Many dental practitioners are moving their practices over to more private work. But while the headline earnings of private work can look very attractive it is essential to consider the impact of any loss of NHS pension. No-one could deny that the NHS pension scheme is excellent, so its benefits will cost you a lot to replace.
The scheme links your pension to your lifetime’s NHS earnings and is guaranteed for life, irrespective of how long you live. This type of scheme is known as ‘defined benefit’ (DB), and is rarely offered to new employees in the private sector. So the costs of replacing that ‘lost’ pension should be included when calculating your private fees.
Like most DB schemes the NHS pension is complex, and expert advice is essential to assess how much you would need to save through a private pension, such as a self-invested personal pension (Sipp), to provide a replacement retirement income.
Sipps and other ‘defined contribution’ (DC) private pension arrangements do not provide a guaranteed retirement income linked to former earnings. Instead they build up a fund that you can draw on in retirement or use to buy an annuity from an insurance company. An annuity is a guaranteed income for life based on the size of the fund and your age and state of health, among other factors. To a large extent, therefore, the income you can draw will depend on how much you invest and how well you do it.
Here are the basic calculations to help you make some informed decisions. Remember that when you consult a professional financial adviser you need to consider your personal financial position and your retirement objectives. Your NHS pension builds up according to the formula: NHS annual pension = Total lifetime net income (dynamised) x 1.4%
All NHS income earned in any one year is multiplied by a dynamising factor to bring it up to current values. The dynamising factor represents the increase in earnings each year. All those dynamised earnings are added together to give total lifetime earnings in today’s terms. Your pension is simply 1.4% of that total.
For example, consider a typical practitioner aged 60, retiring this year, having earned on average £55,000 a year net NHS pensionable income in today’s terms throughout his or her practising life of 37 years. Then: Total dynamised lifetime earnings are £55,000 x 37 = £2,035,000. So he or she can expect a pension of: £2,035,000 x 1.4% = £28,490 a year in pension (inflation-proofed) + £85,470 (three times the pension) as a tax-free lump sum.
The NHS pension is actually based on total dynamised income, not average income, but I have used ‘average’ income here to simplify the calculations. In practice, the amount of income on which your pension is based – the GDP pensionable income – is your NHS gross income less an amount allowed for expenses. Currently this is 56.1% of NHS gross earnings, so the GDP pensionable income is 43.9% of those earnings.
NHS pension contributions in a given year will provide, among other benefits, an inflation-proofed pension on retirement of 1.4% of that year’s net pensionable income – the 43.9% of gross earnings – dynamised to compensate for increases in dental earnings between that year and retirement.
Ideally, you need to assess the amount of NHS pension you will forgo during your years in private practice. Once you have that figure, you should calculate the size of fund you will need to build up in your Sipp to buy an equivalent pension in the form of an index-linked annuity. You can also draw a retirement income directly from your Sipp, but the comparison with the cost of an annuity provides a good target for your private pension savings. A professional pensions adviser will help you with these calculations.
As a rough guide, the cost of a level annuity – that is, not rising with inflation – is between 15 and 20 times the annual income it pays. An indexed annuity will cost more. For example, for a man now aged 60, a pension fund of £100,000 will currently (March 2006) buy a flat rate annuity of about £5,900 a year. For a woman the income would be slightly lower, at £5,400. This is because the average woman lives four or five years longer than men and so the income is paid over a longer period.
For ‘joint lives’, where the income continues to your partner on your death, your £100,000 will buy £4,800 a year. This is based on a couple where the man is aged 60 and the woman is 55. You can build in inflation-proofing but in this case the starting income for the joint annuity would be £2,000 for the couple. Where the annuity is just for one person – ‘single life’ – the indexed starting income would be about £2,800 a year.
Depending on your age and your attitude to investment risk, among other things, while in private practice you would need to invest 30-40 times the 1.4% – that is, 42-56% – of the NHS pensionable net income you have given up to achieve a comparable private pension at retirement. This equates to 18-25% of your NHS gross turnover.
You may be able to lower this level of private pension contribution if you can achieve investment returns that exceed the rate of inflation, but naturally you need to consider how much investment risk you can tolerate. This will depend on the ‘investment term’ – that is, the number of years before you need to start drawing on your pension fund – as well as your personal attitude to risk.
Replacing your NHS pension will cost a lot of money. So it is vital to start planning as soon as you consider moving into private practice, and to bear this cost in mind when you set your private fee scales. A good quality Sipp with expert investment advice can reduce this cost. And make sure your financial adviser is conversant with the NHS pension scheme.
To find out what level of pension you can expect from the NHS, call the NHS Pensions Agency on 01253 774774 and ask for a Pensions Forecast and a Schedule of Contributions. Check this schedule to make sure all your NHS employments have been included. The NHSPA website, www.nhspa.gov.uk, also has a lot of useful information.
Ralph Davies is a Medical Sickness Advisory Board member. For more details on how medical sickness can help you in relation to pensions or pension forecasting, call 0800 197 0310 or visit www.medical-sickness.co.uk/medics