Public sector pensions are an increasing drain on public finances - a trend that can't continue, especially in these austere times (to see why this is a problem read my earlier article).
Lord Hutton has published his final report after 9 months of study into how the Government might solve this problem.
The report makes a number of recommendations, as follows:
Replace final salary pensions with a career average revalued earnings (CARE) scheme
Under final salary schemes retirement income is calculated based on the number of years' service and salary at retirement. For example, someone with 30 years of service in a 1/60th scheme earning £40,000 at retirement would enjoy a pension of £20,000 a year (calculated as 30 x 1/60 x 40,000).
A CARE scheme instead calculates pension income based on average earnings over that period of service and the number of years' service. The report's favoured option seems to be taking each year's salary and increasing that in-line with average national earnings up until retirement, at which point it's multiplied by 1/61 to get retirement income, which will increase by inflation (not earnings) when in payment.
So in our above example, if the person's salary had increased by average earnings each year the only change would be the 'accrual' rate of 1/60th falling to 1/61th, so income would be 30 x 1/61 x 40,000 = £19,672.
The proposed CARE scheme would most penalise those whose earnings have increased faster than the average during their career - a group the report refers to as 'high flyers'. They could lose out significantly as the below example shows:
|Salary change over 30 years of service||Final Salary (1/60 accrual rate)||CARE (1/61 accrual rate)|
|£15,000 to £40,000
(in-line with average earnings)
|£15,000 to £80,000
(rises faster than average earnings)
|Assumes average earnings rise by 3.5% a year.|
Adopt a single benefit scheme with tiered contribution rates
This means all employees should be able to accrue the same benefits regardless of salary, but might have to pay differing levels of contributions to enjoy them. The report favours this approach over a 'salary cap' on pension benefits for higher earners.
Align public sector retirement age with the state pension retirement age
The normal retirement age (NRA) for public sector pensions should increase to be in-line with the state pension (it's not uncommon for longer serving members to have a NRA of 60). There should also be flexibility to retire either side of this, subject to a fair pension adjustment (i.e. reflecting life expectancy).
Existing final salary benefits should be protected
New rules should only affect future service, not existing benefits built up under final salary rules.
Introduce a fixed cost ceiling for taxpayers
This is perhaps the most sensible recommendation from taxpayers' point of view and the most worrying if you have a public sector pension. Fixing the proportion of public sector pensionable pay that taxpayers effectively fund leaves the door firmly open for further public sector pension cuts if any initial changes don't save the required amount of money.
How do public sector pension contributions compare to the private sector?
If you're curious, the table below (taken from the report) sheds some light. It doesn't cover the benefits received for those contributions (preventing accurate comparison), but does help paint a picture of the extent taxpayers ae funding public sector pensions (via employer contributions).
|Scheme||Employee contribution||Employer contribution|
||5.5% - 8.5%
||1.5% or 3.5%
|Police (1987 scheme)
|Police (2006 scheme)
|Fire (1992 scheme)
|Fire (2006 scheme)
|Armed Forces (officers)
|Armed Forces (others)
|Local Government (LGPS)
||5.5% - 7.5%
||14% - 25%|
|Private Sector (average final salary*)
|Private Sector (average money purchase*)
|Source: IPSPC. * open schemes only.|
Are the Hutton Report recommendations a good thing?
Probably not if you work in the public sector, especially if you are, or expect to be, a high earner over the course of your career.
But from a taxpayer's point of view putting a lid on public sector pensions expenditure is necessary and the only way to practically achieve this is to reduce average benefits, whichever way that might be implemented.
However, while there's little choice but to cut public sector pensions, I do have sympathy for those affected. Let's not forget they're already going to be hit from this April by switching annual pension inflation-linking from RPI to CPI. CPI tends to be lower as it doesn't include housing costs - the Pensions Policy Institute predicts this move will reduce the average public sector employee benefit rate from 24% to 20% (ok, still high, but a significant reduction nevertheless).
The report urges the Government to introduce any changes during the current parliament, that is by 2015. So, as seems to be case with most pension proposals these days, we'll have to continue watching this space...