Pensions: Why the public sector can no longer exist in a gold-plated bubble

11th March 2011

There has been no escaping the headlines following the publication of a final report by the Independent Public Service Pensions Commission.

Led by Labour peer Lord Hutton, this commission has made a series of proposals designed to deal with the "unsustainable" rising cost to the taxpayer of funding public sector pensions.

At a headline level, the proposals were broadly summarised as "work longer, pay more, get less". 

This is the message the unions will be keen to promote to their members, as they attempt to trigger industrial action in protest to changes to their generous pension schemes.

At the heart of these proposals was a term of reference provided to the commission by government.  It was asked to come up with a way of making public sector pension arrangements both sustainable and affordable in the long term. 

In coming up with these suggestions, the commission had to take the current economic challenges faced by the UK into account. 

It is important to remember that the dire state of our national finances was not the driver behind these proposals; action needed to be taken on the rapidly growing cost of public sector pensions regardless.

Defined benefit pensions remain the norm for the public sector whilst at the same time becoming rare as a hen's tooth in the private sector. 

The closure of those defined benefit schemes that are left in the private sector continue whilst any changes to them within the public sector have remained off limits.

Whilst the Commission has made 27 separate proposals within their final report, there are three that are particularly important to understand.

Firstly, and most controversially, is the proposal to change the basis of benefits from final salary to career average earnings. 

In simple terms, this means calculating pension benefits for each member based on the average of their salary throughout their public sector career, rather than based on their salary in the final few years of employment.

This change to a Career Average Revalued Earnings (CARE) scheme should take place by 2015, which is the scheduled end of this Parliament.  It is worth noting that benefits accrued to date will not see their calculation basis change; this proposal is only for future pension benefits.

Secondly, the Commission recommends that scheme members should retire later.  They are proposing that the scheme retirement age be increased in line with the State Pension Age, which is scheduled to increase from 65 to 68 between December 2018 and April 2046.

There are concessions within the proposals for members of the uniformed services (the armed forces, police and firefighters) who should see their minimum retirement age increased to age 60.  Many of the members of these services are currently able to take earlier retirement without penalty.

 

Thirdly, there is a proposal to review the inflation basis during the accumulation of pension benefits and when benefits are paid out in retirement.  Pension benefits will keep pace with average earnings inflation when they are being accumulated.  The Consumer Prices Index (CPI) measure of price inflation will be used to revalue pension income in retirement, but any periods of deflation will slow down subsequent increases when a return to inflation occurs.

 

There are other important proposals within the report.  These include that lower and higher earners should benefit from the same general pension scheme design, but higher earners should pay proportionately more for their membership of the pension scheme in the future.  The proposals will also see the cost of providing pension benefits taken into account when reviewing the overall remuneration package for members.

What these proposals will undoubtedly mean, assuming they are implemented in full within the Budget later this month, is that all public sector members will need to review their plans for retirement.

Interpreting the likely benefits from defined benefit pension schemes is never a simple task, although scheme administrators have been improving the quality of their communications over the years. 

There is a need for professional independent financial advice, to understand what retirement income might look like in the future and to create a strategy for funding the gap between expectations and requirements. 

Members of the public sector will need to look past the sensationalist headlines and militant Union reactions to understand their own plans for retirement and work out a plan of action based on these.

Martin Bamford is a chartered financial planner with Informed Choice Follow him on Twitter @martinbamford

He also blogs on Informed Choice's website

 

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