Understanding the lifetime allowance

Higher earners and/or individuals with long service in the NHS Pension Scheme may be affected by the lifetime allowance. The Lifetime Allowance restricts tax relief members can have by taxing the benefits built up above it (the lifetime allowance charge). The charge is always paid through an adjustment to your pension.

As such, if your pension is still growing and you’re getting close to going over the lifetime allowance, you might be wondering what that means for your pension benefits and thinking about whether you should retire soon to avoid paying a lifetime allowance tax charge.

To help colleagues start thinking about the lifetime allowance and to illustrate how the mechanics of the lifetime allowance work, and that it acts like an income tax threshold, we have set out an illustration below.

The current (standard) lifetime allowance is £1,073,100 (for the 2022/23 tax year) and benefits are tested against this limit at retirement. More detailed information about the lifetime allowance can be found on the NHS Business Services Authority’s website.

More illustrations showing how lifetime allowance charges are calculated in the NHS Pension Scheme can also be found on the NHS Business Services Authority’s website.

For our illustration, we’ve used an example of an “Officer” member of the NHS Pension Scheme who was age 59 on 1 April 2022 (and so has both 1995 section and 2015 scheme benefits). They are below the lifetime allowance if retiring at age 59 and are considering the extra benefits they could build up by staying in work an extra year, and what would happen to their benefits if they started to breach the lifetime allowance.

What happens when the lifetime allowance is breached?

Once the lifetime allowance is exceeded (which includes all pension benefits inside the NHS Pension Scheme and those built up elsewhere) then generally speaking members accrue around 70%-75% of the full amount of the pension entitlement (this is age dependent and may also be lower if an individual is subject to other pension tax charges, such as the Annual Allowance).

Anything below the threshold is unaffected and is not subject to any lifetime allowance charge.

For completeness, automatic tax free cash in the 1995 section is usually unaffected (unless that exceeds 25% of the lifetime allowance).

Is it worth staying in the NHS Pension Scheme once the lifetime allowance is reached?

Clearly, breaching the lifetime allowance would mean that they would build up lower levels of pension benefit in the future for the contributions paid. However, could they still benefit from continuing to be a part of the pension scheme to increase what they take home in retirement?

In this position, the individual will need to determine themselves whether what they pay in, is worth what they may get out, net of any extra tax they pay.  Only benefits above the lifetime allowance are reduced in value – anything below the lifetime allowance is unaffected by benefits tipping over this threshold.

By staying, many individuals can continue to build on their pension benefits, which can mean an increase to their annual income at retirement, as well as a larger lump sum. Staying in the NHS Pension Scheme also has benefits like Life Assurance and other family benefits.

April 2022 – an extra note on inflation:

Finally, it is also important to note that inflation is currently high (as of April 2022) compared to historic levels and could potentially increase further, before it starts to reduce again. Therefore, if the individual in our example below wished to retire at 59 (and potentially use Retire and Return) on 1 April 2022, and inflation were 10% in September 2022 (Consumer Price Index inflation was 7.0% for the 12 Months to March 2022 – source: ONS), then their pension at age 60 could be broadly in line with the pension at 60 shown above without the need to work the extra year.

Therefore, whether or not it would be better to retire at 59 to receive a guaranteed inflation increase next year, or keep on building up benefits in the 2015 scheme (and retain their salary link on their historic 1995/2008 section benefits) will depend on their own view of their future career and the options available to them if they choose to use an alternative option such as Retire and Return.

Other considerations

Finally, please note that in this example we have not considered the impact of the annual allowance (another form of pensions tax) on the member’s benefits. However, some higher earners may also find themselves affected by this, too. More information on the annual allowance can be found on the NHS Business Services Authority’s website.

In addition, in the 1995 section, benefits paid after Normal Pension Age (60) are not subject to increases for late payment and so individuals staying beyond Normal Pension Age need to consider this when assessing their options and the value that they are receiving from continuing to build up benefits.

Individuals should therefore consider all of these factors when making long-term retirement planning decisions and as such, the decision for any member as to whether to retire or not, or keep building up benefits in excess of the lifetime allowance can be more difficult.

If you need to speak to a financial advisor, you may want assurance that they understand, in detail, how the NHS Pension Scheme works before you obtain the advice. The Money Advisory Service may be able to help with this.

How could pensions be affected if the lifetime allowance is breached?

Annual pension income Lump sum at retirement
Retire at 59 (without breaching lifetime allowance) £44,622 a year for life Lump sum of £128,762
Retire at 60 (breach the lifetime allowance) £48,609 a year for life: That’s £3,987 more per year than
retiring at 59
£134,430 a year for life: That’s £5,668 more per year than
retiring at 59

The details below show how the lifetime allowance calculation is performed.

Retire at 59 without breaching the lifetime allowance

The benefits the member may take at 59 (accounting for any early payment reductions) are:

Retire at 59 1995 Section 2015 Scheme Total
Service 33 2 35
Pension £41,954 p.a.* £2,668 p.a.** £44,622 p.a.
Lump sum £128,762** £128,762***

The member needs to check if they will breach the lifetime allowance at retirement. The value of an individual’s benefits which are tested against the lifetime allowance are:

Lifetime allowance value = (20 × annual pension) + lump sum
= (£44,622 × 20 + £128,762)
= £1,021,202.

The standard lifetime allowance is £1,073,100. Therefore, this member has not breached the lifetime allowance and is not subject to any additional charges. 

But, what could happen if the member stayed an extra year, built up another year of 2015 scheme benefits?

Retire at 60 and breach the lifetime allowance

The benefits the member may take at 60 (accounting for any early payment reductions), after building up more benefits are:

Retire at 60 1995 Section 2015 Scheme Total
Service 33 3 36
Pension £44,810 p.a.* £4,302 p.a.** £49,112 p.a.
Lump sum £134,430*** £134,430***

The member needs to check if they will breach the lifetime allowance at retirement. The value of an individual’s benefits which are tested against the lifetime allowance are:

Lifetime allowance value = (20 × annual pension) + lump sum
= (£49,112 × 20 + £134,430)
= £1,116,670.

The standard lifetime allowance is £1,073,100. Therefore, this member has breached the lifetime allowance by £43,570 and is subject to an additional charge. This is calculated as follows:

Excess above lifetime allowance charges Tax to pay Reduction to pension Remaining pension at 56 after lifetime allowance charges
£43,570 £10,893
(25% x £43,570)
£503 p.a.
(£10,893/21.66)
£48,609
(plus a lump sum of £134,430)

A summary of how the benefits have changed between age 59 and 60 is as follows:

Pension Lump sum
Retiring at age 59 £44,600 p.a. £129,000
PLUS additional build up between 50 and 60 £4,500 p.a. £5,000
LESS lifetime allowance charge (£500) p.a.
Retiring at age 60 £48,600 p.a. £134,000
Change +4,000 p.a. +5,000 p.a.

This shows that even allowing for the LTA charge, both the pension and lump sum increase so the member needs to consider if this is good value.

* includes early retirement adjustment of 4.5% at 59.
** includes early retirement adjustment of 33.2% at 59 and 30% at 60.
*** includes early retirement adjustment of 2.3% at 59.
Assumes pension from 1995 section is reduced to recoup lifetime allowance charge. Factors used to calculate the reduction to NHS pension to recoup the Lifetime Allowance charge.

Example assumptions

  • The individual is aged 55 as at 1 April 2022.
  • The individual was in the 1995 Section of the NHS Pension Scheme until 31 March 2015. They joined the 2015 Scheme from 1 April 2020 – they had ‘tapered protection’. The illustrations do not make any allowance for the McCloud judgment, if applicable, for members eventually being given a choice between receiving their legacy (1995 or 2008 Section) and 2015 Scheme benefits in retirement for the period 1 April 2015 to 31 March 2022.
  • The individual is an “Officer” member. The example does not reflect “Practitioner” benefits.
  • The individual has a pensionable salary of £106,500 in the year to 31 March 2022 and receives a  2% increase on 1 April 2022 i.e. the individual’s salary for 2022/23 is therefore assumed to be £108,630.
  • The illustrations are based on the current actuarial factors in force in the Scheme (August 2021) – these are used for calculating any reductions to benefits because benefits are paid prior to Normal Pension Age. In the 1995 section, benefits paid after Normal Pension Age (60) are not subject to increases for late payment and so individuals staying beyond Normal Pension Age need to consider this when assessing their options.
  • The current lifetime allowance charge factors are set out in these examples.
  • The member does not have special class status or Mental Health Officer status – therefore, their 1995 section benefits will be reduced to reflect the fact that they’re being paid before Normal Pension Age prior to age 60. Individuals with special class status or Mental Health Officer status may be able to draw their benefits earlier without these reductions applying. See the NHS Business Services Authority website for more information about special class status and Mental Health Officer status.
  • The illustrations do not allow for the uptake of certain options that members may be able to exercise, for example, they do not allow for the exchange of pension for additional cash.
  • The figures quoted may incorporate a small degree of rounding.
  • All of the examples are illustrative only and are not designed to represent the particular circumstances of any one individual. Find out which pension scheme you are a member of on the NHS Business Services Authority website.

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