NHS Pension - Lifetime Allowance

Last post I discussed the intricacies of the annual allowance, how earning above a certain amount or being stung by changing CPI's can cause you to be foul of the annual allowance. This post I will go over the lifetime allowance and how it applies to the 2015 scheme.

Lifetime Allowance

As previously noted in the previous posts, your pension you accrue in the 2015 scheme is an accumulation of years of pension contributions. 1/54th of your pensionable pay is added year on year, with it being revalued at the end of the year to keep with inflation. However the government only allows a certain lifetime amount to be kept as a pension before you will need to be taxed. Currently the lifetime allowance for the tax year 2020/2021 is £1,073,100. That does seem like a large amount doesn't it? What's more, it rises every year with CPI (inflation) so next year it is going up by 0.5% to £1,078,900.

But how does it work for the NHS pension scheme - there is no big pot of money, its a defined benefit scheme meaning a guaranteed income from pension age. How can you calculate your lifetime allowance from the NHS pension?

The calculation is actually pretty simple, you just multiply your NHS pension by 20. So if you have an accrued NHS pension of £40,000 then your lifetime 'pot' at the moment is £800,000 and you are below the lifetime allowance. We can also see that currently with a lifetime allowance of £1,073,100 that anyone with a pension under £53,655 (£1,073,100 / 20) will be within the allowance.

Tax Charges

What's the downside of contributing to the over the lifetime allowance then. Taxes! Currently you will pay 25% tax towards anything above the lifetime allowance if you take it as a scheme pension (annually) or 55% tax as a lump sum. How does this work for the 2015 NHS pension? This charge is then divided by an age-related actuarial factor and your NHS pension is reduced by this amount. Best shown through an example:

Example 1. Bob, 68 years old. NHS pension of £60,000. Retiring January 2021 so lifetime allowance currently £1,078,100. 2015 scheme only (so will be several years in the future). Also consider £60,000 may not be worth a lot in several decades time unlike now).

Bob's Lifetime pot is £60,000 x 20 = £1,200,000

The excess fund is £1,200,00 - 1,078,100 = £‬122,000

Therefore the tax charge payable is £122,000 x 25% = £30,500 

He is 68 years old meaning the actuarial factor he will apply to this charge is 17.28. A list of the actuarial charges can be found here. 

£30,500 / 17.28 (his age-related actuarial factor) = £1,765.05 reduction in his pension

His new pension is £60,000 - £1,765.05 = £58,234.95 

One way of avoid this in retirement is just to stop contributing as much when you get close to your limit. However that may not be possible in some cases. Some may say that the charge isn't that bad and possibly still better than what you can get on the private market. 

In our example, with our 68 year old with his £60,000 year pension, if he were to have increased his pension to £61,000 prior to retiring, after the lifetime allowance tax, he will have only increased it by £710.65 to £58,945.60. Also considering that you pay tax on your pension, he will be in the 40% tax bracket and so will only take home £426.39 extra (annually). 

Another way of reducing the tax bill is to take out as much as possible as a lump sum. The 2015 NHS pension allows up to 25% of the taken out as a lump sum. For every £12 of lump sum taken, the annual pension is reduced by £1. The maximum tax-free allowance is 25% of the current life-time allowance (£1,078,100 / 4 = £268,275). The example below will outlay Bob's pension with a tax-free lump sum.

Example 2. Bob 68 years old, NHS 2015 pension, £60,000, decides to take tax-free lump sum of £268,272 at retirement. This reduces his pension by £22,356 (£268,272 / 12 = £22,356) to £37,644.

Bob's capital value of his pension = £37,644 x 20 + £268,272 = £1,021,152

Therefore he is below the life-time allowance and no extra tax is applicable. Personal circumstances may dictate whether this is a better option for him, as if he was to live a long life, financially this isn't as beneficial for him. Some people may prefer having the money upfront to spend (pay off mortgage, buy a fancy car, around the world cruise, first class 5 star hotels, etc.).

If you found this useful, please share below. I will next look into the issue of Maternity pay in the NHS.