We have a significant number of clients where one or both parties are Civil Servants, which is unsurprising given that around 17% of the UK workforce is employed in the public sector.
Public sector pensions are widely recognised as valuable benefits, offering a guaranteed and inflation-protected income in retirement. However, many people don’t realise they can increase this income by purchasing Additional Pension entitlement within these schemes.
This week’s blog explores the benefits of boosting your public sector pension and examines how combining Defined Benefit (DB) and Defined Contribution (DC) pensions can create a balanced and effective retirement plan.
Defined Benefit vs Defined Contribution
To fully appreciate the advantages of purchasing Additional Pension entitlement, it’s important to understand the difference between Defined Benefit (DB) and Defined Contribution (DC) pensions:
- Defined Benefit Pensions: These provide a guaranteed income for life, which typically increases yearly to keep up with inflation. You build up your entitlement annually based on your salary. For example, in the NHS Pension Scheme, your income entitlement grows by 1/54th of your annual pensionable pay. They are not affected by investment performance, making them one of the most reliable ways to ensure financial stability in retirement.
- Defined Contribution Pensions: With a DC pension, the money you and your employer contribute is invested. The income you receive in retirement depends on how well those investments perform. DC pensions give you more flexibility—you can take out money as you need it or buy an annuity—but this comes with investment risks. Your retirement income isn’t guaranteed and can go up or down.
Years ago, DB pensions were common in both the public and private sectors. However, they have largely disappeared from the private sector, where most employees are now enrolled in DC pensions. Meanwhile, public sector workers still benefit from the security of DB pensions.
The Benefits of Purchasing Additional Public Sector Pension Entitlement
If you’re a member of a public sector Defined Benefit (DB) pension scheme, you can buy additional pension entitlement.
This is well worth considering for those with surplus cash and/or income, as the financial benefits often make sense.
As always, this is best explained by way of an example:
Example: Charlie’s NHS Pension
Charlie is 44 years old and works for the NHS, earning £70,000 a year.
- So far, he has built up a pension entitlement of £15,000 a year. Part of this will be payable from age 65, and the rest from his State Pension Age of 68.
- Charlie is currently in the NHS Pension 2015 Scheme, contributing 12.5% of his salary. This means he’s automatically adding £1,296 (1/54th pay) to his annual pension entitlement.
- He and his wife, Claire, now have surplus income and are considering ways to boost their retirement income.
Charlie decides to purchase an extra £500 per year of pension income, which includes cover for his dependents.
- Cost: The one-off cost for this additional income is £6,660 (gross).
- Tax Relief: Charlie is a higher-rate taxpayer, in which case he qualifies for 40% tax relief. After reclaiming tax relief via HMRC or his tax return, the net cost is reduced to £3,996.
By spending £6,660 (or £3,996 after tax relief), Charlie secures £500 of inflation-protected income every year for the rest of his life.
- This gives him an effective return of 7.5% per year before tax relief (£500 ÷ £6,660).
- Once you factor in tax relief, the return jumps to 12.5% per year (£500 ÷ £3,996).
This makes it an attractive option compared to other ways of securing guaranteed income, such as buying an annuity in the private market.
Charlie could repeat this process each year, further boosting his pension income and ensuring greater financial security in retirement.
The Sweet Spot: A Blend of DB/DC Pensions
What does an ideal retirement look like?
For many, it means having a mix of:
- A Guaranteed income to cover essential expenses, plus a ‘little extra’ for everyday discretionary spending (eating out, hobbies, weekend trips, etc.), plus
- A flexible pot of money to fund more aspirational goals, such as retiring earlier, dream holidays, a new car, becoming debt-free, etc.
This is where a combination of Defined Benefit and Defined Contribution pension can work brilliantly.
Revisiting the previous example:
Example: Charlie and Claire’s Retirement
Fast forward 20 years and Charlie and Claire have now retired.
- Charlie has build up a DB Pension providing an income of £45,000 a year
- Claire has accumulated a DC Pension worth £750,000
When they combine this with their State Pensions (once these start), Charlie and Claire enjoy a reliable post-tax income of about £4,000 a month. This is enough to cover all their household bills and leave some extra for regular discretionary spending.
However, the flexibility of Claire’s DC pension gives them added freedom:
- They can use it to pay off any remaining debt.
- It can bridge the gap before Charlie’s NHS and State Pensions start.
- It’s there for bucket list goals like travel or home renovations.
This balance—guaranteed, inflation-protected income from Charlie’s DB pension, combined with the flexibility of Claire’s DC pension—provides a compelling mix of security and versatility, ensuring they can meet both their needs and aspirations in retirement.
The Downsides of Additional Public Sector Pension Purchase
There are potential drawbacks to consider when purchasing an additional DB pension:
- Inflexibility: Once purchased, the entitlement is locked into the scheme and can only be accessed from the Minimum Pension Age (currently 55, rising to 58 by 2028).
- Limited Growth Potential: DB pensions offer stable, inflation-linked income but lack the higher investment returns that could be achieved in a DC scheme.
- Tax Implications: Additional pension purchase counts towards the Annual Allowance (£60,000 in 2024/25), and exceeding this limit can trigger tax charges.
- Upfront Cost: Purchasing additional pension entitlement requires significant upfront payments or higher monthly contributions, tying up capital that could be used elsewhere.
- Longevity Risk: The main drawback of this strategy is that its value depends on how long you live. While benefits are available for dependents, they are usually reduced. For example, a surviving spouse typically receives 33.75% of your pension, a single minor child receives 16.875%, whereas if there are two or more children, they share 33.75% equally.
Conclusion
Purchasing Additional Public Sector Pension entitlement can be a valuable way to secure a stable, inflation-protected income for retirement, especially if you have surplus income or savings to invest. It offers a guaranteed return that is difficult to match elsewhere. When combined with the flexibility of a Defined Contribution pension, this approach creates a powerful strategy to balance financial security and lifestyle goals in retirement.
However, it’s essential to weigh the potential downsides, including the lack of flexibility, upfront cost, and limited growth potential compared to other investments.
Please note this blog is for general information and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and does not contain all the information that an investor may require to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is correct as of the date it is received or will continue to be correct. We cannot accept responsibility for any loss due to acts or omissions made for any articles.
