NHS Pension

This is a topic that I have been meaning to learn about for the longest and finally we are here. So let's get into it straight away.

NHS pension is one of the largest and most generous pension scheme in Europe. There are about 3.4 million people are in the NHS scheme. However due to the complex nature of the scheme and the benefit, most people does not really know that much about how it works other than it is government backed and certainly one of the most generous pension scheme out there.

I have tried to find answers and explanation to understand this for some time with actually getting more confused every time I read something or watch a video and eventually getting bored or frustrated and leaving the research for later date.

Finally I believe i have something concrete and have enough knowledge about it write it in a palatable way.

I opted out of pension in 2019 after few months in the NHS mainly due to one factor and that is retirement age. I did not want to retire age 68. I know I might work until 68 anyway but I wanted to have the flexibility.

But I was aware that if I cant take this big decision with just considering one factor. I might be ignoring a lots of facts and loosing a lot of value and opportunity. Specially because every financial advisor suggest to opt in due to the generous benefit and return it provides.

However in finance there is no ''One size fits all'' So I knew I had learn more. I decided that I might end up finding that everyone was right and NHS pension is best suited for me anyway. But there is no loss in learning and whats a year or two ( It turns out year or two is vital. Lol. Will talk about it later)

Anyway , so I decided to finish my training and opt in if I find out that NHS pension is best suited for my circumstances or it might be that in this case ''One size fits all is true'' but I gave myself some time. Also after joining NHS, slowly lifestyle creeped up and the 10% seemed a lot at the time. So for me there was no confusion at the time. now few years down the line I think I have managed to accumulate all the information I need for me or anybody for that matter to make an informed choice rather than just automatically enrolled in or opt out because someone said so.

Let's start , shall we?

What is NHS pension?

This is a pension scheme for NHS employees.

It is different than traditional pension. It's called defined benefit scheme. Which means that depending on your contribution amount and year you have contributed, you get a defined or guaranteed fixed income for the rest of your life.

Income for life is the key wards here to understand.

For instance: if your pension is £50k annually( see calculation section to know how this is calculated) . This will be the case for the rest of your life. If you happen to live 50 years after retirement. NHS pension would pay you 50 grand a year for 50 years. This is also true if you sadly pass away just 2 years after pension.

It is actually payable as long as you are alive. It does not run out. Unlike traditional pension where you have a certain amount accumulated over the years and you take what you need out of it but you may run out.

NHS scheme is technically an insurance called Annuity where you buy the insurance for an annual income for the rest of your from retirement in exchange for contribution when you work.

Which scheme am I in?

With different changes over time, there are 3 NHS pension scheme depending on when you started contributing. 1995, 2008 and most recent 2015.

However from 1st April 2022 everyone in the scheme has automatically be contributing the the new 2015 NHS pension scheme. So we will only be discussed based on NHS pension scheme 2015

From 1 April 2022, all new and active members of the NHS Pension Scheme are members of the 2015 Scheme

When can I start taking my pension out?

This is probably the most important information for many. We all want to when can we take our money out and enjoy the sunshine in Bahamas or a hot coffee in Patagonia.

The age of retirement used to be fixed i.e: 60 years in previous schemes but unfortunately from 2015 scheme, this is now linked with state pension age. Meaning you retirement age is not fixed and may change in the future along with the state pension age. State pension age the age when government start to pay you the ''state pension'' if you contributed to national insurance for certain years . (See the pension topic for detail)

So when can I retire? Currently its 66 years but will be 67 from 2026 and 68 years from 2044. So people who have 20 years more to retire will have the retirement age of 68 years.

As the FIRE (Financially independent retire early ) movement getting more and more traction another popular question is can we retire early from NHS pension. Answer is yes but with a cost. Check the early retirement section for detail after the breakdown of the income to make the most sense of it.

How does it work?

You contribute a percentage of your income through out your carer and when you retire you get a Fixed annual salary for the rest of your life.

How much do I have to contribute?

Following is the percentage that you need to contribute to your NHS pension. This is pre tax. So if you have an annual gross salary of £60k, you will contribute 12.5% of £60k to your NHS pension. Thats £7.5K per year or £625 per month.

What is my pension/retirement age:

How much pension I will have after retirement?

NHS pension does not technically have a pension pot. You are essentially buying an insurance with contribution over the years that guarantees an annual salary. So the actual pension pot is pointless and somewhat vague, but important figure would be your annual pension and we can calculate how much pension you are going to get annually after retirement.

How my NHS pension is calculated?

We just first need to know the factors affecting the pension amount.

1. Salary: |As you contribute a percentage of your salary, the higher your salary, the more you will get in your pension.

2. Years contributed: Duration of contribution is one of the important factors for compounding effect. The longer you contribute the higher your pension income/salary would be.

3. CPI: Consumer personal index AKA Inflation . One of the best feature of NHS pension is that it is inflation protected. That means if the inflation skyrockets, you pension return would go up along with that as well.

   
   

Generally speaking, You annual salary after pension is 1/54th of your in service salary which will increase every year by factor of CPI plus 1.5%. I know. What does that even mean ? please check out the examples and the extendable paragraph ''Nerdy bit''   for more detailed breakdown.

Example 1:

You have worked in NHS for 20 years and your salary was static through out these years at £70k annually.

In this scenario, Your NHS pension after retirement would be roughly about £33704 per year before tax.

You can take a lump sum of 25% tax free, if you do that lump sum would be £193k but this will then reduce your annual allowance to £25270 per year.

So if you are in NHS for 20 years earning about £70k annually , you will end out with £25k- £33k annual salary for the rest of your life if you retire aged 68 or after.

Nerdy bit/Breakdown

A simple breakdown of this calculation can be done three steps:

Accrued pension:You annual pension is 1/54th of your annual salary while working.  

As your salary is 70K, if you contributed for just 1 year , your annual pension after retirement (Age 68) would be 70K/54= 1296 per year for the rest of your life.

So If you contribute for 20 years , you will get 20 x 1296= approximately £25920 per year for the rest of your life.

This is called your accrued pension.

So just with your contribution, your annual pension after retirement would be £25960 per year.

Revaluation: 

But thats not all. As NHS pension is is inflation protected, Your annual contribution gets revalued by a factor of Inflation (CPI)* +1.5%. *(Consumer price index)

What does that mean? That means, year by year your accrued income would be reevaluated by the inflation plus 1.5 %.

Last 20 years average CPI has been about 2.5% this year until July it has been 2.2%. For the sake of this example, let’s assume that the CPI is 2% each year on average for next 20 years. So total revaluation factor is 3.5%

1. Year 1 (Initial Accrual):

   - Pension earned: £1,296.30

   - End of Year 1 revaluation: £1,296.30 x 3.5%= £1,341.67

2. Year 2:

   - Pension earned for Year 2: £1,296.30

   - Revalue Year 1 accrual: £1,341.67x 3.5% = £1,388.62

   - Total accrued pension by end of Year 2: £1,388.62 (Year 1) + £1,296.30 (Year 2) = £2,684.92

This process would continue each year.

After 20 years, you'd revalue each year's accrual and sum them up to get the total pension accrued.

3. Final sum up: Simplified Accrual After 20 Years

You'd have the pension accrued in Year 1 revalued 19 times, the pension accrued in Year 2 revalued 18 times, and so on.

So the total pension accrued by the end of Year 20 would be approximately in the range of £34,000 to £36,000 per year.

This might raise more question than answer it. Just check the ''Nerdy bit''  Section and that should answer all the question.

Example 2:

Lets look a more realistic number :

Say you have started contributing in NHS pension age 30.

Lets say your salary Progression is a follows:

1. Age 30-33 (4 years): £50,000 per year as Foundation year 2 and SHO/Core/speciality trainee year 1-3

2. Age 34-37 (4 years): £72,000 per years as registrar (On average)

3. Age 38-67 (21 years): £115,000 per year as consultant. I know this will go up after few years but let's keep it simple for ease of understanding.

-Total Pension Pot (Estimated): £2,475,720 that's £2.47 million

- Maximum Lump Sum (Optional): £322,920

-If you don't take any lump sum amount then your annual pension: £107640

- Remaining Annual Pension After Taking Lump Sum: £80,730 

''Nerdy bit''

Lets breakdown the pension income of example 2.

Step 1: Calculate the Total Annual Pension at Age 68

Salary Progression:

1. Age 30-33 (4 years): £50,000 per year

2. Age 34-37 (4 years): £72,000 per year

3. Age 38-67 (21 years): £115,000 per year

Annual Pension Accrued (Using 1/54th Accrual Rate)

- Age 30-33: \(4 \times \frac{£50,000}{54} = £3,703.70\)

- Age 34-37: \(4 \times \frac{£72,000}{54} = £5,333.33\)

- Age 38-67: \(21 \times \frac{£115,000}{54} = £44,722.22\)

Revaluation (Assume Average 3% Revaluation Per Year)

The revaluation of the pension amounts is crucial to estimate the total pension at age 68. We revalue each accrued pension annually by 3% until retirement at 68.

- Revalued Pension from Age 30-33: Approx. £10,640

- Revalued Pension from Age 34-37: Approx. £14,040

- Revalued Pension from Age 38-67: Approx. £82,960

Total Annual Pension at Age 68:

- Total Annual Pension: £10,640 + £14,040 + £82,960 = £107,640

Determine the Total Pension Pot

A rough estimate of the pension pot can be found by multiplying the annual pension by a factor that accounts for life expectancy and interest rates.

Let's use a factor of 23:

Estimated Pension Pot: £107,640 × 23 = £2,475,720

Calculate the Lump Sum

In the 2015 NHS Pension Scheme, members can choose to exchange up to 25% of their annual pension for a lump sum at a commutation rate of 12:1.

Maximum Amount to Exchange: £107,640 × 25% = £26,910

Lump Sum: £26,910 × 12 = £322,920

Summary

- Total Pension Pot (Estimated): £2,475,720

- Maximum Lump Sum (Optional): £322,920

- Remaining Annual Pension After Taking Lump Sum: £80,730

These estimates assuming constant revaluation rates and average life expectancy however this should be tailored to individual circumstances with professional advice.

So in a nutshell you pay ab0out 10% of your salary as doctor throughout the years and in return you can get a very decent salary of £80k to £100k for the rest of your life assuming your worked around 38 years and retired after 68.

That is a great income after retirement by any stress and great secure return for the money you put in .

So what is the catch ? why not everyone is in the NHS pension?

Whats the catch? Factors contributing for people to opt out.

Obviously not everyone is not in the NHS pension. Although the exact number of people who are not in the scheme is not published but in 2011 and 2022 almost 500 people opted out of the pension everyday. This is double than recent previous years.

There must be some issues that forcing people to not consider it or opt out. I think the following 3 are main issues.

Low income:

Junior doctors , nurses ,HCA does not get a great salary. Paying 10 % of that tight income can be hard for many specially for single earner with a family of 3 more. So many prematurely opt out to consider it late or just simple cant afford it.

Retirement age.

The crucial factor many is the retirement age. 68 is just too late for many. There are two issue with this , one is that most people does not want to work full time until that late. Although most end up doing it any way. You can retire early and take your pension out but there is a hefty amount to pay for that. Will discuss ''early retirement '' in the next section.

However the other important factor to consider is that if you live up to 80, you are going to get pension for 12 years which in total is about £960-1.4 mil of life time income . Considering the amount invested over these years, this might not be a good return for many, off course if you say live up to 95 that works out pretty amazing.

But wait can I not pass my pension pot to my children or to my spouse when I die? Answer is unfortunately No and yes and this also brings the 3rd factor , inheritance.

Inheritance of NHS pension:

From what I gather most people are not fully aware of the actual rule for inheritance of NHS pension. Although your family will get a lump sum after you pass away depending the time elapsed from retirement, As discussed before there is no pension pot as such like traditional pension so this can not be passed to your family.

However your civil partner and children will get a portion of Dependents' Pension

You wife or dependent children ( You have to nominate this beneficiary) might also be eligible for a lump sum.

Lumpsum:

This can vary depending on several factors, such as whether you die in service (while still working) or after retirement.

1. Death in Service

If you die while still an active member of the NHS Pension Scheme and working,

The lump sum is usually 2 times your annual pensionable pay at the time of your death.

Fot example:

If you are earning £70,000 per year, the lump sum would be:

£70,000 x 2 = £140,000

2. Death After Retirement

If you die within 5 years of retirement:

The lump sum is calculated as the balance of 5 years' worth of pension payments minus what has already been paid to you.For example:

Suppose your annual pension is £70,000.

5 years of pension payments would be: £70000 x 5 = £350000

If you’ve already received 3 years' worth of pension before your death:

Total received: £70000 x 3 = £210000

So total Lump sum: £350000 - £210,000 = £140000

If you die more than 5 years after retirement:

No lump sum is usually payable, as you've already received more than 5 years' worth of pension payments.

Death After Leaving the NHS but Before Retirement

If you leave the NHS and defer (postpone) your pension and then die before starting to receive it, the lump sum death benefit is usually 2.25 times the deferred pension.

Time of death	Lump sum amount received by dependent
While working	2 times annual salary
Within 5 years of retirement	Total pension in 5 years -Pension already received
After 5 years of retirement	No lump sum
Death After Leaving the NHS but Before Retirement	2.25 times deferred annual pension

Pension:

You Spouse or Civil Partner will receive a pension. You dependent child will receive a portion of pension as well if they are or up to 23 years of age or dependent due to disability or other causes.

The following is the way to calculate it.

If you die while in service or :

Your spouse or civil partner would receive 33.75% of the pension annually if you had retired on ill health grounds at the time of your death. (This is not much , so please check the ill health retirement section in early retirement)

If you die after retirement:

Your spouse or civil partner generally receives 33.75% of the pension you were receiving at the time of your death.

For example:

Assuming your pension is £34000 per year:

Spouse/Civil Partner Pension:

33.75% of £34,000 = £11,475 per year. This would be £23625 if your pension is about £70K

So your spouse will get £11,475 per year on a £34k pension. This would be £23625 if your pension is about £70K.

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Children: Only up to age 23 or fully dependent:

Underaged or dependent children would receive 16.875% of your pension. i.e: £5737.50 for £34K pension about £11k for a pension of £70k per year

Because for most, children will be >23 years while you are retired, they will not be eligible for it but in case of early death or disable or under aged child following is the calculation with example:

Pension for Dependent Children:

The amount depends on the number of eligible children:

One child:

They would receive 16.875% of your pension

Two or more children:

Together, they would receive a total of 33.75% of your pension (split equally among the children).

For example

If you have one child and your pension is £34,000 per year

One Child’s Pension:

16.875% of £34,000 = £5,737.50 per year

If you have two or more children:

Total Pension for Children:

3.75% of £34,000 = £11,475 per year, split equally among the children.

Can I retire early from NHS pension?

Yes, You can retire early but might have to pay a hefty penalty .

It depends on how early from your Normal pension age (State pension age) you are taking your pension out. The following chart explains how to calculate that.

As the Pension age is 68, if you want to retire at age 60, You will receive 34% less pension.

For example if your usual pension would have been £70K at 68 but you decide to retire at 60, your pension reduced to £46000. If you want to retire at private pension pension age which is usually 10 years earlier than state pension age, this would go down even further to 42%.

If you decide to retire at 58 instead of 68 from NHS pension , you will loose 40 % of your pension as early retirement penalty.

This is one of the reason many people opt in for private pension as the retirement is currently 55 and projected to be 58 in 2044.

Will talk about SIPP(self invested private pension in detail in another blog. Please ask any question and I will try to answer them.

I will add a FAQ at the end of this post as well.