over the adjusted income. Therefore you can be left with a minimum annual allowance of £4,000 if you earn £312,000 or more. It is possible to use unused annual allowance from the previous 3 years if you do breach the current year's annual allowance.

How do they calculate the annual NHS pension contributions?

Using the guide from the NHS Business Services Authority, we can see how they calculate your pension growth. Your Pension Input Amount (PIA) is calculated by subtracting your starting amount at the start of the year (Opening Value) from your end of year amount (Closing Value). 

Opening Value

1. Your NHS pension is calculated until the day prior to the start of the pension input period (PIP). The pension input period is aligned to the tax year (normally 6th April until the 5th April the following year).


2. This amount is multiplied by 16.


3. This amount is then adjusted in line with inflation to reflect its value with the amount at the end of the pension input period. The inflation (CPI) percentage uses the value from the September CPI before the PIP start.  

Closing Value

1. Your NHS pension is calculated up to the last day of the pension input period (end of tax year). Importantly as mentioned in my previous post, your pension gets dynamised in line with inflation (CPI) + 1.5%. The CPI value for this calculation is taken from the September CPI after the PIP start. This calculation is done prior to the end of the PIP period, and will include the pension contribution from the current year. 


2. This amount is multiplied by 16.

PIA

1. The Opening Value is subtracted from the Closing Value. 

The PIA is what is looked at when looking at annual pension contributions. So how easy is it to breach £40,000? A few examples I think will explain it better - prepare for some maths.

Example 1 - NHS Worker James, NHS Pensionable pay £50,000, NHS Pension at start of PIP £20,000, Last year's September CPI 2%, Current PIP September CPI 2%.

Calculating his Opening value is as follows:

    £20,000 x 16 x (1+2%)  = £326,400 (his opening value - using CPI from previous year)

His Closing value can be calculated as follows:

    £20,000 x (1+2%+1.5%) = £20,700 (this is dynamised growth of his pension, using CPI from current year)

    (£50,000 / 54) x (1+2%+1.5%)= £958.33 (this is what he adds to his pension this year, which is also dynamised at the end of the year)

    £20,700 + £958.33  = £21,658.33 (his end of year pension amount)

    £21,658.33 x 16 = £346,533.28 (his closing value)

Therefore his pension growth/pension input amount (PIP) is closing value minus opening value:

    £346,533.28 - £326,400 = £20,133.28 - this is less than the annual allowance of £40,000 so this is tax free. 

Example 2 - NHS Worker Jane, NHS Pensionable pay £140,000, NHS Pension at start of PIP £40,000, Last year's September CPI 2%, Current PIP September CPI 2%.

Calculating her Opening value is as follows:

    £40,000 x 16 x (1+2%)  = £652,800 (her opening value)

Her Closing value can be calculated as follows:

    £40,000 x (1+2%+1.5%) = £41,400 (this is dynamised growth of her pension)

    (£140,000 / 54) x (1+2%+1.5%)= £2,683.33 (this is what she adds to her pension this year, which is also dynamised at the end of the year)

    £41,400 + £2,683.33 = £44,083.33 (her end of year pension amount)

    £44,083.33 x 16 = £705,333.28 (her closing value)

Therefore her pension growth/pension input amount (PIP) is closing value minus opening value:

    £704,711.04 - £652,800 = £52,533.28 - this is more than the annual allowance of £40,000. The excess (£12,533.28) will be taxed.

From this we can also calculate how much someone can earn before they breach the annual allowance regardless of dynamising. If someone earns over £135,000 in NHS pensionable pay, they will then contribute more that £40,000 prior to any inflation calculations. 

£135,000 / 54 x 16 = £40,000 

Differences in CPI values between years can cause growth in your pension that can cause you to breach your annual allowance.

Example 3 - NHS Worker Jim, NHS Pensionable pay £100, NHS Pension at start of PIP £45,000, Last year's September CPI 0%, Current PIP September CPI 4.5%.

Note the difference of CPI values and small Pensionable pay - this is to allow them to retain their membership to the scheme.

Calculating his Opening value is as follows:

    £45,000 x 16 x (1+0%)  = £720,000 (his opening value, using CPI from previous year)

His Closing value can be calculated as follows:

    £45,000 x (1+4.5%+1.5%) = £47,700 (this is dynamised growth of his pension, using CPI from current year)

    (£100 / 54) x (1+4.5%+1.5%)= £1.96 (this is what he adds to his pension this year, which is also dynamised at the end of the year)

    £47,700 + £1.96 = £47,701.96 (his end of year pension amount)

    £47,701.96 x 16 = £763,231.36 (his closing value)

Therefore his pension growth/pension input amount (PIP) is closing value minus opening value:

    £763,231.36 - £720,000 = £43,231.36 - this is more than the annual allowance of £40,000. The excess (£3,231.36) will be taxed.

As you can see, even though Jim did not earn much, due to the increase in pension due to dynamising alone (£2,700), he will have breached his annual allowance and will have to pay a tax bill. Those with large pensions can be liable for large tax bills based on how the CPI changes year on year (and there isn't anything they can do about it). Bare in mind that CPI values can also drop, and you can therefore end the year with a lower closing value than the opening value. 

That was a complicated topic - hopefully you were able to follow that; thankfully the lifetime allowance is slightly easier to comprehend, which I will go over in another post soon. 

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