Save billions by reforming ‘unsustainable’ public sector pensions
Moving new public sector employees onto defined contribution (DC) pension schemes could save taxpayers £37bn a year in the long run, a new report has found.
The report, produced by Policy Exchange, argues that moving public sector workers onto a DC scheme would also send an “important signal” to the bond market that the government was serious about tackling public debt.
Most public sector pensions operate as defined benefit (DB) schemes, whereas private sector schemes tend to be DC. The former provide savers a guaranteed income in retirement, with employers often contributing more to ensure that this is the case.
DC schemes, in contrast, are funded primarily by the employee, as the participant defers a portion of their gross salary into a fund. Employers may then match the contribution.
Richard Tice, deputy lead of Reform, welcomed the report. “The current situation with public sector pensions is unsustainable and needs reform. We are very focused on this issue,” he said.
Huge employer contributions
Policy Exchange noted that employers make a contribution of 25-30 per cent for public sector schemes, compared to an average private sector contribution of six per cent.
Additionally, in most public sector pension schemes, the contributions of existing public sector workers are not invested, but rather returned to the Treasury.
This means the pensions of current retirees are generally paid for out of current spending, which Policy Exchange said creates “massive spending liabilities” for taxpayers – currently valued at £1.4bn.
It argued that the government should gradually move public sector workers onto a DC scheme with a standardised employer contribution of 10 per cent, with employees contributing five per cent.
“Such a scheme would still compare favourably with the majority of private sector schemes and would ensure public sector employees continued to receive a good income in retirement, with the total proportion of salary being invested into an employee’s pension being above the 12 per cent recommended by Pensions UK,” the think tank said.
The move would cause a short-term increase in public spending, as existing liabilities were met and new scheme contributions would be invested in a dedicated fund, rather than taken into general Treasury funding.
The additional cost would rise to a peak of £3.4bn six years after adoption, according to Policy Exchange, before decreasing and turning positive for the government after around 14 years.
But Policy Exchange said that the costs of the scheme may never materialise if the measure eased concerns in the bond market about levels of government debt, helping to lower the cost of government borrowing.
“A fall in interest rates as a result of just 16 basis points would fully negate the peak additional short-term costs, and create additional savings in every other year,” Policy Exchange said.
Future affordability
However, Steve Webb, pensions minister from 2010-15 and now a partner at consultancy firm LCP, said the “best way” to assess the future affordability of a policy was to look at its share of national income, rather than its total cost.
“Public service pension reforms which have already taken place mean that future costs are falling as a share of GDP,” he said, pointing to the latest long-term forecasts from the Office for Budget Responsibility (OBR).
The watchdog predicts that the cost of public service pensions will fall to 1.4 per cent of GDP by 2053, down from 1.9 per cent at the moment
Webb doubted whether the policy would really have any significant impact on the UK’s borrowing costs. “The argument that this ‘tough’ long-term decision (which saves nothing for 14 years) will impress the bond markets so much that you get lower interest rates needs to be taken with a pinch of salt,” he said.
“It’s exceptionally unlikely that the OBR would scale back the estimated cost of this policy on the basis of a hypothetical interest saving.”