NHS Pension Lump Sum: How Much Tax-Free Cash Can You Take?

One of the biggest decisions at NHS retirement is whether to take a tax-free lump sum, and how much. A lump sum can clear a mortgage, help family or fund a big trip, but it permanently reduces the pension you receive each year. Here is how to think it through.

The 12 to 1 swap

In all sections of the NHS Pension Scheme, you can give up some of your yearly pension in exchange for cash. Each £1 of yearly pension you give up gives you £12 as a lump sum. This is called commutation.

So giving up £1,000 a year of pension gives you a £12,000 lump sum.

The 1995 section automatic lump sum

If you have benefits in the 1995 section, you automatically get a lump sum of three times your yearly pension without giving anything up. You can then commute more pension for extra cash on top, at the same 12 to 1 rate.

The 2008 section and the 2015 scheme have no automatic lump sum. Any cash comes from commuting pension.

The maximum

The total tax-free lump sum is limited to 25% of the value of your benefits, using a standard formula. In practice that works out at roughly 4.3 times your yearly pension before any commutation.

Two examples:

• 2015 scheme, yearly pension £20,000. The maximum lump sum is about £85,714. Your yearly pension would fall to about £12,857.
• 1995 section, yearly pension £15,000. You get an automatic £45,000. The maximum total is about £80,357, which would reduce your yearly pension to about £12,054.

How long to make it back

Because of the 12 to 1 rate, it takes 12 years of the reduced pension to "pay back" the cash you received. If you take the maximum in the 2015 scheme and live more than 12 years after retirement, you would have received more in total by keeping the full pension.

That simple sum ignores the fact that your pension rises each year with inflation. Allowing for that, the true break-even point is several years longer. On the other hand, cash in hand now has value too, especially if it clears expensive debt.

Things to weigh up

• Health and life expectancy: if you expect a long retirement, keeping more pension may be worth more over time.
• Debts: using a lump sum to clear a mortgage or loan can save more than it costs.
• Tax: the lump sum is tax free within the normal limits, while pension income is taxed. For someone who will pay higher rate tax in retirement, the lump sum can be more attractive.
• Survivor benefits: pensions paid to a surviving partner are based on your pension before commutation in most cases, so taking a lump sum does not normally reduce them.

Make the decision with your statement

Your NHS Pensions retirement quote shows your exact pension and the lump sum options available. It is worth speaking to an independent financial adviser before deciding, especially if you have other pensions or savings.

Lump sum and tax-free allowances

Most people's NHS lump sums are well within the tax-free limit. There is now a lifetime limit on tax-free lump sums across all of your pensions, the lump sum allowance. Only people with very large pension savings are likely to reach it, but if you have significant private pensions as well, take advice before you retire.

Common questions

Can I take a lump sum and keep working? Yes. If you take your NHS pension and return to work, you keep the lump sum.

Does a lump sum affect my State Pension? No. The State Pension is separate and is not affected.

Can I change my mind? Once your pension is paid, the decision is fixed. Make sure you are comfortable before you submit your retirement form.

Common mistakes to avoid

• Taking the maximum automatically without thinking about how long you expect to draw the pension.
• Forgetting that a lump sum from the 1995 section is automatic and you may not need to commute any more.

Try the numbers

The pension lump sum calculator shows the maximum lump sum, the reduced pension and the payback period for any yearly pension in the 1995, 2008 or 2015 sections. To estimate your pension in the first place, use the pension at retirement calculator.