Hypothetical Annuity Cost, Explained

1. The short answer

The hypothetical annuity cost is NHSBSA's estimate of what it would cost to buy a similar pension from an insurance company on the open market, at the date of your statement.

It is there to show what your NHS pension is worth in terms you can compare with a private pension pot. It is not money you have, it cannot be taken out of the scheme, and it is not a cash equivalent transfer value (CETV). NHSBSA say plainly that it must not be used for divorce settlements.

2. Where you will find it

It appears in the pension section of your Total Reward Statement, alongside the other figures for your benefits: your estimated pension, lump sum and adult dependant's pension.

NHSBSA describe it as "not a standard benefit". Everything else on the statement is something the scheme would pay you or your dependants. This line is an illustration added to give those benefits a price.

3. What the figure represents

An annuity is a product you buy from an insurer with a lump sum. In return the insurer pays you an income for life. When someone with a private pension pot retires, buying an annuity is one of the ways to turn that pot into an income.

The NHS pension already is an income for life, with no pot behind it. The hypothetical annuity cost reverses the usual question. Instead of asking "what income would my pot buy?", it asks "what pot would I need to buy the income the NHS has promised me?"

That is why it is useful. A doctor comparing the NHS scheme with a SIPP, or trying to explain to a partner what the pension is worth, can see a single capital figure rather than an annual one.

4. Why it is so large

People are often startled by the size of the number, especially next to a modest-looking annual pension. It is large because the income it prices is expensive to buy:

• It is guaranteed for life. The insurer carries the risk that you live to 100.
• It rises with inflation. NHS pensions in payment are increased each year, and an insurer providing inflation-linked income charges considerably more than for a flat one.
• The NHS version comes with more. The scheme also pays pensions to a surviving partner and eligible children. NHSBSA do not say exactly which benefits the figure prices, but any cover of that kind adds cost when bought privately.
• Insurers price cautiously. They invest in low-risk assets, hold capital against the risk of getting it wrong, and make a margin.

Put together, a guaranteed, inflation-linked income is one of the most costly things to buy on the open market. The hypothetical annuity cost is simply that cost written down.

5. The assumptions behind it

NHSBSA publish two assumptions that matter for reading your figure.

It uses market conditions on the date of your statement. Annuity prices move with interest rates. NHSBSA warn that "costs could vary significantly at different dates", so the same pension can show a noticeably different figure from one year's statement to the next without anything about your benefits having changed.

It assumes fixed normal pension ages. The factors used assume a normal pension age of:

The 2015 Scheme line is worth noticing. Your actual normal pension age in the 2015 Scheme is your State Pension age, or 65 if later, which for most doctors now working is 67 or 68. The calculation assumes 65. A pension that starts earlier makes more payments, so it costs more to buy, and the figure is priced on that basis rather than on the age you could actually take it unreduced.

NHSBSA do not publish the full set of factors, so it is not possible to reproduce the figure exactly from your statement.

6. What it is not

NHSBSA are explicit about the limits, and they are the part most worth remembering:

• It is not a value you can take. "It is not possible to take this value from the pension scheme." There is no pot to withdraw, cash in or draw down.
• It is not a transfer value. It must not be used as a cash equivalent transfer value.
• It is not for divorce. It must not be used for divorce settlements. NHS Pensions have separate forms and guidance for transfer values needed on divorce or dissolution of a civil partnership.
• It is not used for tax. The annual allowance measures NHS pension growth with its own formula (broadly 16 times the increase in annual pension), not with this figure.

7. Hypothetical annuity cost vs CETV

The two are easy to confuse because both are capital values placed on the same pension. They answer different questions.

Because they are worked out on different bases, the two figures for the same pension are usually different, sometimes by a wide margin. Neither is "the real value". If you need a figure for a legal or financial process, it is the CETV, obtained from NHS Pensions, that counts.

8. Making sense of your own figure

One simple way to read it is as a multiple of your annual pension. Divide the hypothetical annuity cost by the estimated annual pension it relates to.

Using made-up figures: an estimated pension of £20,000 a year shown alongside a hypothetical annuity cost of £500,000 is a multiple of 25. In other words, on that day's prices an insurer would want roughly 25 years' worth of the pension up front to take on the promise.

That multiple is a useful sense check in a few situations:

• Comparing with a SIPP. It shows the size of pot a private pension would need to reach just to buy back the same guaranteed income. The NHS Pension vs SIPP calculator approaches the same question from the other side, working out the investment return a SIPP would need.
• Thinking about opting out. Opting out gives up future accrual of this kind of income. The hypothetical annuity cost of what you have already built shows how much the guarantee is worth on the open market.
• Commuting pension for a lump sum. The NHS scheme swaps £1 of annual pension for £12 of lump sum. Compare that 12 with the multiple your own statement implies, and you have the arithmetic behind the common view that commutation is poor value in pure actuarial terms.

None of these is a recommendation. They are ways of putting a single number on the statement into context.

9. Common questions

Is the hypothetical annuity cost how much my NHS pension is worth? It is one way of valuing it: what the same income would cost to buy privately on the statement date. It is not an amount the scheme holds for you or will pay you.

Can I transfer the hypothetical annuity cost to a private pension? No. It cannot be transferred or taken. Transfers are based on a CETV, and transfers from the NHS scheme to personal pensions and SIPPs are not permitted for most members. See can you transfer your NHS pension to a SIPP?

Why did my hypothetical annuity cost change so much from last year? Annuity prices depend on interest rates on the statement date. A change in market conditions can move the figure a long way even if your pension grew only modestly.

Can I use it in my divorce? No. NHSBSA say it must not be used for divorce settlements. Ask NHS Pensions for a CETV through their divorce process.

Does it include my lump sum? NHSBSA do not publish the detailed basis. Read it alongside the benefits shown on the same statement, and ask NHSBSA if you need to know exactly what it covers.

10. Where to check

NHSBSA, Understanding your statement. The scheme administrator's explanation of each line of the Total Reward Statement, including the hypothetical annuity cost and the normal pension ages it assumes. nhsbsa.nhs.uk/employee-section/understanding-your-statement

Total Reward Statements help. Notes on the statement itself, including that the figure is for comparison only. totalrewardstatements.nhs.uk

NHS Pensions member hub. Transfer values, divorce forms and estimates. nhsbsa.nhs.uk/member-hub

MoneyHelper. Free, impartial, government-backed guidance on annuities and pensions. moneyhelper.org.uk

This guide is general information, not financial advice. For a decision that depends on the value of your pension, speak to an independent financial adviser experienced with NHS pensions.