Public sector pensions - time for a reality check

Final salary pensions provide a guaranteed pension based on years of service and the final salary - they provide tremendous security in old age for the member and their spouse. Pensions can be as much as two-thirds of final salary on 40 years of work, or much shorter periods for certain groups of key workers such as policeman, fireman, high court judges or members of parliament.

Local Authority pension schemes are funded but others, notably the Civil Service, Teachers and the NHS, are un-funded and are paid for by the taxpayer, you and me. 30 years ago a virtuous combination of factors made the schemes affordable.

Times have changed such that very few comparable workers in the private sector have the luxury of a promise of guaranteed pensions, in fact out of the top 100 FTSE quoted companies only five offer new workers membership of a final salary-related pension.

According to the Occupational Pension Scheme survey for 2010 there were 2.1million private sector active members in final salary schemes as opposed to 5.3m public sector employees. There was another 1m active members in private sector defined contribution schemes where the employee takes the risk of the ultimate returns. Overall, public sector pension costs for 2010 were £32billion, less £5b paid for by employee contributions.

Even very successful companies realize that they cannot offer open-ended promises of indexed-linked pensions for retirees who could live into their eighties or nineties (we expect to live a third longer than in the 1950s).

The scope for ‘final salary’ manipulation is legion – promotions or bonuses at or near to retirement to inflate the final salary figure, early retirement without actuarial reduction due to adverse health, favourable early retirement as part of a ‘down-sizing’ package, retiring and then immediate re-hiring etc.

An extreme private sector example of this was that of the former banker Fred Goodwin originally being awarded a pension reportedly up to £703,000pa (until voluntarily reduced) in August 2008 at age 50 after his disastrous tenure at Royal Bank of Scotland (precipitating the biggest loss in UK corporate history).

In truth, all of us would love the security of an indexed final salary pension where someone else provides the guarantee, takes on the investment risk, longevity/annuity risk, not to mention the administration and compliance costs. But if final salary pensions are to be maintained personal contributions will have to increase or benefits will have to be reduced.

Governments, who are themselves public servants, have been afraid to tackle the real issues. Our last government tinkered around the edges but refused to grasp the nettle. The current government, after the Hutton report, has shown some courage by seeking to cap the overall costs of schemes (most to 20 per cent of salary bill) and requesting a higher contribution from workers (either directly or by using a career average, working longer, less indexation, capping total benefits etc).

The latest compromise (‘no reduction for anyone within 10 years of retirement’, when that is exactly the group who has the greatest accrual of benefits and the greatest scope for giving something up) shows just how difficult it is to try and reform such an emotive issue as public sector pensions.

Spare a thought for the millions who have to fund their own private money purchase pension arrangements, especially if policy holders buy annuities at derisory rates. Based on a hypothetical funding calculation (using recent annuity rates - see below) a 25-year-old male would have to contribute 28 per cent of his salary to provide an indexed-linked two-thirds final salary at the age of 65 - an impossible task.

Let’s make no bones about it, final salary pensions can be the best possible and most efficient form of pension provision - it is a travesty that the private sector has largely had to withdraw them.

To retain the support of taxpayers for public sector final salary pensions, there needs to be a reality check of what is ‘affordable’ to us all - citizens of an indebted and ageing western nation, struggling to adjust to a changing world order.

The Hutton report was commissioned and reported in October 2010 and, very reasonably, suggested that solutions should involve affordability and sustainability; adequacy and fairness; transparency and simplicity.

When negotiation is taking place we are struggling to see the logic of industrial action - please make your points quickly and go back to work!

This issue is of enormous importance to everyone in our nation, especially the younger generations who have to help fund the retiring ‘baby boomer’ generations as well as themselves! There has to be justice between the generations as well as between competing groups of workers for society to work effectively. It is a time to think beyond our own interest groups.

Final salary pensions are a great thing. It would be wonderful if they could be available for all, but who should pay for yours – you or other taxpayers? There is an issue of fairness and integrity here that affects the whole of our society.

ACFA is the UK network of Christian financial advisers and related professionals. It aims to be the voice of Christian financial advice and champions best practice in the UK. The ACFA website offers links to Christian financial advisers across the UK.

Note: Male aged 25 retiring 40 years later, final salary £23,700 (national average earnings), starting salary £7,269pa, salary and contributions escalating at 3%pa, investment return of 7%pa, allowance for expenses of 1%pa, spouse 3 years younger, RPI escalating annuity 3.2% and 50% spouse’s pension, retirement fund £492,700, no tax free cash.