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Are Doctors in the NHS pension scheme misdiagnosing their pension?

22 April 2019

The press is having a minor epidemic of commentary about doctors retiring early to avoid Lifetime Allowance (LTA) and/or Annual Allowance (AA) charges but, what’s of concern is whether they are diagnosing the problem correctly, says the Prudential technical team.

Nobody likes paying more tax and it’s a bitter pill to swallow, but if the net result is you are richer is this not a good thing? It may seem nonsensical, but it probably seemed nonsensical the first time that the rat poison warfarin was used to make humans healthier??

The value of the scheme should not be underestimated, looking at those starting out in their careers let’s compare what they would get in the career average scheme compared to a money purchase scheme.

Looking at the BMA website junior doctors in England in Foundation Doctor year one will have a starting salary of £27,146, based on that salary their contribution to the scheme is 9.3% (£2,524.58 gross). For a basic rate taxpayer that costs them £2,019.66 a year / £168.31 a month.

The Patient

The 2015 NHS career average scheme builds up 1/ 54th of pensionable earnings per annum. So broadly speaking (ignoring the CPI increases etc to keep the maths simple for this article) in year one they build up an annual pension of £502.70 per annum. So, for a net cost of £2,019.66 in year one, they have a pension of £502.70, so 24.89% of their contribution as an income?

How would than income compare to a DC scheme? Well assuming a 3% annuity rate (bearing in mind that the income from the NHS scheme is index linked in retirement) to purchase an income of £502.70 per annum would cost £16,757. So, in year one, they have benefits equivalent to £216,757 in the DC world for a cost of £2,019.66?

Full Diagnosis

Perhaps this comparison is a bit simplistic, as the DC pot will (hopefully) increase by more than inflation. The career average pension built up would increase by Treasury Orders plus 1.5%, so if the Treasury Order was 2% the increase would be 3.5%. But increasing the £502.70 built up in year one 40 years from now, the income would be £1,990.32. Assuming a 3% annuity rate (which may or not be the rate for an increasing income in 40 years’ time) you need a fund of £66,344 to purchase that guaranteed income. So let’s assume that the DC equivalent pension increases by 4% after charges, you’d need a fund in year one of £13,819. That’s 6.84 times the net cost to be in the career average scheme.

Taking this to the nth degree and being ridiculous, to highlight the value of the scheme we’ll assume the doctor is 65 so that benefits can be taken immediately. We’ll also set the LTA and AA at £0. Assuming DC benefits of £13,819 have an AA charge on additional rate (45%) THEN a LTA charge of 25% (assuming the LTA excess is designated to provide income as per the NHS scheme) that would leave £5,700 of a fund. That fund could provide an income of £171 per annum based on the 3% annuity rate.

If the NHS income of £502.70 were all an excess for AA purposes, the value of this is multiplied by 16 giving you an AA usage of £8,043.20, the tax charge on this (assuming additional rate) would be £3,619.44. The scheme would reduce the starting pension by an actuarial factor of 17.3:1 giving a starting pension of £293.48. So this £293.48 is also a LTA excess, but we have to do the LTA valuation of 20 times the starting pension to work out the chargeable amount, which is £5,869.60, charged at 25%  this gives a LTA charge of £1,467.40. If we then apply the LTA actuarial reduction of 18.21 : 1 to this your income after AA and LTA charges is £212.90.

The treatment/prescription (cont)

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