NHS pension vs private pension – how do they compare?

How do you decide whether paying into the NHS pension or a different pension is going to be better for providing a retirement income? Pensions expert Alec Collie explains the main features of both and how they compare

A common question that I frequently receive is: ‘What’s better – the NHS Pension Scheme (NHSPS) or a private pension?’

Often, doctors and other general practice staff are thinking about leaving the NHSPS in favour of a private arrangement.

However, the NHSPS is one of the best pension schemes on offer in the UK in terms of benefits and guaranteed private income. There are very few circumstances that would make leaving it a recommended course of action – indeed, from my 30 years of providing financial advice, I can count on one hand the number of times this has happened. 

To understand why it’s so valuable for NHS practice staff and what it offers, let’s explore its features and the important things to keep in mind when weighing up the NHSPS against a private option.

The NHS Pension Scheme 

This scheme is a defined benefit scheme. This means the scheme promises to pay an income, guaranteed by the government, on retirement.  

The NHSPS comes with a variety of benefits including an ill-health retirement pension, a spouse’s pension and a dependants’ pension should you pass away before you reach retirement age. These benefits are attractive as they provide scheme members and their families with various forms of safety nets, which simply are not available within a private pension.

Pension build-up and contribution rates

Every member of the NHSPS is now in the 2015 Scheme – known as the ‘reformed’ scheme.

The way that the pension works is that, as an active member, 1/54^th of your eligible income is added to your pension pot each year. So, if you were to earn £100,000 of NHS income in your first year as a member, your pot – which is the amount you’d get each year in retirement – would be £1,851.85.

Your pension pot is then ‘revalued’ in line with the CPI measure of inflation each year.  Note that this example is for illustrative purposes only – what a member ‘earns’ is likely to be a combination of ‘pensionable’ (i.e. eligible to be counted towards your pension) and non-pensionable earnings.

What’s the cost to you? Well, the details vary depending on if you work in general practice or hospitals, and whether you are employed or self-employed.

Generally speaking, however, you make an annual contribution that’s based upon a percentage of how much you earn. Sticking with the example above, if you earned £100,000, you would pay approximately £12,500 towards the scheme.

If you look at this in very simple terms and don’t include tax relief on the contribution cost, you can see what exceptional value the NHSPS provides.

Simply taking the £1,851.85 pension earned and dividing it into the cost of that year’s £12,500 contribution tells you, in simple terms, that after seven years of retirement the pension contribution has more than been recouped by the contribution you paid in.

Most GPs, practice managers and staff retiring today would have aspirations of a much longer retirement than this time span. This is one of the reasons the NHSPS is held in such high regard.

The reality is even more beneficial as, due to inflation linking, it will take even less time to recoup the contribution cost as, by the time you retire, the £1,851.85 pension payment will have increased with inflation, and will continue to do so post-retirement.

Now, you may have some service in the ‘legacy’ 1995 scheme or 2008 section. Both of those schemes have very different features or benefits. For example, the 1995 scheme accrues 1/80^th of your final salary for every year or pensionable service, plus a lump sum of three times your pension.

The 2008 section accrues at 1/60^th of your final salary for every year of pensionable service with no automatic lump sum. The final salary year also has some averaging applied, so ask your financial adviser to do some bespoke calculations. You can also find out lots of information on the NHS pension websites of the four UK nations (see further resources below). 

Private pensions 

A private pension is a defined contribution pension – this means that you build up a pot of money which can be used to provide an income in retirement.  

The only element to this type of pension that is controlled is how much you pay into it. This would be an amount that’s affordable to you – this could be monthly, quarterly, half yearly, in lump sum payments or whenever you can afford to do so.

The funds from private pensions can be put into investment funds of varying risk levels based upon your risk profile. How much you get back in the future depends on how much you paid into the pension and how the investments perform, meaning there is less certainty compared with  the income you’re guaranteed from the NHSPS.

When you retire, instead of having a set amount of income per year, you would have a set fund value. This could be better described as a savings pot worth a set amount of money.

Withdrawal options

Once you reach retirement age, you have several options as to how you choose to use this capital to support you.

You can ‘buy’ a pension by purchasing something called an ‘annuity’. There are many different options available with the income you receive depending on what you include in the policy, and your age and health stats. As a general rule, you will get a 4% return for every £100,000 invested in an annuity.

The second option is taking ad hoc from your pension. You can take your 25% lump sum, although limits apply, and the rest out as taxable withdrawals – this is called flexible access drawdown (FAD).

Or, you can take partial withdrawals where a percentage is tax free and a percentage is taxable. Your individual circumstances will determine what’s best for you.

The most popular option tends to be FAD. If you had a pot of £500,000 you could withdraw it all in the first year if you wished to do so. This is not necessarily a sensible strategy, but it is possible. 

What is more likely, as part of good financial planning, would be to choose to withdraw a sustainable percentage of the funds every year, for example, around 4% per year.  This means that the value you withdraw each year – the 4% – would hopefully be almost fully replaced by investment growth. The aim of withdrawing a sustainable amount is to try to ensure that your pot lives for as long as you do with minimal year-on-year depletion.

The flexibility of private pensions can be advantageous for tax planning, particularly when the state pension kicks in. At that point, many people choose to reduce their income withdrawals from their FAD because their overall income is higher.

However, remember that you will never get the same level of guaranteed, CPI-linked pension with spousal protections for the same or similar cost with a personal pension as with the NHSPS.

Using the example above, if you wanted a pension of £1,851 per year, you would have to contribute around £60,000 to a personal pension (based roughly on a 3% annuity rate, including 50% spousal pension) – significantly more than the £12,500 you’d have to contribute to get the same in the NHSPS.  

The only point on which personal pensions have an advantage over the NHSPS is that a private pension is inheritable when you die. There are different ways and tax implications of passing on your unspent pension, but one of the most popular currently is to assign your leftover funds to your children, where – depending on your age and pension situation at time of death – they can benefit from either a lump sum or a regular income from your pension plan.

So, which one should you choose?

Both the NHSPS and private pensions are very different means of getting to the same end point, which is income security in retirement. And it’s entirely possible to hold both, although annual contribution limits apply.

However, the NHS Pension Scheme offers exceptional value and should be the primary consideration if you’re working in the NHS and looking to build income for the future.

If you can’t, or don’t want to, direct your income towards being a member of the NHSPS, or if you want to also benefit from a private pension, you should consider seeking professional advice from a financial adviser. If a financial adviser were to recommend you stop contributions into your NHS scheme in favour of a personal pension, I’d always suggest you also get a second opinion.

Before you make any pension decision, it’s essential that you fully understand what any course of action could mean for you and your retirement options.

Bear in mind that the value of investments can go down as well as up and you may get back less than you invest. And please note: tax treatment depends on individual circumstances and may be subject to change in future.

Alec Collie is head of medical at Wesleyan, the specialist financial mutual for doctors