If you are a past, current or even future NHS employee then the chances are that you will have some interaction with the NHS pension. Having some grasp of your pension(s) is crucial to plotting your own financial journey, especially if you have ambitions of financial independence/retiring early. Unfortunately, wrapping your head around the minutiae of the NHS pension can be difficult, especially in the context of ever-changing pension rules. With that in mind, we’ve done our best to provide an overview of the scheme for those wanting to understand their NHS pension.
We find ourselves in a sort of no-man’s land. If you are an NHS employee with enough interest in personal finance to be reading this blog, the chances are you might have done some reading about your pension already. Conversely, those who might benefit most from the information contained in this series are unlikely to be searching for it. When you add in the British taboo for speaking about personal finance, yet alone the less-than-stimulating topic of pensions, chances of disseminating the information to those who want it isn’t great. We only ask that if you find the content of our series useful, please share it with your colleagues so that they may benefit from it too.
The information we’ll provide is up to date at the time of writing, but as always we implore you to do your own research before making financial decisions. As a final caveat before we get started, we’ve chosen to only detail the latest incarnation of the NHS Pension: The 2015 Section. This is because it applies to both us here at MedFI and 75% of NHS staff. If you are a member of the 1995 or 2008 Sections, you can seek more information using the resources dotted throughout our series.
The ‘Classical’ Pension
Any pension is a specific way of saving money during your working years so that you have something akin to a ‘salary’ after you’ve hung up your stethoscope and retired. The goal is to provide income such that you can continue to live your post-retirement life in a way you’ve become accustomed to.
A stereotypical pension involves you diverting a percentage of your (pre-tax) salary into a ‘pension pot’. Typically your employer will also pay into this pot. Often this money is invested in such a way as to grow its value over time. As the years roll by, your pot grows larger and larger. Once you retire that money is taken back out of the pot by you as a fixed amount per year (an annuity) and sometimes also a large chunk at the start of your retirement (a lump sum). You didn’t pay tax on the money that went into the pot so you pay it as it comes back out. The value or your annuity (and lump sum) is entirely dependent on the amount in your pot.
The NHS Pension
The NHS pension differs from the classical pension model we’ve described above. It is known as a ‘defined benefit’ pension; although this is a descriptive term it’s not that helpful as a stand-alone statement. Each year you work for the NHS two processes automatically happen:
1. You pay a percentage of your pre-tax salary in pension contributions. This percentage changes depending on how much you earn (more on this below).
2. Your annual pension grows at a pre-set rate. This rate is fixed at 1/54th of your pensionable earnings.
Let’s look at some examples of how these processes work:
Dr. Dave earns £27,000 in pensionable pay. In a single year:
1. He pays 9.3% of his salary in pension contributions = £2,511.
2. His annual pension grows by 1/54th of his pensionable earnings = £500
This will happen for each and every year you work. Both of those numbers will vary with changing salary:
Dr. Diane earns £54,000 in pensionable pay. In a single year:
1. She pays 12.5% of her salary in pension contributions = £6,750
2. Her annual pension grows by 1/54th of her pensionable earnings = £1,000
You’ve generated two different numbers and both pertain to pensions – what do they mean? The first amount (process 1) is almost irrelevant. It does not represent the value of your pension nor is it being paid into a pension pot. Rather, you could consider it the cost of membership of the pension scheme. This ‘cost’ changes depending on how much you earn as you can see below. In reality it is paying for the annuities of those who have already retired.
Your employer also pays towards the cost of your pension. Compared to your rates (see table below), the NHS pays in at a fixed rate of 20.6%, which makes the NHS Pension relatively ‘cheap’ for employees.
|Annual salary||Contribution rate|
The second process is relevant. For each year you work, process two will generate an amount of pension. When you retire, all of these amounts are added up to make your final annual pension (i.e. your annuity). It might seem that Dr. Diane’s getting stiffed by paying £6,750 for ‘membership’ but her annuity only grows by £1,000. She’s not though, as that £1,000 will be paid to her every year from retirement until death. Let’s look at an example of this:
Dr. Diane earns £54,000 in pensionable pay for each of the 20 years she works for the NHS.
Year 1: her annual pension grows by 1/54th of her earnings = £1,000
Year 2: her annual pension grows by 1/54th of her earnings = £1,000
… etc. for 20 years. At the end of this time, her pension is 20 x £1,000 so is worth £20,000/year*
*More on why this number isn’t quite correct in Part II
Not so menacing after all
We’ve tried to keep this first part of the series basic to avoid an overload of detail straight away – trust us there’s more to come. Hopefully you now understand a bit more about what the “pension contribution” line on your payslip means (i.e. process 1). You can also see how your annual pension grows in relation to your salary (process 2). In Part II we’ll look at how your pension grows and what you might expect from it come retirement.