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The NHS pension scheme

The NHS pension scheme is public service occupational pension scheme. It is a defined benefit scheme which means that it pays a promised pension based on salary and length of service.

Further details about the scheme are covered in the Commons Library briefing NHS Pension Scheme.

UK pension taxation

In the UK, pension tax relief works on the principle that contributions to pensions are exempt from tax when they are made, but taxed when they are paid out. The amount of tax-relieved pension saving an individual can build up is limited by the annual allowance (£40,000 in 2022/23) and lifetime allowance (frozen at its current level of £1,073,100 until April 2026).

The annual allowance was reduced from £255,000 in 2010 to £40,000 by April 2014, and since April 2016, it has been tapered, meaning it reduces further for higher earners. When making these reductions, the Coalition Government put in place measures to mitigate the impact. For example, people at risk of breaching the annual allowance in a particular year can ‘carry forward’ unused allowances from the previous three years and, in certain circumstances, people can apply for protection against a reduced lifetime allowance.

The NHS pension scheme and the tapered annual allowance

Since 2016 a person’s annual allowance is tapered (reduced) if their threshold income (taxed) and adjusted income (total including pension contributions) are above set amounts. When these rules were introduced they applied to people with ‘adjusted incomes’ above £150,000 and ‘threshold income’ above £110,000. The taper could reduce the annual allowance to a minimum of £10,000.

Although these rules applied across all schemes, the higher salaries and nature of many doctors’ work (for example, consultants taking on additional work often at short notice to cover service pressures) meant there was a larger impact on the NHS. This was particularly observed in 2019-20 when the capacity to bring forward unused annual allowances from the previous three years was largely exhausted.

To address the issue, in the March 2020 Budget, the Government announced increases of £90,000 in the income thresholds for the tapered annual allowance (‘adjusted income’ increased to £240,000, ‘threshold income’ to £200,000) and a decrease in the minimum annual allowance to £4,000.

The impact of high inflation on NHS pension tax

The annual allowance calculation for the increase in value of a defined benefit scheme is calculated as the change in the value of any lump sum plus 16 times the change in the value of the annual pension. To allow for price rises, the opening value the pension is increased by inflation as measured by the annual change in CPI the September before the tax year. This is then compared to the actual closing value at the end of the tax year to determine if the annual allowance has been exceeded.

The NHS pension scheme increases the value of the pension benefits it provides based on inflation during the tax year. Because inflation in 2022 is projected to be significantly higher that inflation in 2021 there is an issue in the 2022/23 tax year. The NHS pension scheme will use 2022 inflation to increase member’s existing pension benefits which is very likely to be more than the 2021 inflation measure set in legislation. Any increase above that set in legislation will be counted as contributing towards the annual allowance.  

On 22 September 2022, the Government announced that it would change elements of the NHS pension scheme including correcting pension rules regarding inflation. It was reported that this would be achieved by amending the revaluation date in the NHS pension scheme.

Calls for further reform of pension tax rules and the NHS pension schemes

In its October 2019 report on Taxation and Life Events, the Office of Tax Simplification, an independent office of HM Treasury, said the Lifetime and Annual Allowance charges could present significant complexities for pension savers in different circumstances. It said that, given the aim of limiting the overall pension tax relief going to any individual, applying both the annual and lifetime allowance might be unnecessary. For defined benefit schemes, like the NHS Pension Scheme, one option might be to apply the lifetime allowance only. 

In March 2020, the British Medical Association (BMA) welcomed the changes to the tapered annual allowance, but said that a pay increase or a promotion could still result in doctors facing significant tax bills for exceeding the standard £40,000 annual allowance. The BMA has argued for the option of a tax-unregistered (where contributions receive no tax relief) pension scheme for those affected, pointing to a similar scheme for the judiciary. In response to Parliamentary Question on 18 May 2021, the Government rejected this approach on grounds that the circumstances of judicial appointments are unique and a similar approach would not benefit the vast majority of NHS staff who would then receive no tax relief on their contributions.


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