One of the reasons I started learning about personal finance was to try and make sense of the NHS Pension Scheme. Many of my colleagues pay in and assume they’ll be sorted in the end. That sort of goodwill makes you an easy target for cheeky governments. So if you’re an NHS employee or just interested, here’s a one-pager on basics of the NHS Pension Scheme. The headline:
The NHS Pension is an unfunded defined benefit career-average revalued earnings (CARE) pension.
Wading through that finance-speak.
- Defined benefit
When you come to take the pension you receive a set amount yearly/monthly, a defined benefit (DB).
Defined benefit pensions come in many forms, from the old style final salary (where you continue to receive your final salary yearly as your retirement income), to the CARE schemes as explained below. Most public sector jobs retain defined benefit schemes (civil service, teachers pension etc) and some corporations hold it for their top brass.
Private companies have largely moved to defined contribution (DC) pension schemes. Here the amount you pay in is set, and what you receive depends on how much you have saved at the end. These used to managed in investment funds by selected providers, but since the pension freedoms legal changes people have lots more options (SIPPs etc). DB schemes are unlikely to allow you to make such changes without transferring your money out (1).
Most pension schemes are ‘Funded’. This means the scheme holds assets from contributions against future liabilities (future pension payments). On an individual level, this would mean an individuals’ (and their employers’) contributions are invested so to pay out the future pension of that person. DB pension scheme liabilities are valued on an actuarial basis. That is, some very smart math geeks add up lots of numbers on life expectancy to value the cost of paying future pensions.
In an Unfunded scheme, the contributions are used to pay current pensioners. There is no ‘float’. In the case of the NHS Pension Scheme, the Treasury guarantees the scheme liabilities. There is no pot of assets lying about. They effectively work on a ‘pay as you go’ basis. Cynics argued that the 2015 scheme came about because they realised the old scheme was too expensive with people living longer.
- Career-Average Revalued Earnings (CARE)
CARE schemes are the modern DB scheme set-up, argued to be fairer (cheaper). You receive a pension based upon a fraction of your pensionable earnings, revalued yearly for inflation. For each year you pay into your NHS pension, you add 1/54th of your earnings for that year to the pot. To account for inflation each your pot is ‘revalued’ and increased by inflation (Treasury Order, currently 1.7% as the CPI) plus 1.5% (2).
Caveat; this only covers the 2015 scheme. The 1995 and 2008 sections are final salary with different calculations. Frustrating for those of us migrated over.
So that’s the description, what about the nuts and bolts?
The pension contribution line on your payslip should have a little percentage next to it. That percentage is defined by your earnings, rising if you earn more because we live in a fair and equitable society. This amount has no impact on the amount in your pot – better to think of it as a ‘membership fee’. The percentage of your salary you pay as a ‘membership fee’ is defined by the table below (2):
|Annual salary||Contribution rate|
Your local NHS employer also pays in 20.68%. This, while seeming generous, also has no benefit on what you receive other than being their contribution to your ‘membership fee’.
You receive your pension at state retirement age (although this does vary for a minority, check your own eligibility). You receive 1/54th of the earnings of each year you contributed, revalued yearly by inflation +1.5% up until the point you retire. You receive this like a continued salary or annuity. Remember those? Currently out of fashion, but previously annuity schemes you bought at retirement were where you paid a lump sum to receive a yearly amount back in the future. The NHS pension does similar.
Because it’s a guaranteed yearly amount from retirement (practically age 68 for most), and it’s revalued for inflation it’s a pretty sweet deal. It’s possible to build up pensions which would be worth millions if you were buying them as an annuity or DC equivalent. Hence the issues with the Tapered Annual Allowance.
In almost all circumstances joining and remaining a member of the NHS Pension Scheme is a good idea. Even if you’re joining close to retirement (3).
Actually working out how much you will receive is a bit of a nightmare – hence further issues with the Tapered Annual Allowance. This is because you don’t know your contributions until the end of the tax year, you don’t know your current revaluation, and you have to guesstimate future revaluation.
You can formally request an estimate here (4). Expect in 3-6 working months.
Or a quicker and easier route is to go to the NHS Business Services website and log into your Total Reward Statement (a faff) (5). This will provide various figures, plus an annuity equivalence estimate. You can plug these figures into a variety of calculators such as these provided by the Scottish Public Pension Agency or the HSC Pension Scheme Services (Northern Irish I think). (5, 6)
It’s also worth noting that on your death a nominated partner can receive a lump sum, adult dependent’s can receive a pension, and children under 23 can also receive a pension.
- You can’t transfer out
Since April 2015 members of unfunded public sector pension schemes cannot transfer out to Defined Contribution schemes (1). It’s unfunded; there’s no pot of money to take your contributions from. In effect, this means many are ‘trapped’ in the NHS Pension Scheme.
- It’s inflexible
It’s an opt-in or opt-out deal. You can’t change providers if they don’t offer what you want, you can’t select a different DC pension. You can’t move your pension around the stock market. You pays your money, many thanks for your blood, sweat and tears, here’s your reward guv.
- The Tapered Annual Allowance
To HMRC your pension pot is 20x your annual defined benefit at the end. Unlike with a private Defined Contribution scheme, you can’t cut contributions if you think they’ll breach the Annual Allowance. Those contributions and revaluations which rely on some fiendish calculations and professional intuition (guesswork). This is leading to effective tax rates of 100+%, and tax bills running into six figures (1). Likewise, there is little to no ability to negotiate alternative compensation arrangements in lieu of employer pension contributions if it looks like they will breach the Tapered Annual Allowance. I’ve ranted about it before (7). The changes announced in the recent (March 2020) Budget upped the threshold to £200k, which should solve this problem for the majority (8).
- It’s low hanging fruit for HM hungry Treasury
“Rich doctors are already compensated way more than us in the private sector” etc…
The unfunded nature makes it an expensive ongoing concern. Weighing that liability against pissing off NHS employees is a mighty headache.
The NHS Pension scheme remains a significant carrot for workers in the NHS who spend a working lifetime being beaten with sticks. It’s clunky, inflexible and beats most DC schemes in terms of return – it’s guaranteed!
There’s still plenty of caveats. If you’re struggling MedFi has a five-part series with worked examples (9). They also cover factors to consider if you want to retire early (10), how to top up and buy out for early retirement (11), and what happens if you’re on extended leave or you’ve buggered off elsewhere (12). I’ve avoided all of this for sake of brevity and sanity. I’d also recommend Junior Doctor Finance for an explanatory page, plus a quick calculator (13).
The NHS Pension Scheme turns out to be like the NHS itself… monolithic, byzantine, effective. Hope this was useful, would welcome any comments below,
N.B. I am indebted to the Young FI Guy for some of his original post text relating to the NHS Pension and the Tapered Annual Allowance.