The secret truth behind public sector pensions

Since the General Election of May 2010, there has been growing ill-feeling between public sector workers and the coalition government.

The government's headache is that, under the last Labour government, the public payroll increased by nearly a million workers to exceed six million employees. What's more, with the shortfall between government spending and tax revenues predicted to reach £127 billion in 2011/12, the coalition has no option but to prune public sector pay.

Pricey pensions

In order to curb the cost of the public sector, the government plans to cut its workforce by 440,000 workers during this parliament. In addition, it is freezing the pay of higher-paid public-sector workers until 2012/13.

Furthermore, the government is worried about the spiralling cost of paying generous, final-salary pensions to current employees and retired workers. Thanks to longer lifespans and falling investment returns, the cost of providing these gold-plated pensions has exploded.

In order to provide guaranteed pensions based on salary and length of service, final-salary pensions require yearly contributions of up to 30% of pay. As a result, the vast majority of private sector employers have closed down their final-salary pension schemes.

Pensions apartheid

Today, the UK has 29 million workers: 23 million working in the private sector and six million working in the public sector.

Then again, while nearly four-fifths (79%) of workers are in the private sector, almost seven-tenths (70%) of those with final-salary pensions work in the public sector. Thus, in an independent review of public-sector pensions, Lord Hutton warned that this public-private pensions apartheid was "fundamentally unfair".

In order to curb the cost of providing generous pensions to government workers, the coalition has proposed a number of changes to future pension entitlements. These include:

1. bringing normal retirement ages for public-sector workers into line with the State Pension;
2. paying pensions based on career-average earnings, rather than final salaries;
3. basing future pension uplifts on the Consumer Prices Index (CPI) measure of inflation, rather than the higher Retail Prices Index (RPI); and
4. requiring members to pay higher contributions.

Following the breakdown of negotiations between the government and trade unions, public sector workers went on strike last month in the biggest day of industrial action since the late Seventies.

Who pays what?

We've heard many arguments for and against public sector pensions, but what do the numbers tell us? When it comes to funding these schemes, who pays what?

Take a look at my first table, which shows contribution rates for four major public sector pension schemes:

* These are members' gross contributions, which will be reduced by tax relief of 20% to 50%.

As you can see, teachers pay 6.4% of their before-tax salary into their pension scheme and taxpayers contribute 14.1%, for a total of 20.5%. These are broadly in line with the contribution rates into similar private-sector schemes. However, civil servants pay a mere 1.5% of pay into their pensions, with taxpayers contributing 18.9%.

The Armed Forces pay nothing into their pensions, with all 29.4% of pay coming directly from taxpayers. However, given that our servicemen and women must put their lives on the line in hostile conditions, often for low pay, I would argue that those who serve also deserve decent pensions!

Finally, the pension scheme for Britain's judges is obscenely generous. Members of the judiciary pay in 1.8% of salary, while taxpayers contribute a further 32.2%.

Another question worth answering is: for every £1 members pay in, how much do taxpayers contribute? My second table answers this question:

As you can see, for every £1 teachers contribute, taxpayers add £2.20. Civil servants pay in £1 and get another £12.60 from taxpayers. Lastly, the contribution from taxpayers is nearly 18 times that from judges. Surely you're joking, Mr Justice?

Higher contributions from members

In summary, some public sector pension schemes are much more generous than others. Even so, for all of these schemes to remain sustainable in the long term, contribution rates must rise across the board.

While teachers could pay an extra 2% of pay a year into their pensions, my view is that civil servants and judges should shoulder much steeper rises in their contribution rates.

With Britain's national debt rising by more than £10 billion a month, it seems ridiculous that some privileged public sector workers can get away with paying under 2% a year, while taxpayers fund almost all of their copper-bottomed pensions!

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