Annual allowance explained
Annual allowance is the amount of pension savings an individual can make in one year without paying tax. If an individual builds up pension savings that exceed the annual allowance, a tax charge is due on the value of the excess benefits. For members of the NHS Pension Scheme, the amount of pension savings over the year is not based on the value of employee and employer contributions paid into the scheme, it is based on the increase in the value of the member’s pension benefits over the year.
How annual allowance is calculated
NHS Pension Scheme members may be subject to the standard annual allowance or a lower tapered annual allowance, depending on their taxable income.
The standard annual allowance limit is set by HMRC and has been set at £40,000 since 6 April 2014. The annual allowance was previously set at a higher level, meaning that a wider range of NHS staff may now earn benefits that exceed the allowance.
The tapered annual allowance reduces tax relief for higher earners. NHS Pension Scheme members may have a lower tapered annual allowance if they have:
- threshold income above £200,000
- adjusted income above £240,000.
Threshold income includes basic salary, taxable benefits, other employment income, property income, investment income and pension income.
Adjusted income includes threshold income, plus the value of pension savings.
If an individual is subject to a tapered annual allowance, their annual allowance of £40,000 is reduced by £1 for each £2 of adjusted income above £240,000, to a minimum annual allowance of £4,000. The reduction is applied up to a minimum annual allowance of £4,000 once adjusted income reaches £312,000. This means the member’s individual tapered annual allowance will be between £40,000 and £4,000. The gradual tapering of the annual allowance is shown in the graph.
Further restrictions may apply if the employee has taken any pension benefits from a money purchase or defined contribution scheme, such as a personal pension scheme.
How benefits in the NHS Pension Scheme are tested against annual allowance
The value of pension growth over the year, known as the pension input period (PIP), is calculated by subtracting the value of the member’s pension at the start of the year from the value of the pension at the end of the year.
The value of pension growth is multiplied by a factor of 16.
The resulting figure is the pension input amount (PIA).
If the PIA exceeds the individual’s annual allowance, any excess benefits are subject to a tax charge at the member’s marginal rate of income tax. The HMRC calculator can be used to work out the tax charge.
Those likely to be affected
A range of factors may contribute towards an individual breaching their annual allowance. As many of these factors depend on the individual’s personal finances, it may not be possible for employers to identify who may be affected in advance. However, members are more likely to exceed the annual allowance if:
- they have long service in the NHS Pension Scheme (this includes any membership in the 1995/2008 Scheme as well as the 2015 Scheme)
- they are members of the 1995/2008 Scheme (although it’s still possible for members of the 2015 Scheme to be affected)
- they receive a significant increase in pensionable pay
- they are promoted several times within a brief period
- they have pension savings in other workplace pension schemes
- they receive taxable income from other sources (e.g. income from other employment, pension income, self-employment and income from rental properties)
- inflation is low.
The NHS Pension Scheme Annual Allowance (AA) and Tax Ready Reckoner tool is designed to help members understand the benefits they are building up in the scheme and their potential annual allowance liability.
NHS Pensions will write to members who they believe may have built up pension savings in the NHS Pension Scheme that exceed the annual allowance for the previous tax year. This letter is called a pension savings statement and contains all the information a member will need to calculate and pay their tax charge. Members may have pension savings elsewhere, so it is the individual’s responsibility to include details of other pension arrangements and identify and calculate any tax liability. Staff will often look to their employer for help in understanding their statements and what to do next.
An example pension saving statement is available on the NHS Pensions website.
Payment options for affected NHS Pension Scheme members
We recommend that members of the NHS Pension Scheme who are affected or concerned about the annual allowance seek independent financial advice about their individual circumstances. We have published a list of organisations that are able to offer expert guidance and advice on pension tax issues for members of the NHS Pension Scheme.
There are three options available to NHS Pension Scheme members who breach the annual allowance:
Members may use any leftover annual allowance from the last three tax years to cover an annual allowance tax charge.
Members of the NHS Pension Scheme can ask NHS Pensions to pay some, or all of the annual allowance tax charge to HMRC on their behalf. In return, pension payments in retirement are reduced by a corresponding amount.
This option is available to members:
- with benefits over the standard lifetime allowance*
- who have incurred a tax charge of over £2,000
- who submitted a request to use scheme pays before the deadline.
*Scheme pays is not available for tax charges incurred on excess benefits above the tapered annual allowance.
Members must notify NHS Pensions of their intention to use scheme pays before the annual deadline for the relevant tax year. Use our annual allowance key dates and actions infographic to remind yourself of key timescales and deadlines.
To help support your conversations with staff about scheme pays, we have created a presentation and accompanying recording.
More information on scheme pays can be found on the NHS Pensions website.
Members may pay the annual allowance tax charge directly to HMRC from existing personal funds or savings through the self-assessment tax return.
For more information on payment options, use our one-page guide which can be shared with staff to help improve awareness and understanding of the annual allowance.
Responsibilities and deadlines
Calculate their tax charge, inform HMRC and ensure the tax charge is paid.
Provide accurate employee data to NHS Pensions, help to answer any queries and signpost staff to an independent financial adviser when necessary.
Calculate the pension input amount, send pension savings statements and pay the tax charge to HMRC for members requesting to use scheme pays.
*PIP stands for pension input period. This is the time over which growth in a members pension
saving is assessed.
Further information and resources
Lifetime allowance is the amount of pension savings an individual can make over a working lifetime without paying tax. All pension benefits, except the state pension, count towards the lifetime allowance. If an individual’s total pension savings exceed the lifetime allowance, a tax charge is due on the excess benefits.
Visit our web page for more information on the lifetime allowance and how to support members of the NHS Pension Scheme that are likely to be affected by it.
Pension tax is a complex area and we have published a series of resources to support your conversations with staff:
- Ready reckoner tool and demonstration – individuals can assess their annual allowance liability.
- Annual allowance guide - highlights the payment options available to affected members.
- Annual allowance key dates and actions – an infographic that sets out key actions for employers and NHS Pension Scheme members.
- Annual allowance and scheme pays recording – explains the allowance, pension saving statements and provides examples of paying annual allowance charges.
- Pension tax – local options for affected staff – covers local options employers can put in place to support members who are facing pension tax issues.
- Access to pension tax guidance and advice – a list of organisations that can provide independent financial advice to NHS Pension Scheme members.
- Pension tax webinar recording – explores how employers can help staff facing pension tax issues to support retention and service delivery.
- Pension taxation slide pack – can be used to provide an overview of pension taxation for board members.