What happens if you exceed the Annual Allowance?

This article is intended for NHS Pension members who have become aware that their pension input exceeds the Annual Allowance.  If you are unsure whether this applies to you please first see our previous article ‘Annual Allowance: Does it Affect You? A Guide for NHS Pension Members’.

Carry forward unused allowance from previous years

If you have an Annual Allowance excess, the first thing to note is that you can carry forward any unused Annual Allowance from the previous three years.  For example, if this year you are £10,000 over the Annual Allowance but three years ago you were £10,000 under it, you can carry forward the unused allowance to cover this year’s excess. 

Some doctors will ordinarily be within the Annual Allowance but special circumstances in one year will take them over, such as a pay rise (perhaps associated with a promotion or Clinical Excellence Award) or increase in hours.  In these circumstances there is likely to be sufficient unused allowance from the past three years to offset the excess. 

If you can cover this year’s excess by carrying forward unused allowance from the past three years there is no Annual Allowance tax charge and the rest of this article can be disregarded.

Other doctors will routinely exceed the Annual Allowance, particularly those earning £110,000+.  Many doctors in this situation are reaching the point where they have no further carry forward available to use.  As a result, they are now facing Annual Allowance tax charges on the excess.

You pay, or Scheme Pays

Where there is insufficient carry forward available, the remaining excess is subject to an Annual Allowance tax charge at your marginal rate of income tax (i.e. 20% for basic rate taxpayers, 40% for higher rate and 45% for additional rate).  You can either pay the tax charge to HMRC through your tax return, or ask NHS Pensions to pay on your behalf, in which case they will reduce your pension benefits accordingly to recoup the charge plus interest.  This is called the ‘Scheme Pays’ option. 

Note: The Scheme Pays option is only available if your pension input amount exceeds the standard Annual Allowance of £40,000 and you have an Annual Allowance charge of £2,000 or more.  If you have an Annual Allowance charge because of the Tapered Annual Allowance be aware that you can still only ask for Scheme Pays if your pension input amount for the NHS Pension exceeds £40,000 and only for the Annual Allowance charge in respect of the excess over £40,000, even where your Tapered Annual Allowance is lower.

Estimating the cost of Scheme Pays

The reduction in your benefits at retirement depends on when you retire and the section or scheme you are in.  To provide an indication of what the reduction might be, NHS Pensions provide factors that can be used to calculate an estimate.

Examples

For a member of the 1995 Section with a normal pension age of 60 and currently aged 45, the factor you would use is 14.8 and the estimated reduction to the pension at age 60 would be: Annual Allowance charge paid by the 1995/2008 Scheme ÷ 14.8. 

For a member of the 2015 Scheme who is 23 years away from the normal pension age of 68, the factor is 8.7 and the estimated reduction to the pension would be: Annual Allowance charge paid by the 2015 Scheme ÷8.7. 

For the full table of factors see this factsheet from NHS Pensions.

Applying for Scheme Pays

To utilise the Scheme Pays option you must apply by 31 July following the end of the tax year in which the Annual Allowance excess has arisen.  For example if you have an Annual Allowance excess in the tax year 6 April 2017 – 5 April 2018, you must apply for Scheme Pays (should you wish to use it) by 31 July 2019.

Note that if you utilise Scheme Pays but die before retirement the recovery due because of Scheme Pays will be written off and your estate will receive the same level of benefits as if you didn’t utilise Scheme Pays.  Similarly, your dependents benefits will be based on your pension before any recovery for Scheme Pays.

If you exceed the Annual Allowance again – and some high earning doctors are likely to exceed the Annual Allowance every year at present – you can elect for Scheme Pays each tax year in which you are eligible, if desired.

Please note this article is for information only and does not constitute personal financial advice.  Tax rules and allowances are subject to change.  For advice on your personal circumstances please contact Richard Higgs on 0117 966 5699 or richard.higgs@wealthwestmedical.co.uk.

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