The Awkward Truth About Pensions

But because we may not be able to quantify one liability as precisely as another is no reason to ignore it. Moreover, the distinction between explicit and implicit liabilities may be more apparent than real. After all, there is a strong and reasonable expectation that the government will not default on its long-standing commitment to pay state and public sector pensions, not least because that would bring significant hardship to millions of people entering retirement. So taxpayers really need to see the best estimate of all the government’s liabilities. And while state pensions make up more than half of government liabilities, there is another item that lands us with a £3 trillion headache: unfunded public sector pensions. The traditional settlement for workers in the public sector was to forego better pay in the private sector for a role of public service, to be rewarded with job stability and a decent pension. Many years ago, a lot of private firms also offered similarly generous pensions, on a ‘defined benefit’ basis. Usually referred to as ‘final salary schemes’, these entitle an employee to a predefined percentage of their final or career average salary as a pension.

They are funded by contributions paid by both employers and employees based on salary; any shortfall in the funds to meet the pension entitlement of the employee must be made up by the employer. But as people started to live longer, businesses realised that their pension schemes were unaffordable and switched to ‘defined contribution’ models, where individual cash pots were built up for each person based on contributions. However, the public sector did not have to follow suit. Workers stayed on defined benefit models, meaning that the liabilities for taxpayers stacked up as people lived for longer, drawing down a chunky annual pension. This became more acute as equivalent pay in the public sector began to outstrip the private sector.

So the number of civil servants picking up annual pensions of £100,000 or more has tripled since 2015, as the Intergenerational Foundation recently discovered. The schemes of yesteryear, designed to make sure the poorly paid lollipop lady lived a comfortable retirement after years of dedicated service, now ensure the public-sector top brass live off six-figure annual incomes for the rest of their lives. So how do things fare for new entrants to the private sector? The TaxPayers’ Alliance has crunched the numbers and it makes for alarming reading. Let’s say an employee, aged 25, is joining the workforce at the national median wage of £35,464 a year, and working through to the normal retirement age of 68. Based on making the same level of pension

contributions throughout their working life, in the private sector they could expect to retire on 19.59% of their final salary — or £6,947 a year, based on current average earnings. In the civil service, the same entrant would get 70.73% of their final salary, or £25,084 a year. How about the NHS? Our new graduate would be looking at 74.99% of their final salary, or £26,594 a year. If our worker decides to be a teacher, they would expect 72.45% of their final salary, or £25,694 a year. The contrast could not be starker. Those working in the public sector will on average retire on a workplace pension nearly four times that of someone working in the private sector. This will be despite making the same personal pension contributions as their public sector equivalent. Employer pension contributions in the public sector (paid by the taxpayer) are on average 23.8% higher than for those working in the private sector. The public sector pension schemes mentioned above are unfunded, meaning that they are paid for annually using tax revenues.

There is no pension fund under management, being invested and generating returns. That’s not true for all pension schemes in the public sector — the local government pension scheme consists of 98 different funds; academy schools and Transport for London also operate funded schemes. But the unfunded schemes are potentially ruinous because they are still so generous compared to the deals in most of the private sector and the long-term bills are simply passed to tomorrow’s taxpayers. What is the long-term outcome? For one thing, our 25-year-old worker shouldn’t bank on receiving a full, universal state pension when they reach their late 60s. It is possible that at some point in the near future it will shift to being means tested, or the starting age shifted out well into the mid-70s. As for unfunded public sector pension schemes, they will arguably be even harder to reform into a more sustainable model. In the meantime, when you hear junior doctors asking for a 35% pay hike, take a moment to think about the additional bills for unfunded public sector pensions and what that means for our future generations of taxpayers.