Pensions Update - 29th May 2011

Minutes before they broke up for half term I had a stormy meeting with teachers alarmed at proposals to reform their pension.

The architecture of British pension policy stretches back to the early twentieth century: the understanding is that the state, i.e. taxpayers, will preserve dignity in old age by keeping the ‘wolf from the door’, but to live in comfort you have to make savings of your own which may include an occupational pension scheme. The taxpayer’s part of this deal is the basic state pension currently £102.15 per week and as of 1st April this year to be increased annually by the higher of average wages, average prices, or 2.5%.

It costs taxpayers £59 billion per year – although many recipients believe they paid for it through their national insurance contributions when they were working. Actually they didn’t: there is no national insurance fund; the money goes into the same pot as all tax revenues; the system is ‘pay as you go’, which means that current pensioners are being supported by current workers, and the current workers will be supported in retirement by the taxes and contributions of future workers. The total cost of the taxpayer support for this basic pension deal is over £100 billion when you take into account all the add-ons (such as Pension Credit and minimum income guarantee, housing benefit, council tax benefit, mortgage interest support, winter fuel payment, cold weather payments, free TV licences, free bus travel, higher personal allowance tax thresholds, free prescriptions and eye tests, and etc.).

The problem is with the second part of the bargain – the effort you need to make on your own behalf, including occupational pensions, in order to live comfortably in retirement. For years private sector pension schemes have been adapting to the higher cost of people living so much longer by increasing the contributions and reducing the costs – mainly by moving away from benefits based on final salary to benefits based on what the savings fund will actually be worth at retirement.

Public sector pensions, however, have not been adapting. Furthermore, many are not funded by savings: they work like the basic state pension with current pensioners drawing their benefits from the contributions of current workers. This worked fine when people died sooner after retirement so that there was an affordable ratio of workers to pensioners in the scheme. For example, in the nineteen sixties there were four teachers paying into the scheme for every retired teacher drawing benefits from it. Now that ratio is 1:1 -every retired teacher drawing a pension is supported by the contributions of only one working teacher and, of course, it just doesn’t add up, so the taxpayer is having to bail out the scheme: this year it will cost us £3 billion and by 2015 it will cost nearly £5 billion.

The Government has accepted Lord Hutton’s report into public sector pensions which concluded that taxpayers cannot be expected to go on bailing out the relatively much more generous public sector pension schemes. He has recommended a judicious combination of later retirement, higher contributions, and reduced benefits (principally moving from final salary to career average salary as the basis for the pension). These will now have to be negotiated in detail with the unions for each public sector scheme.

This is not good news for workers in the public sector, anymore than the disappearance of final salary schemes in the private sector was anything but bad news. We cannot, however, just bury our heads in the sand and pretend that our increased longevity doesn’t come at a cost. If there is any good news it is this: the fundamental principle of the Hutton report is that accrued rights must be honoured. So, if you were a teacher that has paid into the scheme for 30 years when the scheme closes –probably next April, then at retirement your pension would be based on your 30 year entitlement to a proportion of your final salary when you retire. The new higher costs and reduced benefits would only apply to the remainder of your career after the implementation of the new scheme.

It will be unpleasant medicine but the rug will not be pulled from under anyone’s feet, and furthermore, public sector pensions will still be relatively more attractive than those available in the private sector.