BMA Guidance on Restricting Pensions Tax Relief – October 2010

Summary
On 14 October 2010, the Government announced its proposed changes to the
taxation of pension savings due to be introduced from April 2011.

In summary, the proposed changes are:

 Annual Allowance (“AA”) to reduce from £255,000 to £50,000 from April
2011;
 The single valuation factor will be increased from 10 to 16;
 Indexation of accrued benefits will be in line with the Consumer Prices
Index (CPI) (“inflation proofing”);
 Unused AA from up to three previous years can be “carried forward” and
offset against excess pension savings made in a particular year. For this
purpose, the AA in previous years is assumed to be £50,000.

In addition, the Lifetime Allowance (LTA) will be reduced from £1.8m to £1.5m,
although the Government has stated that it is minded to delay implementation
until April 2012. This is in order to allow sufficient time to design a protection
regime that ensures that anyone with pension pots currently above £1.5m
(subject to a cap of £1.8m), or anyone that is making pension savings based on
the LTA being £1.8m, is protected from any tax charge. The Government also
believes that those who are currently protected by either Primary or Enhanced
Protection should continue to be so.

More information is set out in a paper published by HM Treasury:

http://www.hm-treasury.gov.uk/d/restricting_pensions_summary141010.pdf

Who is exempt?
Deferred members are to be exempt from the AA regime. In addition, the AA test
will not be applied in the year of death, or in the case of lump sums paid in
respect of serious (terminal) ill health.

The Government also recognises that it may be appropriate to provide exemption

from the regime in other cases of major ill health, and further details are awaited.

However, it has been confirmed that exemptions from the AA test will not be
granted in the year that benefits come into payment, on redundancy or for
individuals with Enhanced Protection.

Who is most likely to be affected?

The following members are most likely to be affected:
(i) members with long service and/or significant promotional or pay rises
(ii) high-earners and members with Enhanced Protection
(iii) members retiring on (non terminal) ill health or redundancy grounds
(iv) members buying “Added Years” or “Additional Pension”

The examples below demonstrate the potential tax charges for doctors and GPs –
including those buying “Added Years” or “Additional Pension”. In all of the
examples, CPI over the relevant period is assumed to be 2%.
Examples have been shown for the following sections of the NHS Pension Scheme
– the impact will be similar for other schemes offering benefits similar to those
shown.

Hospital/Community doctors (1995 Section) provides benefits on a 1/80ths

basis and cash at retirement of 3 times pension

GPs (1995 Section) provides benefits based on career earnings and a

retirement lump sum of 3 times pension. Pension is based on 1.4% of
“dynamised earnings”. Pensionable earnings are recorded each year and a
revaluation factor is applied. The revaluation factor used to re-value earnings
each year is 1.5% above CPI. The resulting figure is known as “dynamised
earnings”.

What will happen if an individual cannot afford to pay the tax charge?
There may be circumstances in which an individual receives a large increase in
their pension savings in a given year and cannot afford to pay the resulting tax
charge. The Government has acknowledged this and is considering options for
such individuals to be able to make the payment from their pension entitlement.
It will consult with interested parties before taking final decisions in advance of
April 2011.

Example 1a – Promotion from specialist registrar to consultant

Andy is promoted from specialist registrar (SpR) to consultant and his pensionable
salary increases from £46,708 to £75,994. He is accruing benefits in the NHS
Pension Scheme (1995 Section) and has completed 10 years’ membership at the
start of the relevant year.

Step 1: Calculate pension benefit value at start of the year and “inflation proof”:
Pension = (£46,708 x 10/80) x 1.02 = £5,839 x 1.02 = £5,956
Lump sum = 3 x £5,956 = £17,868

Step 2: Calculate pension benefit at end of the year:

Pension = (£75,994 x 11/80) = £10,449
Lump sum = 3 x £10,449 = £31,347

Step 3: Calculate increase in pension benefit value over the year:

Pension = (£10,449 - £5,956) x 16 = £71,888
Lump sum = (£31,347 - £17,868) = £13,479

Step 4: Test against Annual Allowance:

Annual Allowance exceeded by: (£71,888 + £13,479) - £50,000 = £85,367 -
£50,000 = £35,367.
So, need to look at any unused allowances over previous 3 years.

Step 5: Carried forward Annual Allowance from previous 3 years1:

Year X – 1 unused Annual Allowance: £34,933
Year X – 2 unused Annual Allowance: £36,111
Year X – 3 unused Annual Allowance: £37,232
Total unused allowance: (£34,933 + £36,111 + £37,232) = £108,276

Step 6: Calculate any tax charge payable:

Total Annual Allowance: £50,000 plus £108,276 = £158,276
Therefore, as £85,367 is less than £158,276, Andy will not be subject to any tax
charge.
1
Assuming Andy progressed through the Trainee pay points at a rate of one per
year

Example 1b – As per Example 1a, but also buys £5,000 of Additional

Pension (“AP”)

Let’s now assume that Andy wants to buy £5,000 of Additional Pension (i) by
making a single lump sum payment, or (ii) by funding the Additional Pension via
the payment of regular additional contributions over a period of 20 years.

(i) Paid for by a single lump sum

Step 1: As above.

Step 2: Calculate pension benefit at end of the year:

Pension = £10,449 + £5,000 = £15,449
Lump sum = 3 x £10,449 = £31,347 [Note: AP does not include an
automatic lump sum]

Step 3: Calculate increase in pension benefit value over the year:

Pension = (£15,449 - £5,956) x 16 = £151,888
Lump sum = (£31,347 - £17,868) = £13,479

Step 4: Test against Annual Allowance:

Annual Allowance exceeded by: (£151,888 + £13,479) - £50,000 = £165,367 -
£50,000 = £115,367. So, need to look at any unused allowances over previous 3
years.

Step 5: Carried forward Annual Allowance from previous 3 years (as above):
£108,276

Step 6: Calculate any tax charge payable:

Total Annual Allowance: £50,000 plus £108,276 = £158,276
Andy will therefore be liable for an AA charge of 40% of (£165,367 - £158,276) =
£2,836.

(ii) Paid for by regular instalments over a period of 20 years

Step 1: As above.

Step 2: Calculate pension benefit at end of the year:

Pension = £10,449 + (£5,000 x 1/20) = £10,699
Lump sum = 3 x £10,449 = £31,347 [Note: AP does not include an
automatic lump sum]

Step 3: Calculate increase in pension benefit value over the year:

Pension = (£10,699 - £5,956) x 16 = £75,888
Lump sum = (£31,347 - £17,868) = £13,479

Step 4: Test against Annual Allowance:

Annual Allowance exceeded by: (£75,888 + £13,479) - £50,000 = £89,367 -
£50,000 = £39,367.
So, need to look at any unused allowances over previous 3 years.

Step 5: Carried forward Annual Allowance from previous 3 years (as above):
£108,276

Step 6: Calculate any tax charge payable:

Total Annual Allowance: £50,000 plus £108,276 = £158,276
Therefore, as £89,367 is less than £158,276, Andy will not be subject to any tax
charge.

Example 2a – Salaried GP, pensionable salary of £70,000 and £2.0m

dynamised earnings

Belinda is a salaried GP with a pensionable salary of £70,000 and £2.0m

dynamised earnings. She is accruing benefits in the NHS Pension Scheme (1995
Section).

Step 1: Calculate pension benefit value at start of the year and “inflation proof”:
Pension = £2.0m x 1.4% = £28,000
“Inflation proof” = £28,000 x 1.02 = £28,560
Lump sum = 3 x £28,560 = £85,680

Step 2: Calculate pension benefit at end of the year:

Dynamised earnings: [£2.0m x (1 + (2% + 1.5%)) + £70,000] = £2.140m
Pension = £2.140m x 1.4% = £29,960
Lump sum = 3 x £29,960 = £89,880

Step 3: Calculate increase in pension benefit value over the year:

Pension = (£29,960 - £28,560) x 16 = £22,400
Lump sum = (£89,880 - £85,680) = £4,200
Total = £26,600

Step 4: Test against Annual Allowance:

As £26,600 is less than £50,000, Belinda will not be subject to any tax charge.

Example 2b – As per Example 2a, but has also been building up “Added
years”

Let’s now assume that Belinda has been buying four years of “Added Years” over
a period of 25 years from her 35th birthday. At the start of the relevant year she is
aged 55 and has been paying for these Added Years for 20 years – her average
earnings over this time was £70,000.

Step 1: Calculate pension benefit value at start of the year and “inflation proof”:
Pension = £2.0m x 1.4% = £28,000
“Added Years” pension = [4 x (20/25) x £70,000] x 1.4% = £3,136
“Inflation proof” = (£28,000 + £3,136) x 1.02 = £31,759
Lump sum = 3 x £31,759 = £95,277

Step 2: Calculate pension benefit at end of the year:

Dynamised earnings: [£2.0m x (1 + (2% + 1.5%)) + £70,000] = £2.140m
Pension = £2.140m x 1.4% = £29,960
“Added Years” pension = [4 x (21/25) x £70,000] x 1.4% = £3,293
Total pension = £29,960 + £3,293 = £33,253
Lump sum = 3 x £33,253 = £99,759

Step 3: Calculate increase in pension benefit value over the year:

Pension = (£33,253 - £31,759) x 16 = £23,904
Lump sum = (£99,759 - £95,277) = £4,482
Total = £28,386

Step 4: Test against Annual Allowance:

As £28,386 is less than £50,000, Belinda will not be subject to any tax charge.
Example 3a – Self-employed GP, pensionable salary of £150,000 and
£2.7m dynamised earnings

Colin is a self-employed GP with a pensionable salary of £150,000 and £2.7m

dynamised earnings. He is accruing benefits in the NHS Pension Scheme (1995
Section).

Step 1: Calculate pension benefit value at start of the year and “inflation proof”:
Pension = £2.7m x 1.4% = £37,800
“Inflation proof” = £37,800 x 1.02 = £38,556
Lump sum = 3 x £38,556 = £115,668

Step 2: Calculate pension benefit at end of the year:

Dynamised earnings: [£2.7m x (1 + (2% + 1.5%)) + £150,000] = £2,944,500
Pension = £2,944,500 x 1.4% = £41,223
Lump sum = 3 x £41,223 = £123,669

Step 3: Calculate increase in pension benefit value over the year:

Pension = (£41,223 - £38,556) x 16 = £42,672
Lump sum = (£123,669 - £115,668) = £8,001
Total = £50,673

Step 4: Test against Annual Allowance:

Annual Allowance exceeded by: £50,673 - £50,000 = £673
So, need to look at any unused allowances over previous 3 years.

Step 5: Carried forward Annual Allowance from previous 3 years:

Year X – 1 unused Annual Allowance: £1,041
Year X – 2 unused Annual Allowance: £2,696
Year X – 3 unused Annual Allowance: £4,296
Total unused allowance: (£1,041 + £2,696 + £4,296) = £8,033

Step 6: Calculate any tax charge payable:

Total Annual Allowance: £50,000 plus £8,033 = £58,033
Therefore, as £50,673 is less than £58,033, Colin will not be subject to any tax
charge.

Example 3b – As per Example 3a, but has also been building up “Added
years”

Let’s now assume that Colin has been buying four years of “Added Years” over a
period of 25 years from his 35th birthday. At the start of the relevant year he is
aged 55 and has been paying for these added years for 20 years – his average
earnings over this time was £150,000.

Step 1: Calculate pension benefit value at start of the year and “inflation proof”:
Pension = £2.7m x 1.4% = £37,800
“Added Years” pension = [4 x (20/25) x £150,000] x 1.4% = £6,720
“Inflation proof” = (£37,800 + £6,720) x 1.02 = £45,410
Lump sum = 3 x £45,410 = £136,230

Step 2: Calculate pension benefit at end of the year:

Dynamised earnings: [£2.7m x (1 + (2% + 1.5%)) + £150,000] = £2,944,500
Pension = £2,944,500 x 1.4% = £41,223
“Added Years” pension = [(4 x (21/25) x £150,000] x 1.4% = £7,056
Total pension = £41,223 + £7,056 = £48,279
Lump sum = 3 x £48,279 = £144,837
Step 3: Calculate increase in pension benefit value over the year:
Pension = (£48,279 - £45,410) x 16 = £45,904
Lump sum = (£144,837 - £136,230) = £8,607
Total = £54,511

Step 4: Test against Annual Allowance:

Annual Allowance exceeded by: £54,511 - £50,000 = £4,511
So, need to look at any unused allowances over previous 3 years.

Step 5: Carried forward Annual Allowance from previous 3 years: Nil.

Payment of the additional contributions towards Added Years has meant that he
has no unused Annual Allowance in any of the 3 previous years to carry forward.

Step 6: Calculate any tax charge payable:

Total Annual Allowance: £50,000 plus Nil = £50,000
Colin will therefore be liable for an AA charge of 40% of (£54,511 - £50,000) =
£1,804