UK public sector pensions ‘unfair’

Public sector final salary pension schemes in the UK are “unaffordable and unfair” and could lead to “fiscal calamity” if they are not reformed, a report has warned.

The pension promises made to public sector workers are like a “Madoff-style pyramid, now collapsing under the weight of insufficient contributions, rising longevity and demographic change”, the Centre for Policy Studies said.

It warned that unless the schemes were reformed, the problems would get worse as the number of people employed by the state fell, and it called for the pensions to become self-sufficient so that they were sustainable.

The group said the rapidly growing liabilities faced by the unfunded schemes were alarming, while the Treasury is also having to make up an annual shortfall between the amount received each year in pension contributions and the amount that has to be paid out to members who have already retired.

In 2005/06 this shortfall was £200 million, but it is expected to balloon to more than £10 billion by 2015/16 and continue rising.

When employer contributions are factored in, the taxpayer is footing the bill for 80 per cent of the money paid into the schemes, which the group said was “unreasonably high”.

The schemes are also contributing to a growing pensions inequality, with public sector workers continuing to enjoy the benefits of final salary pensions, while the majority of these schemes have now been closed to private sector employees.

There is also inequality between low and high paid public sector workers, with “disproportionally high pensions” paid to high earners.

Overall, the study warned that the cost of funding the schemes would lead to a rising tax burden on today’s workers, who would have less money to save towards their own retirement.

The report, written by former investment banker Michael Johnson, said the simplest way to solve the problem would be to raise employees’ contributions, while pensions being paid could also be cut, although it acknowledged that this would be “very challenging” politically.

Instead, Mr Johnson put forward two possible solutions, a so-called brave one and a cautious one.

Under the brave approach, the government would press ahead with closing public sector final salary pension schemes and replacing them with defined contribution ones as early as 2020.

The cautious approach would involve replacing the current final salary schemes with career average ones up to a salary cap of around £38,000, with a defined contribution scheme above that level.

But Mr Johnson added that a pre-requisite to reforming public sector pensions would be to raise the basic state pension to a flat rate of around £140 a week.

He said this would not only boost the retirement income of low earners, but it would also ensure that it paid people to save and it would ease negotiations with unions over changes to public sector occupational schemes.

Former minister Lord Hutton is currently reviewing public sector pension schemes on behalf of the government.

He is expected to call for contributions levels and retirement ages to be increased, while he may also propose replacing the current final salary schemes with career average ones.