Public Sector Pension Changes
December 14th, 2011
As you may have seen on the television and read in the newspapers, public sector pension schemes are currently the subject of calls for radical reform, largely because of the increasing cost to the public purse of funding these schemes- There are seven main schemes currently being reviewed: -the Armed forces, Civil service, Fire service, Local government, NHS, Police and Teachers schemes.
These schemes vary widely in terms of the contribution rates and benefits payable, although the most common feature that they all share is the fact that they all currently offer an annual pension benefit linked to the member’s number of year’s service and final salary at retirement.
All these schemes have also been subject to some significant changes already in recent years, most notably:-
• An increase in retirement ages (in some cases, like the Police, to tie in with the new minimum age of 55, and in others to move the normal pension age from 60 to 65);
• Changes to the schemes benefit structure (such as the rate at which the pension is accrued on a year by year basis); and
• Some schemes introducing different contribution rates depending on how much the member earns.
Analysis by the Independent Public Service Pensions Commission, however, has found that the current final salary structure of these schemes unfairly favours higher earners, even where there are tiered contribution rates in place. This is because higher earners are likely to benefit from increasing income as they progress through their careers, whereas lower earners are much less likely to experience such increases.
So what are the proposed changes?
The Coalition Government set up the Independent Public Sector Pensions Commission to look at reforms to public sector pensions that would be ‘’fair but affordable’’ and the Commission’s report, published in March 2011, contained 27 recommendations, with the key ones being:-
• For future service, all public sector schemes should move to a “career average revalued earnings” (CARE) basis as soon as possible, with revaluation in line with average earnings – The net effect of moving from a “final salary” to a “career average revalued earnings” basis is likely to mean a lower figure (for most people) on which future pension entitlement will be calculated.
• With exceptions for certain schemes, the Schemes Normal Retirement Age (NRA) should be linked to the State Pension Age (which will rise to 66 in 2020).
• Contribution rates should be on a tiered basis, increasing with earnings – Effectively meaning that contributions overall will be at a higher level than they are currently (the Government has estimated an overall average increase of 3.2% pa); and
• There should be a cost ceiling on the tax payer’s contribution to public sector pensions, with changes to the scheme needing to be made if that ceiling is breached.
The Government is now proposing that approximately one million public sector workers who are due to retire in the 10 years from 1 April 2012 will no longer have to move to a CARE basis for their future accrual or have a later NRA – although they will still have to contribute more if they earn over £15,000 a year and they will remain impacted by the change in the inflation measure used for increasing pensions in payment from the (higher) retail price index to the (lower) consumer price index.
In addition, it has been proposed that contribution increases will not be spread uniformly, with those earning under £15,000 a year, or serving in the armed forces, seeing no increase at-all and those earning between £15,000 and £18,000 having any increase capped at 1.5%. p.a.
The bad news for the highest earners though is that they could see a 6% increase by 2015, and if this applies to the NHS scheme, some members could end up having to pay a 14.5% contribution each year.
What have been the reactions to the proposals?
It is perhaps unsurprising that there has been considerable opposition to the changes, given that the ‘triple whammy’ blow will involve higher contribution rates, later retirement ages and lower benefits – especially now increases to public sector pensions in payment will use the (lower) CPI, rather than the RPI, as the inflation measure. And, the fact that these changes are being proposed to happen all at once – rather than staggered over time – probably doesn’t help matters much either.
It mustn’t be forgotten though that even if the changes are implemented as proposed, public sector schemes will remain among the most generous available, and will still represent very good value for member contributions.
So what are the implications if you are a member of one of the schemes affected?
If you are a higher earner faced with significantly increased contributions to pay, you may be considering whether you should opt out of the scheme. However, given the inflation linked guaranteed benefits you would be giving up and how much it would cost to replace them if contributions were made to a money purchase scheme instead, any decision to opt-out of the scheme will almost certainly result in you losing out at retirement.
Given that the difference between a ‘career average’ salary pension and a ‘final salary’ pension can be significant for higher earners, you may wish to seek advice regarding how best to make up a possible shortfall in your expected pension at retirement. For example, a scheme member averaging salary increases of 2% a year above inflation with 40 years’ service in a career average scheme could expect to receive around 30% less as a pension than on a ‘final salary’ basis.
It is impossible to quantify in advance the precise impact on any individual cases, but subject to affordability there will probably be a strong case for making additional pension contributions to help reduce any potential shortfall. If you can afford to make them, the merits of paying into an ‘in-house’ additional voluntary contribution scheme would need to be compared against the merits of paying into an individual personal pension or stakeholder instead – an area that we will be more than happy to provide guidance on.