Life after work – the good, the bad, the ugly

A REVIEW of both the state pension and public sector pensions was announced in the Queen's Speech in a week in which Treasury Secretary David Laws promised to send a "shock wave" through government spending.

These two reviews take place against a background of austerity in Europe, where politicians are pushing through public sector cuts. On Thursday Spain voted for wages to be cut by 5 per cent and the retirement age increased by two years. State employees in Ireland have already accepted a cut of up to 15 per cent in salary and higher pension contributions. Portuguese public sector pay and pensions are also to be guillotined.

In Greece, public sector pay is to be frozen until 2014, bonuses hacked and retirement ages increased. Well-paid Italian state managers will see their salaries cut in stages until 2013, while other wages will be frozen and pensions deferred.

At home, the Cabinet has agreed a 5 per cent pay cut to be followed by a wage freeze for the rest of this Parliament, with a promise of more news on public sector wages in the budget. So it is unsurprising that against such a background, pensions commentators are bracing themselves for blood-curdling changes to the current regimes for both state and public sector pensions.

Tom McPhail, head of pensions research at Hargreave Lansdown, said: "The mood music is all about austerity and fairness, about sharing the pain. It seems only logical to conclude that a state pension at 70 is on the way and the time is now thought ripe for tackling public sector pensions."

Dr Ros Altmann is a member of the Public Sector Pensions Commission, and independent think-tank currently putting the final touches to proposals for reform. She said that a first step is to make public sector pensions transparent: "Staff must be told precisely how much they cost, so they are clear about what they represent in terms of additional pay. In some cases it is worth nearly 40 per cent of salary. This will then enable them and those working in private industry to compare the value of different jobs more accurately."

Part of the new transparency should be an end to the various wheezes currently used to keep the bills down, such as public sector employees paying lower rates of National Insurance.

She said: "They pay lower NI to earn a pension they can collect at 60, when the rest of the population will have to wait until anything up to 70 to get that same pension. This can't go on."

But Chris Curry of the Pensions Policy Institute (PPI) said it was too early to predict likely outcomes from the reviews.

He said: "We need to see first what their remit is and who is heading them. Certainly continued affordability has been highlighted as a key issue. But adequacy is another one. Many relying on public sector pensions are part-time women workers who probably wouldn't get a pension at all if they worked elsewhere."

And it's not all bad news. The government plans to restore the link between the state pension and earnings by up-rating it from next year in line with either average earnings, prices or 2.5 per cent, whichever is the higher. This will guarantee a much bigger pension, when we finally get it.

The story so far:

State pension age

Women have traditionally expected a state pension from age 60, and men from 65; however, these ages are already due to rise under reforms implemented by the last government. Women's pension age begins climbing this year to reach 65 by 2020. After that both men and women will see their pension age rise further, beginning in 2024 to 66, and reaching 68 in 2046.

However, many, even pensions tsar Lord Turner, who drew up the reforms, believe this is too little too late. He, along with many others, now believes the public should be prepared to wait until 70 for a basic state pension.

The coalition is launching a review to look at whether the timetable should be speeded up so that men work until 66 from 2016, and women from 2020.

However the financial incentives are clear for a government anxious to cut public spending. According to the PPI, each year you defer state pensions saves between 2 and 3.5 billion.

Furthermore, the National Institute of Economic and Social Research puts at 10bn the extra tax and National Insurance paid as a result of delaying retirement. But these figures do not allow for higher unemployment costs which might be associated with later retirement, nor the social security bills for those unable to stay at work and no longer in receipt of a pension.

Public sector pensions

There are seven main public sector pension schemes, covering teachers, civil servants, local authorities, armed forces, fire, hospital and police. The problem is six of them are unfunded, which means they are paper promises only. Today's pension payments are paid for by today's staff contributions, with the government making up the difference. Only the local authority schemes are funded, but not fully.

Pensions accrued to date by the five million members of these schemes, which are largely index-linked, final salary, are put at around 1 trillion. Not only does this number dwarf the entire national debt, but there is no cash set aside to pay it.

Furthermore the cost of pensions not yet accrued is expected to rise by 40 per cent by 2027, because we are all living longer. And as the state shrinks, so the numbers of employees making contributions to pay pensions also looks set to be reduced.

In the private sector, companies have sought to deal with the pensions crisis by closing final salary arrangements to new and existing employees, asking staff to work longer and contribute significantly more. Only around a million in private industry can still look forward to a pension linked to their final salary.

This has led to arguments that public sector pensions are unfairly generous, and those working in private industry are discriminated against. Whereas 85 per cent of state workers belong to a pension scheme, the number is only 40 per cent for private companies. Fewer than a third have a salary-linked pension, compared with 90 per cent in state employment.

According to the PPI, pensions are worth an average 23 per cent extra salary for existing state employees, rising as high as 39 per cent for the armed forces – the latter do, however, accept a negotiated lower salary.

The last government attempted to reform state schemes on the grounds they could not be afforded, but backed down in the face of union anger. Some changes affecting new staff were implemented. Many will have to wait until they are 65 for a pension, while the great bulk of existing employees can still retire on a full pension at 60.

The terms on which pensions accrued was actually improved by the latest reforms, so pensions could be earned faster, in return for giving up a lump sum. But the average value of the pension has fallen to 20 per cent of salary.

But it is the rising cost to the taxpayer which concerns the government. Although it has pledged the review will not affect pensions already earned, it has given no guarantee about future pensions for existing staff.

Reforms might include forcing all staff to wait longer for their pension, potentially up to the age of 70. The final salary arrangements could be scrapped and replaced by an average salary, or money purchase arrangement. Index-linking could be ended. Contributions could be sharply increased, which amounts to a pay cut.

Altman said: "Pensions of this quality have now largely disappeared in private industry. It is not fair to ask taxpayers, who often have no pension at all, to pay higher taxes to meet these bills. It is like asking the boss to pay his employees a salary he can't afford for himself."