NHS Pension - The Basics

The NHS pension is often a mis-understood financial benefit that many employees generally just forget about. They know a lot of money gets taken from their payslips with the assumption they'll get it back later when they retire. I recently decided to look into it further so I thought it'd be useful for me to break it down as easily as I can.

First this to say is that the NHS pension is a defined-benefit (DB) scheme, not a defined-contribution (DC) scheme. What you pay in is not added to some pot of money; it's better thinking of it as a membership fee. There are two NHS pension schemes, the old 1995 final salary scheme and the newer 2015 Career Average Revalued Earnings scheme (CARE). I'll go over the 2015 scheme as it is applicable to most people now (and what I am mostly in).

The NHS pension is a guaranteed income for life upon retirement. It is index-linked, meaning that it will increase with inflation (Consumer Price Inflation) every year. This sort of scheme is rare these days and generally a very good deal for the vast majority of workers. 

What you contribute

What you pay towards the scheme is defined by your salary. Below is the employee contributions percentages taken from your pensionable pay. 

Your employer also contributes a whopping 20.68% to the scheme, though in reality it is 14.38% with the extra 6.3% being topped up by NHS England. However this could end at any moment, which would definitely affect a lot of GP practice's bottom line! 

If a 33-year old NHS worker earns £50,000 in pensionable pay, they will contribute 12.5% of that - £6,250 pre-tax in a year. The employer (and NHS England) will have contributed £10,340.

This is all pre-tax so it mean's you shouldn't notice it as much in your take home pay. As I said previously, you should think of the NHS pension like a membership, not like a pot of money which you will see why in a bit.

What you get

This depends on how much your pensionable pay is, how many years you contribute and inflation. It is best worked out with an example. 

The same NHS worker earns £50,000 of pensionable pay in their first year in the NHS. 1.85% (or more accurately 1/54) of this wage is added to what will be their NHS pension every year. Therefore after year 1, he will have added £925.26 to his NHS pension. 

At the start of year 2 of work, the value of their NHS pension (£925.26) is increased (or decreased) by the inflation (CPI) + 1.5%. Note that CPI can be negative but that is uncommon (last time was 2015 when it was -0.1%). Currently it sits at 0.3% - found here; of note, the government tries to keep CPI at 2%. So in this example we will keep CPI at 2%, which added to 1.5% will increase the pot by 3.5%. This turns it into £958.34. 

Now our NHS worker may get a pay rise!  We'll assume they will get a 1% increase year on year, very generous but given Covid spending, may actually be better than expected. Therefore in year 2, they will receive £50,500 in pensionable pay, and add £935.19 to their NHS pension. This gives a total of £1,893.52 in their pension pot.

This process of revaluing and adding to the pot is repeated for all years they are working and a member of the pension scheme. Below is the calculations for 35 years in the scheme. 

So the age of 68, they will have built up a retirement income of £70,999.56 yearly from the NHS pension when they retire. 

It is also possible to acquire a lump sum upon retirement, however it will eat into your annual pension. For every £12 you take as a lump sum, you remove £1 from your annual pension. You can only take out up to 25% of your capital value of your pension (which is your annual pension x 20), and also bare in mind there are tax implications if you are above your lifetime allowance. 

Some interesting things about these calculations. If assuming all the prior wage increases and inflation, by 35 years their annual pension is worth more than what they are earning after 35 years in the same job, maybe they should have asked for a larger pay-rise earlier 😂. Also not noted is the annual allowance and lifetime allowance (in which they breach) but will go over in a follow up post. I think I will look into creating an app that will help display this information better. 

When can you claim it?

The state pension age currently is currently 66. This is the age in which you can claim your state pension. The NHS pension is linked to this age as well. This is set to rise to 67 between 2026 and 2028 and to 68 between 2044 and 2046 (and possibly higher still after). It is possible to retire to claim the pension earlier but there are reductions to the amount you would receive (as you would be taking it for more years). Below is the percentage reduction of your accrued pension you would get by taking it early.

Also consider that taking it early means less years accrued. So in our example, by taking it 13 years early means an accrued pension of £32,844.29. A 46% reduction of that brings it down to £18,392.80, quite a steep hit - but you do get the money sooner. 

It is worth it?

In our example, the NHS worker ends with a pre-tax pension of £70,999.56. You still pay income tax on pension, but do not pay national insurance. Additionally the pension amount will increase with CPI every year to keep with inflation. 

In total, they contributed £260,376.72 pre-tax over the course of their 35 year career. Now as long as they live for at least 4 more years, they will have made back their money. With an average life span of 81 years in the UK at time of writing, they'll have 13 years of pension payments, meaning that our doctor will have been paid over £900,000 from the NHS pension scheme. Not a bad investment. 

How is it funded? It's pretty much like a Ponzi scheme. Clearly you wont have contributed enough for all the years you'll be paid. The members and their employers who are current members, will be the ones paying your pension. This is one of the reasons why they started reducing the annual and lifetime allowance as the government started to realise that potentially this model couldn't last forever with such massive pensions. I'll go over those issues in a follow up post, along with some other points about the NHS pension such as death and illness benefits. 

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