Changes in Pension Tax

The Chancellor has announced major reforms in the pension tax regime which may help GPs with significant tax bills. Although these changes will apply from the tax year 2020/21, the government has already committed to contributing back any additional pension charge paid by Scheme Pays Election for 2019/20. 

Therefore, GPs who have already opted out of the scheme for 2019/20 or thinking of opting out for 2020/21 may want to consider opting back in, as there may be a reduced or no pension charge at all. 

The key facts to note are: 

• Annual allowance will remain at £40,000. 
• Threshold income (taxable income) will increase by £90,000 to £200,000. 
• Adjusted income (taxable income plus pension contributions) limit will increase by £90,000 to £240,000.
• Minimum annual allowance will reduce from £10,000 to £4,000. 

We shall examine the effectiveness of the above changes with a few examples below.

Example 1

 A GP has income of £200,000 and pension growth of £50,000. Below is the comparison of the tax liabilities between two tax years: 

Tax Year 2019/20			Tax Year 2020/21
Limits:			Limits:
Threshold income	£110,000		Threshold income	£200,000
Adjusted income	£150,000		Adjusted income	£240,000
GP Taxable Position:			GP Taxable Position:
Net taxable income	£200,000		Net taxable income	£200,000
Pension input	£50,000		Pension input	£50,000
Adjusted income	£250,000		Adjusted income	£250,000
Excess above adjusted limit	£100,000		Excess above adjusted limit	£0
Impact on annual allowance:			Impact on annual allowance:
Reduction in annual allowance	£50,000		Reduction in annual allowance	£0
Restricted to minimum allowance	YES		Restricted to minimum allowance	NO
Available allowance	£10,000		Available allowance	£40,000
Impact on tax charge:			Impact on tax charge:
Taxable pension excess(£50,000 – £10,000)	£40,000		Taxable pension excess(£50,000 – £40,000)	£10,000
Tax at 45%	£18,000		Tax at 45%	£4,500

In the above example, although in 2020/21 the GP has adjusted income above £240,000, the threshold income level of £200,000 was not breached due to the extended limits, and therefore the full £40,000 allowable will be available. 

The same GP with an identical position will pay £18,000 tax in 2019/20, however this would reduce to £4,500 in 2020/21 due to the changes in limits.

In example 2 below, we consider a GP with less taxable income, but high pension growth. This is particularly relevant for GPs reducing their sessions, but with a larger pension fund. 

Example 2

A GP has £120,000 taxable income and pension growth of £80,000 during the year. The tax impact comparison under the two tax years will be as follows: 

Tax Year 2019/20			Tax Year 2020/21
Limits:			Limits:
Threshold income	£110,000		Threshold income	£200,000
Adjusted income	£150,000		Adjusted income	£240,000
GP Taxable Position:			GP Taxable Position:
Net taxable income	£120,000		Net taxable income	£120,000
Pension input	£80,000		Pension input	£80,000
Adjusted income	£200,000		Adjusted income	£200,000
Excess above adjusted limit	£50,000		Excess above adjusted limit	£0
Impact on annual allowance:			Impact on annual allowance:
Reduction in annual allowance	£25,000		Reduction in annual allowance	£0
Restricted to minimum allowance	NO		Restricted to minimum allowance	NO
Available allowance	£15,000		Available allowance	£40,000
Impact on tax charge:			Impact on tax charge:
Taxable pension excess(£80,000 – £15,000)	£40,000		Taxable pension excess(£80,000 – £40,000)	£40,000
Tax £30,000 at 40%	£12,000		Tax £30,000 at 40%	£12,000
Tax £35,000 at 45%	£15,750		Tax £10,000 at 45%	£4,500
Total tax charge	£27,750		Total tax charge	£16,500

The example shows that the tax liability will be significantly less under the 2020/21 rules, and the GP will save approximately £11,500 in tax in comparison to the previous tax year. 

While this is good news for the majority, very high-earning GPs may suffer an additional tax burden due to the reduced minimum annual allowance of £4,000. We examine this in example 3 below.

Example 3

A GP has £230,000 taxable income and their pension growth is £90,000 during the year. The tax impact comparison under the two tax years will be as follows: 

Tax Year 2019/20			Tax Year 2020/21
Limits:			Limits:
Threshold income	£110,000		Threshold income	£200,000
Adjusted income	£150,000		Adjusted income	£240,000
GP Taxable Position:			GP Taxable Position:
Net taxable income	£230,000		Net taxable income	£230,000
Pension input	£90,000		Pension input	£90,000
Adjusted income	£320,000		Adjusted income	£320,000
Excess above adjusted limit	£170,000		Excess above adjusted limit	£80,000
Impact on annual allowance:			Impact on annual allowance:
Reduction in annual allowance	£85,000		Reduction in annual allowance	£40,000
Restricted to minimum allowance	YES		Restricted to minimum allowance	YES
Available allowance	£10,000		Available allowance	£4,000
Impact on tax charge:			Impact on tax charge:
Taxable pension excess(£90,000 – £10,000)	£80,000		Taxable pension excess(£90,000 – £4,000)	£86,000
Tax at 45%	£36,000		Total tax charge	£38,700

As can be seen from above, the high-earning GP is actual subject to a higher tax charge due to a reduced minimum allowance now applicable for 2020/21.

Other Considerations

It is also important to consider cash flow position. Pension tax is similar to any other tax and a taxpayer not only pays pension charge for the year, but also 50% of the previous year’s charge on their payment on account. Therefore, when considering cash flow, tax savings could potentially be even larger if charges are reduced. 

Another consideration should be the benefits of being an active member of the scheme. For those GPs who stay in the scheme as an active member, they are entitled to death in service benefits. If you choose to opt out and stop contributing for the scheme, you are not entitled to death in service benefits for the time that you are a deferred member. 

There are also other personal financial implications to opting in and out of the pension scheme, and therefore clients should seek financial advice from an Independent Financial Advisor before taking further action. 

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