Campaigners should tread carefully in calling for reforms for those in the NHS pension scheme
Recent articles reporting the furore around the annual allowance and how it “unfairly” impacts individuals in public sector defined benefit schemes have piqued my interest.
Adding fuel to the fire was news the British Medical Association is calling on the government to reform both the AA and the tapered AA for doctors in the NHS pension scheme. It has also been suggested doctors and other public sector workers are taking early retirement to avoid the lifetime allowance charge.
Regarding the latter, the LTA should be scrapped for other money purchase arrangements for the simple reason the individual carries all the investment risk in their pension. However, I do not believe in such action for public sector DB arrangements, as the member carries no investment risk whatsoever and, indeed, many of these schemes are underpinned by the taxpayer universe.
Back to the AA, though, given the number of comments made on some of these articles, it got me thinking what all the fuss was about.
Pension input amounts
In the case of a DB arrangement, calculating the pension input amount (the pension savings figure measured against the individual’s AA) is slightly more complicated than that for other money purchase arrangements.
It is not, as may be envisaged, a case of using the percentages for employer and employee contributions and applying these to the member’s pensionable earnings. Rather, the PIA for a DB arrangement is a notional contribution based on the increase in the member’s benefits accrued over the pension input period.
Taking the NHS scheme as the basis for an example to work through, for someone with pensionable income of £111,377 or more, personal contributions are set at 14.5 per cent and employer contributions at 14.3 per cent, with an additional levy of 0.08 per cent for the latter.
A recent Department of Health and Social Care consultation recommended employer contributions be increased to 20.6 per cent from 1 April, though member contributions are to stay the same.
Keeping things simple, we will presume the individual in question – let us call him Dr Strangelove – is a member of the 1995 Section of the NHS pension scheme and will remain so until retirement.
He is accruing pension income benefits on the basis of 1/80th for each year of service, with 3/80ths for his pension commencement lump sum.
At the start of the PIP, his NHS pensionable income was £137,931 and he had 34 years’ pensionable service. At the end of the current PIP, it is presumed he has 35 years’ service and his NHS pensionable income is £140,000. CPI in September 2017 was 3 per cent. His PIA calculation would be as follows:
1. Opening value of pension rights:
- Income – £137,931 x 34/80 = £58,621 – £58,621 x 16 = £937,936
- PCLS – 3 x £58,621 = £175,863
- Add together and up rate by CPI – (£937,936 + £175,863) x 1.03 = £1,147,213
2. Closing value of pension rights:
- Income – £140,000 x 35/80 = £61,250 – £61,250 x 16 = £980,000
- PCLS – 3 x £61,250 = £183,750
- Add together: £980,000 + £183,750 = £1,163,750
3. PIA 2018/19:
- £1,163,750 – £1,147,213 = £16,537
Let us also presume Dr Strangelove has private practice income of £20,000 and so has threshold income of £139,700 (£160,000 – £20,300), and adjusted income of £160,000 (for the purposes of tapering, due to the methodology, there is deemed to be no employer contribution in this scenario, i.e. £16,537 PIA minus personal contribution of £20,300).
His tapered AA is therefore £35,000 (£40,000 – £5,000), leaving him with £18,463 to carry forward.
Dr Strangelove has accrued uplift on his index-linked pension benefits worth £2,629 (ignoring the uplift in PCLS) for a PIA amount of £16,537.
Let’s presume this accrual is for an individual in the year they take benefits, and contrast this with the significantly lower benefits another money purchase arrangement PIA of £16,537 would secure through the immediate purchase of an RPI-linked annuity with 50 per cent of the spouse’s pension.
Just to compound this issue, the actual capital value of the contributions made to a DB arrangement can be significantly higher than the calculated PIA. Assuming a total contribution of 28.8 per cent of NHS pensionable income, Dr Strangelove’s contribution in monetary terms would be £40,320 (28.8 per cent of £140,000), £23,783 higher than the actual PIA for AA purposes.
Many would call this “unfair” and it is probably one bomb the BMA should avoid setting off.
Neil MacGillivray is head of technical support at James Hay