What’s the prognosis for the NHS pension?

NHS employees are rewarded with one of the country’s most generous pensions. Here’s your guide to the scheme – its benefits and flaws

The NHS pension scheme has more than three million members and is the second-largest public sector pension scheme. How it operates has implications for all of us. Quirks in its rules mean some doctors and surgeons have been stopping work because they are disincentivised to continue working.

How does the scheme work?

The NHS pension is made up of two schemes – the 1995/2008 scheme, which as the name suggests is made up of two sections; and the 2015 scheme. Both are defined benefit schemes, giving members a known amount regardless of what’s paid in, but the terms and conditions vary.

Most people in the NHS, plus anyone joining the organisation, are members of the 2015 scheme. Rather than being a final salary scheme, where your pension is based on your potentially higher earnings at the end of your working life, this is a career average revalued earnings (CARE) scheme.

This means that each year a proportion of your pensionable pay – in this case, 1/54th – goes into your pension. As well as this, everything in your pension is revalued each year until you retire or leave, the rate for this revaluation determined by Treasury Orders plus 1.5%. Andrea Sproates, head of specialist adviser Chase de Vere Medical, says: “This is roughly the Consumer Prices Index plus 1.5%, which does equal good value for members.”

Membership of the scheme also entitles you to an adult dependant’s pension (including spouse or civil partner), set at 33.75% of your pension if you die first. Life insurance is included too, with the amount paid typically two times your salary, though this is dependent on pension scheme membership status.

How much you have to pay into your pension is dependent on your earnings. Contribution rates start at 5% for anyone earning up to £15,432 a year, and rise steadily to 14.5% for employees who are earning more than £111,377.

Benefits are payable at state pension age but you can take them from age 55 in exchange for a reduction to your annual income.

You can also take a tax-free lump sum of up to 25% of the value of your pension at retirement, swapping £1 of pension income for £12 upfront.

The scheme is unfunded, with the government being the ultimate backstop if there isn’t enough money in the fund to pay pensions.

However, to ensure the right level of funding, NHS employers contribute a chunky 20.68% to the scheme too.

Should I join the scheme?

NHS employees are automatically enrolled in their pension but, although it’s one of the most generous schemes around, plenty of people choose to opt out. According to the Health Service Journal, 245,561 workers have opted out over the past three years, equivalent to around 16% of the active membership of the scheme.

These figures are much higher than other public service schemes, with just 3.4% of teachers, 1.45% of civil servants and 0.04% of the armed forces ducking out of their pensions.

“Some of those opting out are senior consultants who have reached the limit on tax relief, but the most common age group are those aged 26 to 35,” says Steve Webb, director of policy at Royal London. “I can understand why they might want to opt out but with their employer contributing to their pension at 20.63%, what they’re doing is tantamount to turning down free money.”

According to his calculations, an NHS worker earning £25,000 would save themselves £1,420 a year by opting out. But replacing the pension they’d forfeited would cost them £13,000.

“Anyone opting out is giving up a pension worth around nine times what they save,” he adds.

While the economic argument highlights the value of staying in the scheme, Andrea Sproates, head of Chase de Vere Medical, accepts that it’s something that happens, especially where money’s tight or someone doesn’t plan to have a long NHS career. “If you leave within two years you can get your contributions back, minus any tax relief,” she says. “You could also leave it to build up until you retire, in which case it will be increased in line with inflation.”

For those struggling to make ends meet, Mr Webb says the same proposals put forward to solve the tax issues of high earners could be beneficial to those on lower incomes. “The 50/50 option, where they’re able to reduce their contribution in exchange for a lower pension entitlement, could help them too,” he explains.

An opt-out calculator is available on the NHS Business Services Authority website (nhsbsa.nhs.uk/member-hub/leaving-or-taking-break-scheme) to highlight the financial implications of not joining the pension scheme.

Scheme changes

Although it’s still a generous scheme, the pension has seen changes in recent years that have reduced its benefits. Mrs Sproates says the changes reflect improvements in life expectancy. “People are living longer, which makes defined benefit pension schemes more expensive,” she explains. “It has to be sustainable.”

As well as changes to the rate at which benefits are accrued, one of the biggest shifts has been in the earnings the pension is based on. This has moved from the best of the past three years’ pensionable pay, to the average of the best three consecutive years in the final 10 years, to today’s career average revalued approach. This is fine for those on relatively stable salaries but penalises those whose earnings increase significantly during their NHS career.

Similarly, while the earlier pensions included a lump sum at retirement, this is now only available providing it’s exchanged for a portion of their pension income.

Another significant change is to the retirement age. This has increased, stepping up from 60 on the 1995 scheme, to 65 in the 2008 scheme, and now to the state pension age on the 2015 one.

What are its flaws?

Some members of the NHS pension scheme are facing more pressing issues too, particularly those with higher earnings. As well as having to be mindful of the lifetime allowance (£1.055 million in the 2019/20 tax year) and the annual allowance (£40,000), the introduction of the tapered annual allowance in 2016/17 can present them with additional headaches.

“The tapered annual allowance is designed to reduce the tax relief available to high earners on their pension contributions,” explains Jon Greer, head of retirement policy at Quilter. “Where someone has sufficient income, it can reduce the annual allowance to just £10,000 and result in an unexpected tax bill.”

Working out whether you’re affected isn’t particularly straightforward either, with the taper triggered only when you meet two conditions. First, your threshold income, which is your total income from all sources including investments and property, but minus your pension contributions, must exceed £110,000. In addition to this, your adjusted income, which is your total income plus the real growth in pension rights over the tax year, must be more than £150,000.

“Once you meet both conditions, you’ll start to lose your £40,000 annual allowance at the rate of £1 for every £2 of adjusted income over £150,000,” explains Mr Greer. “If your adjusted income is £210,000, you’ll be at the lowest level, with an annual allowance of just £10,000.”

Calculating how much your annual allowance will reduce can be frustrating if you have a set salary, but it’s an almost impossible task for those whose earnings fluctuate.

“Working an extra shift to cover a colleague or to help a trust meet waiting list targets can inadvertently push someone over the threshold income,” explains Bhargaw Buddhedev, a partner at Barnett Waddingham. “Then, if the value of that year’s pension rights is sufficient, they could find themselves caught by the tapered annual allowance. It could mean a tax bill of as much as the income they received from the extra shift.”

Furthermore, while some NHS high earners have been hit by the taper in the past, the situation is likely to come to a head this year.

Steve Webb, director of policy at Royal London, says: “High earners have been able to carry forward previous years’ unused annual allowances to dampen the effect of the taper. This year, though, carry-forward will only extend to 2016/17, when the taper was introduced. This will reduce the number of people with significant amounts of available unused annual allowance.”

I don’t work for the NHS, so why does their pension matter to me?

Whether or not you’re sympathetic with the pension plight of NHS high earners, their tax treatment could affect your health and wellbeing. In July an increase in waiting lists of as much as 50% in some parts of the country were blamed on the ongoing pensions row.

“Doctors are questioning whether it’s worth doing extra hours because they can be so heavily penalised,” says Jon Greer, head of retirement policy at Quilter. “Ultimately, this will affect the service you receive from the NHS.”

Steve Webb, head of policy at Royal London, says it also means consultants are passing their lists down to their juniors to avoid a tax bill. “Consultants are having to spend more time talking about pensions than patients,” he explains. “This isn’t right.”

The British Medical Association is also warning that pension problems today could affect the NHS of tomorrow, as the training and mentoring of junior doctors is at risk due to consultants cutting back on their hours.

What’s more, even if you’re not waiting for surgery, these pension issues could make seeing a GP more difficult too. A recent survey by medical website Pulse found that 138 GP surgeries closed in 2018, up from just 18 in 2013. While other factors will also be driving this exodus, government figures show that 57% of the GPs who retired in 2018/19 took early retirement, with many of them citing the pension tax charges as one of the reasons.

Why are some people getting hefty tax bills?

Getting caught out by the taper can mean a chunky tax bill. As an example, Gary Smith, chartered financial planner at Tilney Financial Planning, points to a GP with an income of £220,000 who has seen her annual allowance tapered down to £10,000.

“Her pension contributions for the year were £50,000, representing an excess of £40,000,” he explains. “This is added on top of her other income, generating a tax bill of £18,000 (£40,000 x 45%), of which £13,500 results from the tapered annual allowance.”

Unsurprisingly, doctors are using a number of strategies to avoid the taper. Opting in and out of the scheme is one option.

“We’re seeing doctors opting into the pension scheme for a few months a year to build up some pension and retain their rights in the older schemes. These can be lost if they opt out for five years or more,” explains Mr Smith.

As well as being difficult to judge, this ‘hokey-cokey’ approach can also mean they lose their entitlement to life insurance when they’re out of the scheme.

Others take a more drastic approach, turning down extra shifts, retiring early or leaving the NHS altogether.

Even paying the tax bill presents choices. Rather than settle the bill there and then, an NHS employee can use Scheme Pays. This is a facility on the NHS pension, allowing members to borrow the money against their future pension entitlement, with interest charged on the advance.

Deciding which is best isn’t that simple either. Mr Greer says that on the one hand, Scheme Pays will reduce a future pension but, on the other, it could prevent your pension breaching the lifetime allowance. “There’s no one-size-fits-all solution,” he adds.

How will it be fixed?

With doctors downing their stethoscopes, the government is taking steps to address the taper issue. In June, it proposed a 50/50 option, which would allow doctors to halve their pension contributions in exchange for halving the rate of pension growth.

Although more detail is required, a 50/50 option is already in place on the Local Government Pension Scheme. Mr Buddhedev isn’t convinced it will solve the problems of the NHS pension. “With the local government scheme, the benefits are so good that most people are better off taking 100% and paying the tax,” he explains. “As each person’s situation is different, it will only bring further complexity to the NHS scheme.”

The British Medical Association is equally sceptical.

As well as resulting in a lower pension, it also believes that, without any financial incentive to compensate for the lost employers’ contribution, doctors will still feel reluctant to take on extra work.

As Moneywise went to press the government also announced it would review the annual allowance taper for doctors. However, critics were quick to state it would be difficult to implement changes based on individuals’ choice of careers.

Mr Webb says: “ This problem is not unique to the NHS, nor even just to the public sector, so any review must be comprehensive and cover everyone.”