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Rising inflation, a looming problem for NHS pensions: Royal London’s Senior Intermediary Development and Technical Manager, Justin Corliss explains.
Pension tax issues have reportedly already seen a large number of NHS pension scheme members reduce hours, decline additional responsibilities or leave the scheme altogether. This could be exacerbated in the coming months due to a mismatch between how inflation is accounted for in scheme calculations versus those used to assess whether an annual allowance charge is due. And that mismatch doesn’t work in members’ favour.
Since 1st April 2022, all active NHS pension scheme members have been accruing benefits in the reformed career average revalued earnings (CARE) scheme where benefits are based on the pensionable pay earned each year rather than final salary. These benefits are then revalued on 1st April each in line with Treasury Order (currently CPI) from the previous September + 1.5%. In common with all registered pension schemes, annual pension accrual is measured against the annual allowance, be that full, alternative or tapered, to see if an annual allowance tax charge is due.
Let’s see how this works for Dr Green, an ENT consultant who joined the NHS pension scheme in July 2015 so has built up 7 years benefits in the CARE scheme[i]. Her pensionable pay is currently £112,616.24, and she expects it to reach £114,868.56 as at 1st April 2023. The annual CPI rate in September 2021 was 3.1%, rising to an assumed rate of 10% in September 2022.
Assuming Dr Green has £15,793 in pension rights built up in her NHS pension account as at 5th April 2022, using the usual factor of 16, this will have a capital value of £252,688 for annual allowance purposes. This capital value is then adjusted for inflation using CPI from September 2021, giving us an uprated opening value of £260,521. So far so good.
Next, we need to value Dr Green’s benefits at the end of the input period to work out the input for the year. This is made up of new accrual for the periods 6th April 2022 to 31st March 2023 and 1st April 2023 to 5th April 2023, plus the revaluation of benefits accrued in the member’s NHS CARE pension account. And here’s the thing. Public Sector pension scheme (including NHS) members’ benefits are revalued on 1st April each year. So the revaluation falling into the 2022/23 PIP is the revaluation which will take place on 1st April 2023. And this will use CPI from September 2022.
When inflation is relatively static, the inflationary increase to the starting value for the pension input period under the annual allowance calculation offsets all but 1.5% of the revaluation of accrued benefits under the scheme calculation, meaning the benefits built up as a result of the extra year of service account for the bulk of the accrual in that input period.
However, in circumstances where inflation is rapidly increasing or decreasing, this offsetting effect is no longer as effective, meaning that inflation or deflation can impact pension input. Many forecasts suggest the CPI figure for September 2022, which will be the figure used to revalue members’ pension accounts in April 2023, could be 10% or greater in circumstances where the CPI figure used for the annual allowance calculation will be 3.1%.
Coming back to our case study, Dr Green would have approximately £17,850 in her NHS CARE pension account as at 31st March 2023. Assuming CPI is 10% in September 2022, this figure would be revalued by 11.5% on 1st April 2023 making the total built up £19,903. She’ll then have 5 further days accrual making the grand total in her NHS account £19,932 as at 5th April 2023. So for annual allowance purposes the estimated capital value as at the end of the input period would be £318,912.
Finally, to calculate the annual input, we subtract the opening figure from the closing figure:
£318,912 – £260,521 = £58,391. So, Dr Green is going to have pension input in respect of this scheme of £58,391 in the 2022/23 tax year which could give rise to an annual allowance tax charge. To further highlight this issue, if the CPI rate in September 2022 was 3.1% as it was in September 2021, the closing value of Dr Green’s benefits becomes £299,203 reducing pension input to £19,709 which is below the standard annual allowance
In this case study, this mismatch between the CPI figures used for scheme and annual allowance purposes has led to additional pension input of £38,682 and the possibility of a pension tax charge.
So, the current sharp spike we’ve seen in inflation is likely to have a significant impact on many higher earning NHS scheme members (and other public sector pension scheme members) which could result in further scheme exodus to stave off the effects of tax charges.
There may be a light at the end of this tunnel which paraplanners could highlight to advisers. If CPI was to return to a more normal level the following September, let’s assume 3.1%, this would have the opposite effect the following year. Pension input could be significantly lower, or even zero, although it can’t be negative. Not only would this provide NHS pension scheme members with some respite from what must feel like endless tax issues associated with their pension, but it may create some unused annual allowance to carry forward to future years. This could alleviate future annual allowance charges they may face.
[i] Out of scope for McCloud remedy due to date of joining
