NHS and private pensions explained

You may feel like your retirement is far off in the future, and that you don’t need to think about it right now.

But, given that you’re automatically enrolled into the NHS Pension Scheme (NHSPS) when you start working as a doctor or dentist, it’s worth having a good understanding of its benefits – and the difference between the NHSPS and private pension schemes.

In this article, our very own Julie Reid sat down with Specialist Financial Adviser from Wesleyan Financial Services, Daniel Nixon, to find out what you need to know.

Hi Daniel, thanks for taking the time to chat with us today. I suppose the first thing young professionals will want to know is what the NHSPS is?

Hi Julie, thanks for inviting me here to chat about pensions! And you’re right, the best place to start is to share some information about what the NHSPS is.

The NHSPS is a defined benefits scheme. This means that the scheme promises to pay a guaranteed income when you retire. For a practitioner, this is based entirely around their Career Average Revalued Earnings (CARE).

To make things complicated, anyone working within the NHS prior to 2015 will have their guaranteed income calculated slightly differently, but I think your readers will only be interested in the current 2015 scheme.

Thanks Daniel. Can you tell us a little bit about the benefits being in the NHSPS brings?

The NHSPS comes with a variety of benefits, including an ill-health retirement plan and a pension for your spouse or dependent if you were to die before you reach retirement age.

These are key benefits in the eyes of a financial planner, as they provide an NHSPS member and their family with various safety nets that simply aren’t available within a private pension.

Combined with the fact that a defined benefit scheme means the income you receive is guaranteed by the government, this makes the NHSPS a particularly valuable scheme.

And can you explain how the NHSPS is calculated, so our readers can get a greater understanding of how, monetarily, this pension scheme works?

The contribution you make is based on a percentage of how much you earn. For example, if you’ve earned £100,000 in a year, that would be approximately £12,500 a year as your pension contribution.

If you were to earn the same £100,000 of NHS income in a year as an active member, you would earn one 54th of that as new pension (in simplified terms). That means £1,851.85 would be added to your final pension.

However, that wouldn’t be where it ends, as the pension will forever be linked to inflation – that is, until the day that you retire as part of your overall CARE pot. Therefore, the contribution to your final pension at the point that you retire would be much bigger, but the advantage is that you are paid a fixed price for those benefits.

If you consider this in very simple terms, and don’t include tax relief on the contribution cost or inflation of the pension you have bought, you can see the exceptional value that the NHSPS provides.

Simply taking the £1,851.85 pension earned and dividing it by the cost of that year’s £12,500 contribution tells you in laymen’s terms that after seven years of retirement, the pension contribution has more than been recouped by the income paid.

Most doctors and dentists retiring today would have aspirations of a much longer retirement than this time span, and this is one of the reasons the NHSPS is held in such high regard.

The reality is even more beneficial, as due to inflation, it will take even less time to recoup the contribution cost. This is because by the time the member retires, the £1,851.85 pension payment will have increased with inflation, and will continue to do so post-retirement.

However, it’s important to note that when you and your spouse die, an NHS pension has no further value to pass onto anyone, as it can’t be inherited.

Great, thanks Daniel. Now, moving onto private pensions. What can you tell us?

A private pension is a defined contribution pension. This means that you build up a pot of money that can be used to provide an income in retirement.

The only controlled element is how much you pay into it, which would be an amount that is affordable for you. This might be monthly, quarterly, half yearly, in lump sum payments or whenever you can afford to contribute.

The funds from private pensions can be put into investment funds of varying risk levels based on the risk profile of the client. How much you get back in the future depends on how much you paid into the pension and how the investments perform.

I specialise in the dental world and know that some dentists choose to pay into their pensions every January, based on the guidance of their accountant in relation to strategic tax planning. This payment would typically be invested in line with a risk appetite you choose (or determined during a review with your Specialist Financial Adviser).

It might go into one fund or into several, but ultimately, the funds would be aligned to the general risk theme suited to individual circumstances.

What does this mean when you come to retire?

With a private pension, instead of having a set amount of income per year as a pension when you retire, you would have a set fund value. This might be better described as a savings pot worth a set amount of money.

Once you reach retirement age, you have several options as to how you choose to use this capital to support you. The most popular option among dentists tends to be to use Flexible Access Drawdown (FAD). This is where you can choose what you draw from your pension without limitations.

For example, if you had a pot of £500,000, you could withdraw it all in the first year if you wished to do so. This isn’t necessarily a sensible strategy, but it is possible.

What other approaches are there?

As part of good financial planning, what is more likely would be choosing to withdraw a sustainable percentage of the funds every year – around 4%, for example. This could mean that the value you withdraw each year (the 4%) would hopefully be almost fully replaced by investment growth.

The aim of withdrawing a sustainable amount is to try to ensure that your pot lives for as long as you do, with minimal year-on-year depletion. This is because many people opt to take a more defensive investment strategy once they have reached retirement than they do while building up their funds.

This defensive approach is often considered a more sensible one, given that none of us have the luxury of knowing how long our retirement will last.

The benefits of this approach include flexibility when it comes to how much you want to take out year-on-year. This can be advantageous for tax planning, particularly when the state pension kicks in, with many members choosing to reduce their income withdrawals from their FAD as a result of their increased income.

A final significant advantage is that a private pension is inheritable when you die. There are different ways of passing on your unspent pension, as well as tax implications to consider, but one of the most popular currently is to assign your leftover funds to your children.

Depending on your age and pension situation at the time of death, they can benefit from either a lump sum or regular income from your pension plan. This is a clear benefit over the NHS Pension Scheme.

Finally… which one should you choose?

Both the NHS pension and private pension schemes have different means of reaching the same endpoint, which is income security during retirement.

The NHS Pension Scheme still offers exceptional value and should be the primary consideration for those working in the NHS and looking to build income for the future.

We’ve seen more and more dentists in particular working privately – whether that be fully or partially. Dentists unable to direct this income towards the NHSPS should consider seeking further guidance to understand the benefits and flexibility of private pension planning.

This includes considering the opinion of a Specialist Financial Adviser and a specialist accountant to ensure maximum efficiency in both tax and retirement planning.

Please note that the value of investments can go down as well as up and you may get back less than you invest.

Tax treatment depends on individual circumstances and may be subject to change in future.