Joe Hawes, Chartered Financial Planner at CBW takes a closer look at the NHS pension and whether staying in the scheme is a smart move, given the successive restrictions introduced by the Government which are increasingly catching members off guard.
This article was written for, and first published in the May 2018 edition of The Dentist, a magazine publishing dentistry related news and updates.
Many NHS dentists find themselves in a similar predicament that stems from having accumulated substantial and valuable NHS pensions over many years of service. For these practitioners, it’s frequently unclear whether staying an active member of the NHS pension scheme is the right thing to do owing to changes to the lifetime allowance, cuts to the annual allowance and increases to the cost of contributions. Making the wrong decision or simply taking no action at all could potentially cost thousands of pounds over a lifetime.
When the lifetime allowance was first introduced in April 2006 it was £1.5m, rising steadily over several years to £1.8m. Successive cuts have seen this figure scaled back to £1m, but rising to 1.03m from 6 April 2018.
Due to the way final salary pensions are valued at retirement, an annual pension of around £43,500 will use up the entire lifetime allowance and an additional pension will lead to penal taxes. This is the figure for members of the 1995 NHS Pension scheme, which has a separate retirement lump sum accrual. For the 2008 and 2015 schemes, a pension of around £50,000 will use up the lifetime allowance.
The annual allowance was also introduced in 2006 and reached a maximum of £255,000 per tax year before being slashed to £50,000 and then to £40,000. The situation is worse for the highest earners as the standard allowance is now tapered away for individuals with an ‘adjusted income’ of more than £150,000. Therefore, dentists with income of £210,000 or more have a contribution limit of £10,000.
This calculation is fairly complex as it takes into account almost every form of income, such as private practice, investment income, bank interest and rents received; it’s not just NHS earnings. It also includes pension contributions made by employers. Overfunding will lead to a personal tax charge even if contributions are in fact paid by the NHS.
For the highest earners, the cost of contributions has risen to 14.5% of pensionable pay. Dentists with additional years contracts may be looking at paying almost a quarter of their earnings as pension contributions, which could compound the problems discussed above.
Making the most of your pension
It may still be possible to maintain a higher lifetime allowance, using the protection schemes introduced when the lifetime allowance was cut in 2016. It may also be possible to use ‘carry forward’ rules to set contributions in the current tax year against unused annual allowances from previous years. However, this rarely solves the overfunding problem entirely, which can lead to dentists considering exiting the NHS pension scheme.
We assume that reducing the amount of tax we pay will give us the best outcome, and whilst this is often true, it shouldn’t be assumed. As a general rule, dentists get better value from remaining active members of the NHS pension scheme in spite of the costs and taxes compared to consultant surgeons, for instance. This can be seen in the following scenario:
- Consultant surgeon, age 55, plans to retire at age 60
- Capitalised value of all pensions (NHS and private) over £1.2m
- Estimated ‘cost’ of active membership over five years (contributions, plus penalty taxes) £127,500. This is the cumulative, net amount of salary received if pension contributions ceased
- We estimate that the consultant surgeon would have to live 34 years in retirement before this amount was paid back via an increased retirement lump sum and additional annual pension.
Here, it would be advisable to defer membership of the NHS pension scheme, apply for individual protection to maintain a higher lifetime allowance and use the savings made to reduce the practitioner’s mortgage, which was identified as a further financial planning priority and the best value alternative investment.
- Dentist, age 58, plans to retire at age 60
- Capitalised value of pensions (NHS and private) over £1.4m
- Estimated ‘cost’ of active membership over two years (contributions, plus penalty taxes) £15,000. This is the cumulative, net amount of salary received if pension contributions ceased
- We estimate that the member would have to live five years in retirement before this amount is paid back via an increased retirement lump sum and additional annual pension.
In this instance, it would be advisable to remain an active member of the NHS pension scheme in spite of the costs of contributions and a potential lifetime allowance charge. Here, the dentist can apply for individual protection to maintain a higher lifetime allowance, and the pension will retain the ‘dynamising factors’, which up-rate benefits for active members at a faster rate than that which applies to deferred members.
Overfunding, which can lead to significant tax charges is a way of ‘losing’ your pension. However, underfunding and reaching retirement without making the most of the opportunities within the NHS pension scheme could also be argued to be ‘losing’ your pension.
Without a doubt, getting best value for your pension should take into account the following: expected annual pension at retirement age; annual allowance and lifetime allowance limits; affordability of contributions; and any other pensions in place to fund your retirement.
When deciding whether or not to remain an active member of the NHS pension scheme, dentists should look at the bigger picture. This can help to identify whether there are alternative uses for pension contributions, such as repaying debts or helping children through university or onto the housing ladder.
Only by taking all of these considerations into account can you be sure to have made the most of your pension.
To discuss your pension and for more information on how to plan for your retirement, contact the author, Joe Hawes, on the details below. You can also read more on CBW’s Financial Planning service here.