Public sector pensions cost twice as much as thought and require radical reform, commission insists

Public sector pensions cost twice as much as previously thought and now require radical reform, a pensions commission has said.

A report by the Public Sector Pensions Commission has found these pensions cost 40% of salaries, but combined employer and employee contribution rates have been artificially set at around 20% of salary by the government.

The pensions now cost £35bn a year, and only half of the pensions are made up from contributions from workers and employers, who contribute 6% and 14% respectively.

The commission warned there was a “lack of transparency” over the true cost of public sector pension provision.

Peter Tompkins, chairman of the commission, said: “A true assessment of the value of pensions in the public sector today shows they are worth twice what the government suggests in its calculation of the contributions that public sector employers pay. It is a matter both of justice and good economics that public sector employees and employers should bear the full cost of their pension provision.

“Increasing longevity means pension provision has to be looked at again, and the public sector cannot continue to remain immune. The question of why the majority of the workforce should be expected to pay through their taxes to support pensions they cannot afford for themselves must be raised.”

The commission insisted reform should apply to all current members of schemes and not just new members, while protecting past accrual. It said a reformed defined benefit pension could deliver substantial savings and bring the cost of pensions back down closer to 20% of salaries.

The commission’s recommendations include:

  • A reduction of accrual rate to 1/80 or a switch to career average revalued earnings would each save around £10bn a year.
  • An increase in the pension age of 65 for all members would save around £5bn.
  • The reduction in the degree of index-linking – from RPI to CPI – set out in the Emergency Budget will save around 10% of costs.
  • A 2% increase in employee contribution rates could raise up to £2bn a year.
  • Serious consideration should also be given to ending the contracted-out status of public sector pensions, as they are generally paid from age 60, compared with 65 rising to 68 or even higher for the State Second Pension.

The commission said it was also considering options including switching the public sector to funded defined contribution or notional defined contribution benefits, which would reduce the risk to the taxpayer but would involve considerable transitional issues. Also under consideration are hybrid schemes combining core defined benefit and flexible defined contribution top-ups.

But the TUC called the report “an attack on public sector pensions”.

Brendan Barber, general secretary of the TUC, argued the commission was set up by private sector employers. He said: “The real pensions crisis in the UK is the retreat by employers from providing pensions in the private sector – and the big unexpected looming bill for taxpayers is the cost of means-tested benefits for the millions let down by their employers. It is not surprising employer organisations want to change the subject by attacking public sector pensions.”

The commission was set up by the Institute of Economic Affairs, the Institute of Directors and a number of other groups. It is separate to the official commission on public sector pensions, which is being set up by the government and will be headed by former minister John Hutton.

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