Q&A: What's going on with public pensions?

What's happening?

Today a commission advising the Government on how to tackle the huge costs of public pensions – around £32bn a year, met almost exclusively by the taxpayer - issued an interim report.

It said that in the short term, teachers, nurses, and civil servants, and other public sector workers must pay more towards the pensions to lift the burden from the general taxpayer.

The upshot is that state workers face a de facto pay cut within months. Their overall benefits won't change – it's just that more of it will be deferred until retirement.

Why is this happening?

Public pensions have become unaffordable.

Having burned a £1trillion black hole in the Government's coffers, George Osborne branded them 'unsustainable' earlier this year.

The costs are laid bare in Lord Hutton's report today. The total amounts paid out in 2008-09 was £32bn. That's about two thirds of the cost of the basic State pension.

The real problem is that almost all public service pension schemes are unfunded, or pay-as-you-go, including those for the NHS, teachers, the civil service and the armed services (but not local government).

Workers' 'contributions' just go into the same general pot as our taxes. And it is from this that Government pays today's ex-state employees. Effectively the taxpayer has been funding the difference for years.

Earlier this year the National Audit Office estimated that £600 of every Britons' taxes will go towards public sector pensions in 2010.

With life expectancy rising quickly in the UK, the costs are ballooning. Someone retiring now can expect to spend 40% of their adult life in retirement and one in every three daughters born today will live to 100.

Public pensions could grow from costing 1% of GDP each year to 1.4% of GDP over the next 20 years if the Government doesn't act, the Pensions Policy Institute reckons.

So contributions must rise. Is that all?

No. Paying more towards pensions might just be the tip of a large iceberg for state employees.

Former Labour minister Lord Hutton – who is running the commission for the Government – called the pensions 'fundamentally unfair. He said he's working on some 'radical solutions' that will bring about 'fairness between taxpayers and scheme members'.

It now seems almost certain that the age of the final salary pension is coming to an end. Hutton believes these disproportionately reward high earning doctors and civil servants, whose earnings often soar in the final few years of employment.

He said: 'The final salary link in public service pensions is inherently unfair and can lead to high flyers getting almost twice as much back in pensions than those on more modest earnings for the same amount of pension contributions.'

But he is adamant that public pensions are far from the 'gold plated' stereotype they have been given by the media.

'In the most part, the pensions that are paid out to public service employees when they retire are fairly modest by any standard,' he said.

The report found that average public sector pension is about £7,800 a year, about half of pensioners receive less than £5,600 a year, and 90% of pensioners receive less than £17,000 a year.

As such he is keen to keep some sort of link with earnings rather than relying on contributions to determine the level of provision. To do this, he recommends that the Government replaces final salary with more cost-effective 'career average' model. Any changes won't happen for at least four years.

Another likely reform is a raising of the age at which state employees get their pensions so that they're in line with the private sector. Currently, many employees retire at 60. With the state pension age set to be hiked to 66 within the next ten years, the report deemed this unfair.

Any public pensions accrued thus far will be protected under Hutton's proposals. But when the changes are implemented, those schemes will end. So employees will still be able retire at 60, but they'll be able to claim pension accrued up to when the changover point. The new schemes will then kick in later on, probably when they reach 65.

Who is affected?

Almost all public sector workers apart from the armed forces will be subject to paying more contributions for their pensions.

The list includes, teachers, doctors, nurses, civil servants, firefighters et al.

Hutton said it would be wrong to make the 'defenders of our civil liberties' pay for retirement benefits but that others should all bite the bullet.

What do you think? Are public sector pensions unfair? Should the Government take the axe to them? Let us know in the reader comments below...

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