NHS Pension inflationary increase 2021-2022 - A storm coming

The annual allowance allowance calculation for the NHS pension is confusing. I wrote about it here but I still have to go back to refresh my knowledge about it. The hard bit about working it out for tax purposes is to think that it's not the monetary amount you contribute, but its the annual growth of the your pension pot. The maths involved makes my head hurt. 

Importantly, when calculating your annual growth within your pot, they use two different inflation figures. HMRC measures inflation as the CPI figure prior to the tax year in question. For example, for this tax year 2021-2022, HRMC will use the September 2020 CPI of 0.5%. This is done at the start of the tax year (your opening value).

The NHSPA (the authority running the NHS pension) dynamises / uplifts your pension at the end of the tax year, using the CPI in September of the tax year in question plus 1.5%. So for this tax year 2021-2022, the September CPI was 3.1%; so the dynamising factor is 4.6%. This is applied to contributions made during the year as well, this is your closing value. 

The CPI figures for the previous years can be seen below. CPI is currently the highest it has been for the last 10 years. 

The difference between the opening and closing value is calculated and then multiplied by 16, this is deemed your annual growth in your NHS pension. Why this is important this year is that this is the biggest yearly difference between the two figures since the 2015 pension began. If you have a large pension pot already, then the dynamisation of it will already eat a lot into your annual allowance of £40,000.

Example

If you start with a £20,000 NHS pension at the start of the 2021-2022 year. Without contributing to it throughout the year, it will have to grown 4.6% with dynamising to £20,820 by April 2022 (closing value). 

For working out annual growth for tax purposes, you need to apply the HMRC inflation figure to the pension at the start of the year (0.5%). This is £20,100 (opening value). The difference between the opening and closing is £720, which is multiplied by 16 to make £11,520. This is the deemed annual growth of the pension. Without contributing to the scheme, more than a quarter of the annual allowance has been used up!

Those with very large NHS pensions and those with large NHS incomes who have been a scheme member for a while are likely going to be hit with annual allowance tax charges this tax year given the large difference in inflation figures. At least, the annual allowance wont be tapered in the vast majority of workers. Also this tax charge can be 'deferred' until the point you start claiming your pension. This is known as Scheme Pays and can work in your favour (e.g. if you know you'll die soon after you claim your pension 😅). It reduces the total amount of your pension when you come to claim it and you do pay interest on this 'loan'.

Hopefully this has been useful, increased inflation has been one of the effects of opening up again post-pandemic, things have got more expensive and it's likely there will be more to come. Please share below.