Something has been perplexing me for some time. There is always talk of ‘raiding’ private pensions in one way or another but there is little discussion around the cost to the public purse of the public servants pension schemes (Civil Service, NHS, local government and so on).
Those of us who have saved hard for retirement risk seeing the rug pulled from under us, being left financially vulnerable.
We don’t have the luxury of income certainty in retirement and now we are being punished again for being sensible.
If the Chancellor has such a huge hole in her Budget and is planning to increase the state pension age going forward, why isn’t she considering outsourcing the gold-plated pensions of the public sector workers?
If she puts their pensions on the same footing as those of us who are likely to lose swathes of our income surely this will benefit everybody, won’t it?
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Steve Webb replies: There is no doubt that there is now a big difference between the pensions available to people who work in the public sector and those who work in most private companies.
In most cases teachers, nurses, civil servants, local government workers and people in the ‘uniformed services’ are members of traditional salary-related or defined benefit pension schemes.
The key feature of these schemes is that the pension you get is based on how many years you pay in and what you earn. The pension is paid for as long as you live and is fully protected against inflation.
By contrast, the vast majority of private sector workers are building up a different type of pension known as a ‘pot of money’ or a defined contribution pension.
In DC pensions the worker and the firm typically pay money into an investment fund, the money is invested and then at retirement you have a range of choices.
One is to use the pot to buy an income for life (an annuity) but you can also take it all out in one go (subject to tax) or take some out and leave the rest invested.
In many ways modern DC pensions are quite attractive in that you can often access them sooner (typically at 55, rising in 2028 to 57) and you have more flexibility about how you use them.
But the downside is that whilst you are building them up and while you are managing them in retirement, all the risk is on you as an individual.
This means you have to think about things like the ups and downs of investment markets, how inflation might erode the value of your savings, and how to manage the money when you do not know how long you will live.
More fundamentally, the big attraction of public sector DB pensions is that your employer is generally making a very large contribution as well – far more than the typical private sector employer.
As a result, for any given salary level, the public sector worker will typically build up far more pension than their private sector equivalent.
One option, as you suggest, would simply be to change the rules so that everyone moves to a DC pension.
But there’s a catch.
Most of the public sector schemes (excluding local government and the Parliamentary pension) have no fund sitting behind them.
Instead, this year’s contributions by workers and employers are used to fund the pensions of today’s retired public servants.
If we moved to a system where, for example, today’s nurses and hospitals put money into a DC pension pot belonging to the nurse, then we couldn’t use those same contributions to pay for retired nurses. So we would have to raise taxes on everyone to meet the pension promises we have made in the past.
This is the main reason why successive governments have let the system run on as it is.
It would be fair to say that efforts have been made to reduce the cost of public sector pensions.
Some of the big changes in recent years have included the following moves.
– The *age* at which you can draw public sector pensions has been increased; someone starting work today will not be able to draw their full public service pension until state pension age.
In the past, many public service pensions could be drawn at 60 or even earlier, so this is a big cost saving
– The way public sector pensions are protected against inflation has been changed; in the past pensions were linked to the Retail Prices Index (RPI) but now they only go up in line with the generally lower Consumer Prices Index (CPI).
This resulted in a substantial cost saving for the taxpayer.
– Rather than being based on people’s final salary when they leave the scheme, modern public sector pensions are based on people’s ‘career average’ salary.
This isn’t fundamentally a cost saving but it is rather fairer to workers on more modest wages or those whose career does not end up at the top of the public sector.
Fundamentally, good public service pensions are part of the package we offer to people to encourage them to become teachers, nurses, civil servants or local government workers.
We obviously could make those pensions less generous if we wished. But we might find that this would lead to demands for better wages now to compensate, and that would again lead to increased short-term costs for the taxpayer – something most governments are keen to avoid.
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