Specialist financial adviser Simon Cosgrove discusses potential life insurance options when thinking about how to replace NHS benefits.
When moving from NHS to private dentistry, many of my dental clients get in touch for guidance on replacing their NHS benefits. Active members of the NHS Pension Scheme (NHSPS) are entitled to a series of really valuable benefits and the move to private work means that that these benefits tend to be either deferred, reduced or lost altogether.
The most obvious benefit that the NHSPS provides is an income and potentially a lump sum in retirement. The amount will depend on the levels of income and the length of service in the scheme. The more service that you have with the NHS, the more pension you will accrue.
Of course, when you leave the NHS, you are no longer contributing towards the NHSPS and you become classed as a deferred member – this means that you will no longer qualify for the same benefits. Identifying exactly what the changes are and understanding how this would impact you financially are the first steps towards plugging the gap in terms of replacing what will be lost.
Spouse’s pension
One important aspect of the NHSPS is the spouse’s pension. In the event of your death during NHS service, your spouse would be eligible for a pension from the NHS. This is based on a percentage of the total of the pension earned to date, plus a pension based on the proportion of the service that you would have earned had you survived to your normal retirement age. A spouse’s pension is therefore based on future service as well as the pension earned to date. They would also be eligible for a short-term pension of six months’ pensionable pay following your death.
Deferred members however are only eligible for a proportion of the pension at date of death. This means that their spouse’s pension would be significantly less than if they had remained in the scheme. There is no future service in the Scheme and potentially years where they haven’t been an active member of the scheme. The proportions referred to for active and deferred members vary according to which part of the scheme that the benefits are in. There is also a dependant’s pension available for financially dependent children under the age of 23, which has the same considerations.
Death in service
Another significant although often less discussed element of the pension is the death in service benefit. This is two times either the active dentist’s pensionable earnings or their average uprated earnings (depending on which part of the scheme they are a member of) as a lump sum payment. For example, if an NHS dentist who is eligible for two times their pensionable earnings of £60,000 were to pass away, a lump sum of £120,000 would be paid to their named beneficiaries. The death in service lump sum payment drops for deferred members to a multiple of the pension that they would have received had they retired on the date of death. This is obviously going to be significantly less than the amount payable to an active member.
Bridging the gap
When it comes to looking at ways to replace these benefits, there are options. If, by leaving the NHS, you would miss out on £100,000 worth of death benefits, for example, one way of replacing this is with a lump sum of life cover of equal value.
Lump sum life insurance policies are probably the most popular type of life cover and they form an important part of financial planning. A less well-known type of life cover is something called a family income benefit policy, which can work alongside a lump sum payout. This type of policy pays out an income rather than a lump sum on death and could be used to replace the spouse’s and dependant’s pensions that would have been payable had the dentist remained in the NHS, which is particularly useful if there are children who need to be supported (hence the title of the policy).
Pros and cons of a lump sum
A lump sum for financial dependants can be invaluable. It allows them to repay debts such as a mortgage, and thus ease the financial pressure on a family by reducing the monthly outgoings. A lump sum can also be used to create income, if there is a need to do so, from savings interest or investment returns. What can be difficult to calculate, however, is how much income a lump sum needs to create. Also over what period of time and how much of an impact inflation is going to have on it over time.
In general, people are used to using a monthly income to budget rather than large lump sums of money. For example, if someone died and their spouse had a lump sum of £100,000 of the life cover payout remaining after they had repaid their mortgage, they may not know how to make the best use of it.
As well as the problems summarised above regarding the level and period of income required and the impact of inflation, they would also have to consider: should they save or invest the money over the medium to long term? If they are keeping it in a cash savings account, how does the interest rate compare to other options? Will they get taxed on it? Could the money run out if the cost of living rises significantly and unexpectedly, as it has done over the last couple of years? Will they be tempted to spend it on other things, for example a new car?
What are the advantages of a family income benefit policy?
A family income benefit policy solves these problems by providing a guaranteed income every month over a set period of time (for example, until the youngest child is 21), increasing by the rate of inflation every year. This could provide greater peace of mind for the family, allowing them to budget around the payment whilst having a set date for when they know the payments will stop. This type of cover tends to be cheaper than lump sum life policies, as death later in the term of the policy means that the number of payments will be less and so the payout will be less. However, it covers the income needs of the family.
An advantage of both lump sum life policies and family income benefit policies is that their payouts are free of both Income Tax and Capital Gains Tax.
Seeking specialist advice
Getting specialist input can be invaluable. A dental specialist financial adviser would look at your individual circumstances. By assessing your lifestyle and expenditure, they help to determine the appropriate level of cover. This ensures that, should the unexpected happen, your family would be provided for and able to maintain their current standard of living.
If I had a client who was entitled to £100,000 worth of death in service cover, I wouldn’t necessarily replace this directly. It may be more or less than they and their family actually need. I would analyse how much life cover was needed based on that person’s individual circumstances and what is right for them, from both a lump sum perspective and an ongoing income perspective, to ensure that they were neither under-insured nor over-insured.
In addition, if my client were operating as a limited company, there may be even more tax efficient options available to replace the loss of the death benefits. There is no ‘one size fits all’, making it important to seek specialist advice from someone who understands the complexities of the NHSPS and the income patterns of dentists. They should also have the ability to understand the individual requirements of you and your family to offer tailored guidance.
For advice and guidance on replacing the pension and death in service benefits you receive from the NHS, you can book a no-obligation financial review with a dental specialist financial adviser at Wesleyan Financial Services by visiting wesleyan.co.uk/lifes-journey or calling 0800 316 3784.
