Welcome back to the third instalment of our series on the NHS Pension! In Part I we detailed how our pension is built up over our years of work, before learning how that sum is revalued to keep its purchasing power in Part II. In this section we’ll be touching on some considerations for FI(RE), in particular claiming your NHS Pension early and keeping a watchful eye on your pension allowances.
At the end of part II we stated that you could claim your NHS Pension once you’d reached state retirement age (SRA). What if you’re keen to clock our early, sail to the Bahamas and sip piña coladas? Well you can get there by claiming your pension before the state retirement age – as young as 55yrs old. Let’s see what the impact an early retirement will have on your annual pension (and therefore your coconut cocktail purchasing power).
If you’ve decided to take your pension early, a few factors come into play:
1. Your annuity will be smaller because (compared to someone retiring at SRA) you’ll have generated pension for fewer years.
2. Your annuity will be smaller because you’ve spent proportionally fewer years contributing at your highest salary.
3. You’ll be ‘penalised’ for taking your pension early. You’ll have spent fewer years making pension contributions and you’ll be paid your pension for longer, so there’s a percentage reduction to your annuity.
The amount your annuity is reduced by depends on when you take it; the earlier you claim it the greater the reduction. If you claim as early as possible (55yrs) you can expect a hefty 45% reduction in your pension. If you claim with one year left until SRA then the reduction is ‘only’ 6%.
Dr. Diane started NHS work at 25 on £27,000/year and [for the sake of simplicity] continues to be on that salary until retirement age. Let’s see how her pension looks with varying amounts of early retirement:
a. 68yrs old: ~£41,000/year
b. 65yrs old: ~£30,000/year
c. 60yrs old: ~£19,000/year
d. 55yrs old: ~£13,000/year
You might be thinking that Diane’s pension at 55yrs has more than a 45% reduction compared to at 68yrs; this demonstrates factor one above (and also factor two if her salary had increased throughout her career). It’s also another illustration of compound interest. This is crucial to understand if you plan on retiring early; you’ll have to balance the many benefits of stopping or reducing work against the financial implications of doing so. The NHSBSA has helpfully published an early retirement calculator that can help you further understand the impact of such a step, whilst it’s also possible to go back to work after claiming your pension if you want the financial boost or socio-intellectual stimulation.
At the point of claiming your pension, you can opt to take a chunk of money out in one go. This lump sum will have a subsequent impact on your annuity – for every £12 of lump sum you decide to take, you’ll lose £1 off your annuity. There’s also a limit to how much of a wedge you can take out of your pension pie as a lump sum, which is 4.28 times your annuity. Another consideration with taking a lump sum is that, over a certain amount, you will have to pay tax on it.
Whether or not you decide to take a piece of your pension as a lump sum will hinge heavily on your circumstances as you come to the point of retirement. It’s not necessary to decide now, though it is important to understand that this option exists when the time comes.
There’s a capped amount that you can pay into your pension each year: the annual allowance. Breaching this allowance will incur the wrath of HMRC and lead to a tax bill heading your way. This may have crossed your radar as what’s been creating a storm amongst Consultants in recent times, causing them to reduce working hours and consequently their tax bills. Thankfully this has stirred the powers that be into action, with a new consultation (and hopefully changes) on the horizon. This allowance is £40,000/year, though part of the problem is the complexity of the annual allowance and a full explanation goes beyond the scope of this post.
The second limit is on the total value of your pension: the lifetime allowance (LTA). Your pension’s value exceeding the LTA is another sure-fire way to twist the knickers of HMRC and earn a tax bill. The LTA, which is £1.055m at the time of writing, is set to increase in line with inflation. However as your pension increases by inflation + 1.5% (see Part II), you’re at risk of going over the LTA at some point.
i) Dr. Dave’s NHS Pension is such that he’d earn £50,000/year in retirement. The capital value of his pension is 20 x £50,000 = £1m. As this is less than £1.055m he won’t be breaching the LTA.
ii) Dr. Diane’s NHS Pension is such that she’d earn £70,000/year in retirement. The capital value of her pension is 20 x £70,000 = £1.4m. As this breaches the LTA she’ll be subject to extra tax when she claims her pension.
For a more detailed look at both the annual and lifetime allowance, see our later dedicated post on the matter!
One for all
This part of our series has a tilt towards early retirement, though the information it contains is pertinent to anyone with an NHS pension. Knowing how early retirement or taking a lump sum will affect your annuity and being mindful of staying within your allowances are all key components of making your pension work as best for you as is possible. You’re hopefully now developing a serious schema of how your NHS pension works from beginning through to the end. There’s still more handy information to come in Part IV, where we’ll look at your options for adding more money to your pension.