Saving for retirement - NHS pension vs LISA

Gleyjop482

I’m looking for some advice about how to save for retirement, as I recently saw Martin Lewis talk about LISAs.

I’m 39, a resident doctor (a couple of years away from Consultant), and moved to the UK nearly a decade ago. I have 8 years of NI credits built up. My partner bought a house, so I wouldn’t be eligible to use my LISA for a first home.

I already have a cash isa, and a few high interest savings accounts, but I’m looking for something longer term. 

The NHS 2015 pension scheme is a bit confusing to me, and I’m not sure if it’s better to buy nhs additional payments or open a LISA (and put in 1000-4000£ per annum), or do a combination of both. Similarly, I don’t really understand how additional payments to the nhs scheme work (would really appreciate if someone could shed light on that for me!)

I would appreciate any advice! Thanks

hugheskevi

For something longer term, you have a variety of options, the main ones being:

1. NHS Defined Benefit pension - Additional Pension or ERRBO (essentially the same thing)
2. NHS Defined Contribution - Additional Voluntary Contribution scheme you can probably contribute to through salary sacrifice
3. Personal pension (similar to NHS AVC scheme, but with far more choice of provider and investments)
4. Stocks and shares ISA
5. LISA

A key point in deciding between the above is what rate of income tax you are paying now, and what rate you will pay in retirement. If you are a higher rate taxpayer now and would be a basic rate taxpayer in retirement then a pension will have better tax incentives than a LISA. If you are a higher rate taxpayer both now and in retirement there isn't much difference, but the LISA is slightly better. If you have taxable income over £100,000 it is more complicated, but likely to favour the pension.

It may well be that your decision is between NHS DB pension, or salary sac DC AVC contributions (which you may be able to periodically transfer to a personal pension if you want a wider choice of provider and investments), rather than between Added Pension and a LISA. If so, it would still be sensible to open a LISA and deposit £1 so that you have the option to contribute in future should incentives change (either your personal position, or policy change). As things currently stand you can only open a LISA before age 40 so you will soon lose that option.

Added Pension and ERRBO are simply arrangements for you to contribute money now in return for a higher pension in the future. The discount rate used in the calculation is CPI+1.7% which you can think of as a guaranteed rate of return. If you like certainty and want more income payable in retirement until such time as you die, that makes Added Pension and/or ERRBO more attractive.

If you would prefer to invest the money (you should achieve more than CPI+1.7% over a reasonable period) and have the flexibility to use it as you wish, eg using more of it early in retirement before State Pension and maybe your NHS pension comes into payment, that would favour DC. Overall the DC option will be the higher expected return, but with less certainty and no guarantees compared to DB.

Note that the tax treatment of DB and DC is different - to take a tax free lump sum from DB pension involves exchanging pension at a very poor rate so often you would be better just taking the taxed income, whereas from a DC pension it is 25% all tax free.

Moonwolf

Overall I would say that the big considerations are worrying about the big tax thresholds where the effective tax rate can be quite high and additional pension can be a way to avoid that.

Additional Pension is more pension, which gives more options, ERRBO is less flexible but allows early retirement without as big an actuarial reduction. Without a crystal ball, I would guess that more guaranteed pension will be less valuable than flexibility and good tax management.

If you expect private income as a consultant, you might want to take that into consideration as well. A DC pension that you can draw down or leave untouched depending on your private income and NHS pension, it might be more flexible. Also, although the rules will be changing in 2027, a DC pot may have more flexibility for your partner if you pass early.

Lowtrawler

Great pointers from hugheskevi and Moonwolf but you sound like you will be overwhelmed by the ideas they have presented?

Trying to go back to your original post and avoiding the other options presented by the earlier posters - you want to know whether to purchase Additional Pension within the 2015 NHS scheme or to open a LISA and what the relevant benefits of both are?

Additional Pension will provide you with a guaranteed, inflation proof pension when you retire. As hugheskevi pointed out, it is priced to give you a guaranteed return of CPI + 1.7% from the date of purchase to the point of retirement. On retirement, it will increase by CPI annually and be taxed alongside your other income at that time. You will get tax relief on your payments in at your marginal tax rate.

LISA will allow you to deposit up to £4,000 annually until you are 50 and the government will add £1,000. There is no tax relief available on the £4,000 but you will not pay tax when you come to draw down from the pot. Hence, at 39, you could make annual deposits of £4,000 for 11 years = £44,000 and receive £11,000 of government top-up = £55,000 + investment returns.

Assuming you are a 40% tax payer, paying £5,000 into Additional Pension each year will cost you £3,000 compared to the £4,000 for the LISA. However, the whole £5,000 is tax free when paid out from the LISA and you will pay tax on the pay out from the Additional Pension. When you retire, if you are a 20% tax payer, you will pay £1,000 on the £5,000 which means your lifetime cost is the same as the LISA. To summarise, you will use taxed income to deposit into a LISA but all investment growth and government contributions are then tax free at the point of withdrawal. You get tax relief on payments into Additional Pension but are then taxed on all payments out.

You can draw money from the LISA at age 60 without penalty. If you retire and claim your NHS Pension prior to your State Pension Age, it will be subject to an actuarial deduction.

If you achieve an investment return from the LISA of CPI+1.7% you will be better off with the LISA than Additional Pension because you are not taxed on the growth. You will have flexibility to draw from the LISA at an earlier age and, in the event of your death, the LISA is likely to offer more than the Additional Pension.

The only reason to choose Additional Pension over the LISA is the certainty of making a CPI+1.7% return. However, if you invest the LISA into an Index Linked Gilt - TR46, you are currently guaranteed a return of RPI + 2.2%, although that may vary over time, and long-term market returns may prove better still.

If you pay tax at more than 40%, Additional Pension becomes a consideration.

Gleyjop482

Hi everyone,

Thank you all for your advice, you’ve certainly given me food for thought. Trying to make the right decision during this unpredictable time is tricky, but only time will tell!