The NHS Pension Scheme has been in the news for the wrong reasons and there are many NHS employees unsure of whether the NHS pension is worth joining.
What concerns us greatly is that the negative perception of the Scheme is leading to many NHS employees making the wrong choices.
Here we set out to bust some of the myths and half-truths surrounding the NHS Pension.
The 2015 Pension Scheme is not worth joining
Those in previous versions of the NHS Pension had a scheme retirement date of 60 or 65 and pension benefits based on their final salary. The current NHS pension, the 2015 Scheme, has a retirement age linked to the State Pension Age, and benefits based on their career average salary. As a result, many people think that this is an inferior scheme and isn’t worth joining.
However, they often don’t appreciate that the NHS Pension Scheme accrual rate of 1/54th of pensionable earnings in each year of active membership is still very generous and with the pension accrued being compounded at a rate of CPI + 1.5% per annum this accrual can be significant. It is still possible to take benefits earlier than the State Pension Age and, while there is a reduction for doing so, this can still provide good value for money as the benefits are being drawn for longer.
Those hospital doctors who were in the 1995 or 2008 sections of the Pension Scheme may also be unaware that they can lose out with regard to their existing Final Salary benefits if they decide not to join the 2015 NHS Pension Scheme, as the date used for their ‘Final Salary’ calculation is the date they are deemed to have left the NHS Pension Scheme. Equally GPs will lose their dynamising uplift if they choose not to join the 2015 Scheme.
Opting out of the NHS Pension Scheme is the right choice
A recent Freedom of Information (FOI) request by the Health Service Journal found that 245,561 NHS staff had opted out of the NHS pension scheme in the last three years. According to calculations by Royal London, this represents around 16% of the active membership of the scheme. This is incredibly worrying.
Anecdotal evidence suggests that many people are leaving the Scheme based on conversations they are having with colleagues or reports they’ve seen in the media, which perceive the NHS Pension Scheme in a negative light.
However, while there are individual circumstances where it could beneficial for members to leave the Scheme, it needs to be made clear that for many members the NHS Pension represents excellent value and they should stay in it.
According to our calculations, somebody saving into a private pension may need to invest between 4 times and 6 times the amount, of an NHS employee, to achieve comparable benefits to those from the NHS Pension Scheme.
Opting in and out of the Scheme is a good option for higher earners
The NHS Pension Scheme is very flexible in that it allows members to opt in and opt out when they choose. There is a general belief that high earning medical professionals should take advantage of this by opting out of the scheme for periods and so being less likely to face tax charges for exceeding the Annual Allowance. However, if they’re in the scheme for shorter periods they will also accrue lower pension benefits.
There is an old adage that says, “Don’t let the tax tail wag the dog”. It’s important not to consider possible tax charges in isolation, but to compare them against the extra pension benefits that can be accrued by staying in the Scheme. Put very simply, if the benefits exceed the charges then there is a strong argument for staying put and each individual should check their own position before making a decision.
It’s also important to note that those who opt out won’t benefit from a death in service benefit lump sum or a short term pension which is broadly equivalent to 6 months’ pay. If they are out of the Scheme for more than 12 consecutive months they will also not benefit from any enhancements to their dependents’ and survivors’ pension on death. Equally if they are unfortunate enough to retire on the grounds of ill health they will only qualify for a tier one pension, so they could lose out.
Scheme pays represent poor value
If NHS Pension Scheme members face an Annual Allowance tax charge they have the option of either paying it themselves or opting for ‘scheme pays’, where the tax charge is reflected in a reduction in their income when they take their pension benefits.
With ‘scheme pays’ in England, Wales and Northern Ireland the tax charge is compounded at a rate of CPI + 2.4% per annum from April 2019. This can increase the charge considerably over a number of years. However, it’s important to note that pension benefits within the Scheme are also compounded and if these increase at a faster rate than the ‘scheme pays’ charge, then there is some merit in using this for an option. The rules in Scotland are calculated differently, but the outcome is largely similar.
‘Scheme pays’ is likely to be a better option for those who are facing a one-off tax charge or older members where there is less time for the charge to compound. However, others may use this option if they don’t have available funds to pay the tax bill or if they have other financial priorities which mean they don’t want to release money for this purpose. It can also be a useful option for those impacted by the Lifetime Allowance as the tax charge is deducted prior to the Lifetime Allowance tax being calculated.
Working extra hours is not worth it
Doctors are turning down extra work because they believe they’ll end up paying as much, if not more, in tax charges than they’ll earn through the work. This is putting added pressure on the resources of the NHS.
It is understandable that doctors have this perception, as there are many instances where they are hit with extra tax charges through doing extra work, particularly if they are impacted by the tapered annual allowance. What compounds the problem is that the extra hours which doctors work count toward their income, for tapered annual allowance purposes, but are non-pensionable and so they get no pension benefit but may end up paying pension tax charges.
However, this isn’t a ‘one size fits all’ approach, as many doctors can work extra hours and won’t be punished with excessive pension tax charges. This is particularly the case for younger doctors and those with no private practice earnings.
Do your research and get the facts before taking action
The NHS Pension Scheme is generally excellent value; it provides valuable benefits which are guaranteed by the government and would be expensive to replicate with a private pension. The majority of scheme members should ignore all of the background noise and remain in the Pension Scheme.
However, for high earning medical professionals the pension tax rules can be complex and confusing and there are an increasing number of cases where making the wrong decisions could lead to them missing out on pension benefits or facing a significant tax charge. We can’t stress enough that one size does not fit all and each individual’s circumstances may result in a different outcome. It therefore makes sense for high earners, and those who have built up significant pension benefits, to take specialist independent financial advice before they make any decisions or take any action.