Private-sector pensions are shrinking and vanishing, yet public-sector ones are more generous than ever. Why the gap? And is it sustainable? Tim Bennett reports.
What's the latest news on pensions?
"We have got to end the apartheid," said Conservative leader David Cameron last week as he highlighted the huge gulf between public and private-sector pensions. Quite so, says TheDaily Telegraph's Paul Farrow: "the pension playing field is decidedly lopsided". The Taxpayers' Alliance recently revealed that 17,150 public-sector workers have already retired with pension pots worth over £1m. The list of beneficiaries includes 10,500 ex-NHS employees, 3,680 civil servants, 1,800 teachers and 815 judges. Ignoring those at the top, even the average public-sector worker will retire on an annual pension of £17,091, says Dr Ros Altmann, a former adviser to Tony Blair. To match that, given that 80% of employers have closed their final-salary schemes, a private-sector worker would have to save £427,275. In reality, says the Association of British Insurers, the average lump sum used to buy an annuity is just £24,150, enough for an annual income of well below £2,000.
How are all those state pensions funded?
They aren't. You might think a big fund would have been accumulated from past government tax revenues and set aside to cover state pension liabilities. But you'd be wrong aside from some local government pensions, the state scheme is totally unfunded. That means future tax receipts, the lion's share of which will come from the private sector, will foot the bill. Estimates of the future cost of funding existing public-sector pensions range from £650bn if you ask the government up to £1trn, according to some actuarial firms. Expressed as an annual tax burden, that's around £16bn a year, says the Pensions Policy Institute. That's over £400 per working person.
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Do state workers make bigger pension contributions?
No. They pay remarkably little, given their schemes' generosity. As Teresa Hunt notes in The Daily Telegraph, a typical teacher chips in 6.4% of salary, NHS workers from 5%-8.5%, the police around 9.5% and firemen 8.5%. That's peanuts compared to the final-salary-linked pensions they receive. John Ralfe, ex-head of pensions at Boots, estimates, for example, that the recently-improved state pension for teachers is worth 28% of salary. For a civil servant, think 33%. This huge gap between contributions and benefits, with no funding in place to plug the gap, is described by Altmann as "Alice in Wonderland economics".
Well, do they pay more tax then?
No. They pay less, says Altmann, thanks to a quirk in the national insurance (NI) rules. On retirement, everyone qualifies for a basic state pension (BSP) and a state second pension (S2P). These are met from NI contributions. But workers can 'contract out' of the S2P, so that they only have to pay 9.4% NI on their wages instead of the usual 11%, while their employer pays 9.1% rather than 12.8%. This is meant to be invested in a pension to replace the S2P on retirement. But for public-sector workers, this is "nonsense", says Altmann. If you are already in a state-provided defined-benefit scheme, you don't need an S2P in the first place. Yet you still pay the lower rate of NI.
So private-sector workers just have to save a bigger pot?
Not so fast. Even if a private-sector worker wanted to try and match the pension available to their public-sector counterpart, for higher earners it's nigh on impossible. That's because the government limits the total amount that can be saved tax-free. The ceiling is just over £1.65m now. A 65-year-old man retiring today with £1.65m (over that amount, the pot is taxed at 55%) saved in a money-purchase plan could take 25% as a tax-free lump sum, using the rest to buy an annuity. Assuming he wants his pension linked to the retail price index and a ten-year guarantee that will allow his pension to be paid out if he dies, his maximum income based on today's annuity rates is just over £57,000 a year, says the Annuity Bureau. That's less than the pension of top civil servants, policemen (Sir Ian Blair's pension is estimated at £160,000 a year, as well as a lump sum of £672,000), judges and most doctors.
Any good news?
No. Gordon Brown ruined UK private-pension provision when he scrapped the tax credit on dividend income. At a stroke, says Terry Arthur of the Institute of Actuaries, he removed around £17,000 from every private-sector worker's retirement fund; about £175bn in total. Many firms faced with operating final-salary schemes with a shortfall have closed them so quickly, that based on current trends, private-sector, defined-benefit pensions will have vanished within 12 years.
Why are public-sector pensions so generous?
It's not clear. Working for the state brings better job security. Firing a teacher or nurse is almost impossible, other than for gross misconduct. That's not true for private-sector staff, as thousands of redundant Woolworths, Aston Martin and Lehman Brothers workers can testify. Then there's pay. The Pensions Policy Institute puts average public-sector salaries at £25,600 versus £25,300 in the private sector and that's before you consider the more generous pension plans. But the government isn't rushing to change things. Recent moves such as raising the retirement age for new recruits to the civil service, teaching and the NHS from 60 to 65 are expected to save £13bn over 20 years. That won't plug a £1trn hole. The bottom line is that Brown's unlikely to reform a system that provides him and his core voters with a gold-plated pension.
Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.
He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.
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