Q1. Which pension schemes are being reviewed under the “public sector pension schemes” reforms?
A1. The 7 largest public sector pension schemes in England and Wales are under review, these are:
The review also covers the equivalent schemes in Scotland and Northern Ireland and it is clear that the Government expects all schemes to be included but the process and timescale for any changes to these schemes may differ:
Together these schemes have a total active (contributing) membership of around 5 million.
Q2. Why has the government decided to review public sector pension schemes?
A2. The review follows the report by the Independent Public Service Pensions Commission (IPSPC), led by Lord Hutton, which made the following findings:
In Lord Hutton’s opinion we cannot expect the taxpayer to bear the burden of these increasing costs. Members also need to contribute more, for example, by working longer.
In the 2011 Budget the government announced that they accepted all of Lord Hutton’s recommendations as a basis for consultation with public sector workers, unions and employer representatives.
Q3. What changes have been recommended?
A3. A number of changes were recommended by Lord Hutton. These included:
However these changes are still under discussion between the government, trade unions and employer representatives, so the exact detail of the changes is unknown.
It is also important to note that Lord Hutton recommended full protection for all pensions built up before any changes come into force. This includes a continuing link to final salary at retirement (or leaving the scheme if this is earlier) for all service before the date of change.
Q4. What will happen to the USS as a result of the changes to the public sector pension schemes?
A4. While the universities and related organisations which employ USS members may receive significant public funding, the USS is a private sector pension scheme. Therefore it will be unaffected by the proposed public sector pension scheme reforms. It has, however, recently been subject to separate scheme changes which came into force from 1 October 2011.
The HE employees who WILL be affected by these reforms are those who are members of the Teachers’ Pension Scheme, the Local Government Pension Scheme or NHS Pension Scheme. These are mostly employees in the post-92 HEIs.
Q5. Why are public sector pension schemes being changed?
A5. Of the 7 main public sector pension schemes, 6 are unfunded. This means that benefits payments are made directly from employer and employee contributions with any shortfall being met by taxpayer funding. The annual cost of these unfunded public sector pensions is expected to hit £30bn by around 2030. The government says this is unaffordable and it will become even more expensive as life expectancy continues to increase.
The Local Government Pension Scheme (LGPS) is an exception in that it is funded. Over the years employer and employee contributions that were not required immediately to pay members’ benefits have been invested to meet future pension payments. Despite being one scheme, the LGPS is run as a large number of separate local authority funds many of which have significant deficits. Each local authority (or group of authorities) is responsible for making good any deficit in its own fund but has limited options for doing so – improving investment returns, or diverting money from other areas of spending.
Q6. Don’t the employers and employees pay into the pension schemes? Where does this money go?
A6. Yes they do. Public sector employers who offer an unfunded public sector pension scheme (e.g. TPS or NHSPS) pay contributions out of their annual budget. Members’ contributions are deducted monthly from salaries.
These unfunded schemes are known as “Pay As You Go” schemes. This means that the current contributions from employees and employers are used to pay today’s pensioners rather than being invested to pay pensions in the future. Where the contributions paid in are not enough to pay all the pensions the government (i.e. the taxpayer) meets the additional cost. Some schemes currently collect more in contributions than is required to pay the pensions, but this is not expected to continue into the future as the number of pensioners increases and people continue to live longer. One estimate suggests life expectancy increases by 15 minutes every hour. In other words, every 4 years we can expect to live, on average, 1 year longer, and this may yet improve further.
Q7. Does this mean that there will be changes made to the public sector schemes and if so when?
A7. The government have already announced that they intend to increase employee contributions from April 2012. They also propose to introduce benefit changes. Any changes made to the benefits provided by the unfunded public sector pension schemes are expected to come into effect from April 2015. However, it is possible that benefit changes to LGPS could be applied before this date.
These reforms cannot be achieved overnight and discussions between the government, trade unions and employer representatives are ongoing, so the final form of these changes is not yet known. Once the government and schemes have come to an initial view on the details, they will need to consult with interested groups, including employees and their representatives.
Q8. What does “career average/CARE” actually mean and how does it work?
A8. Under this type of scheme the amount of pension paid is based on how much you earn each year during your career. At retirement, these earnings are revalued to counter the effects of inflation over the years (these schemes are often known as CARE or Career Average Revalued Earnings schemes). A career average scheme still provides a defined benefit, which means that the benefits are guaranteed and the risk is carried by the government.
Currently most public sector schemes provide final salary pensions under which the pension is based on the member’s salary at or near retirement. This means that members who receive large pay increases towards the end of their careers also benefit from a significant increase in their pension. The career average approach is thought to be much fairer. For example, in the LGPS it is estimated that the best paid 20% of employees receive a pension per pound of contribution which is almost double that received by lower paid staff. For more information read ‘How a Career Average Revalued Earnings (CARE) scheme works’ at http://www.hm-treasury.gov.uk/d/hutton_how_care_works100311.pdf
Q9. Won’t a move to career average mean that members are worse off?
A9. Not necessarily; there are likely to be both winners and losers from the changes. The term career average earnings scheme is often misunderstood. It does not mean that your pension is calculated using your average salary over your career instead of your final salary. Rather you build up a slice of pension each year based on your salary in that year and this is then increased to counter the effects of inflation. Lord Hutton has suggested these increases should be in line with changes in average earnings. The total of all the annual slices makes up your pension. The exact effect on individuals will depend on the benefit structure set by the government after they have consulted with employers, trade unions and scheme members.
Many people see little change to their pension after a move to the career average approach and some may be better off than they would have been in a final salary scheme. Those on low pay may do better out of the career average approach; those with average earnings, such as teachers and nurses, will get about the same; while those with the prospect of earning higher than average salaries over time, such as doctors and high ranking civil servants, may lose out. In higher education it will be the highest earners that will feel the most negative impact of changes whereas the lower paid support staff are the most likely to benefit from these proposals.
Q10. I am a member of TPS / NHSPS / LGPS - what does this mean for my pension?
A10. The recommendations are designed to ensure public service pensions are fair and affordable over the long term, while providing an adequate level of retirement income for employees. However, at the time of producing this document they are still only recommendations and the government will need to work out the detail in consultation with staff and unions. Until these details are agreed it is not possible to assess the precise impact on individuals.
Q11. Will the changes affect the pension I have already built up?
A11. No, any changes will only apply to benefits built up after the date the changes come into force. Any pension already built up before that date will still be linked to your final salary at retirement and will be payable from your current Normal Pension Age (NPA). This means the effect will be minimal for those members who are near retirement age and the changes will not affect deferred and pensioner members. The government has recently offered a further improvement to the proposals that would mean no changes in pension age or benefits for people within 10 years of their current NPA as at April 2012.
Q12. I am receiving my pension – how will these proposed changes affect me?
A12. Your pension will not be affected by the changes as they only relate to future pensionable service.
The only change to affect pensioners is the decision by the government that annual pension increases should be based on the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) from 1 April 2011. This change, which is expected to produce a lower rate of increase than the RPI, is the result of a change in government legislation and is not linked to the pension reforms for current members.
Q13. I’ve heard talk about people leaving pension schemes to “protect their pension”. What’s that all about?
A13. This relates to a change in the tax regime and is completely separate from the package of reforms now under discussion. The only people who might need to consider whether to remain members of their scheme are those high earners who have already built up (or are close to building up) maximum benefits under the current tax regime. These people might face large tax bills if they continue as members of the scheme. Unless you have been contacted about this issue directly, there is no need to leave the scheme or retire to “protect” the benefits you have already built up as they are not being taken away or changed.
Q14. I understand that the Normal Pension Age will be increasing in line with State Pension Age. How can I work out when I will finally get my pension?
A14. You can check this using the State Pension Age Calculator at www.pensionsadvisoryservice.org.uk/state-pensions/state-pension-age-calculator. Please note, however, that this does not take into account changes announced in the government's recent Spending Review. It will be updated when the changes become law, which is expected to be autumn 2011.
Q15. Will I still be entitled to retirement benefits at age 60?
A15. Lord Hutton recommended that the government should increase the Normal Pension Age (NPA) - the age at which your pension can be paid in full - in most schemes to bring it in line with the State Pension Age (SPA). If you draw your pension before you reach your NPA then it may be reduced to take account of the fact that it will be paid for longer. This change would apply for future service only. Benefits built up within the existing schemes would still be payable at your current NPA (usually 60 or 65).
Your future pension earned after the effective date of the changes would then have a NPA in line with your SPA. If your NPA is not 60 then you would still be able to draw your pension at 60 but it would be reduced based on the number of years between 60 and your NPA. For example, if your NPA was 66 but you drew your pension at 60 it would be paid 6 years early and would be reduced accordingly as it is being paid for 6 years longer.
Don’t forget that if you stay in the scheme until SPA, you will have built up more years of service and the final salary part of your pension will be based on your salary when you retire. Many of the schemes also have flexible retirement options so you could consider going part time and taking part of your pension so you can retire gradually over a number of years.
Q16. I'm not happy with the pension I'm likely to retire with. What can I do?
A16. You may be able to pay extra contributions into your public sector scheme to buy additional years of service or to build up a separate fund which can be used to buy additional benefits when you retire. You should contact your scheme administrators if you would like more information on these options.
Q17. I have read that public service pension contributions will increase by 3% from April 2012 – is this correct?
A17. No. Lord Hutton’s interim report suggested that there was a case for increasing member contributions in recognition of the substantial additional costs resulting from people living longer. This move would also reduce the amount to be paid by the government. The government then announced in its Comprehensive Spending Review that member contributions in the current public service defined benefit schemes would have to increase, on average, by 3.2% over 3 years to 2015, but with protections for the lower paid. For the unfunded schemes there is no other quick way to reduce the government’s costs than to increase member contributions. However for LGPS, as it is a funded scheme, there may be other options, including benefit changes which could save the equivalent amount.
The government has recommended that any increase in employee contributions should be managed so as to protect the low paid, so that many scheme members will either have no increase or a smaller increase, and, if possible, be phased in over a number of years. They have also proposed that the maximum contribution increase for high earners should be limited to 6% phased in over a three year period. These proposals have been discussed with trade unions and employer representatives and proposed contribution levels for the first year (from April 2012) for each separate scheme are being consulted on at the moment.
Q18. Why do contribution rates need to increase?
A18. This is because the government believes there is an imbalance between employer and member contributions. The proposed scheme benefit reforms will be designed to address this, but these will take some time to agree and implement. The contribution changes will be developed in line with the government’s commitment to protect low earners and make the increase progressive, so that those on higher salaries pay higher contributions. The changes are being discussed with the trade unions, employer representatives and other stakeholders.
Q19. An increase in my pension contribution seems unaffordable at a time when pay increases are moderate – how will the changes impact on my monthly wage?
A19. While it is true that scheme contributions will increase for all but the lowest earners, because you don’t pay tax on pension contributions, the impact on your take-home pay will be less than the full amount. If you are a basic rate tax payer your contribution is reduced by 20%. If you are a higher rate tax payer your contribution is reduced by 40%.
It is also important to remember that your employer still meets the bulk of the cost of your pension, paying 14% into the TPS and an average of 18% into the LGPS. The other public sector schemes have similar employer contribution rates. In addition, as well as a guaranteed inflation linked pension for you in retirement, these schemes also provide life cover, spouse and child pensions plus a pension if you get sick and can’t work. These are all valuable benefits which would cost a lot more if you purchased them privately outside the scheme.
Q20. I’ve always been told that my pension is deferred pay to compensate for receiving lower salary than I would in the private sector. Will this change to my pension be reflected in a pay increase?
A20. When the public sector pension schemes were introduced it is true that many public sector workers earned less than their private sector counterparts. At the time, scheme membership was compulsory for all members. In recent years that pay gap has closed to a large extent and in some cases, the situation has been reversed. Also employees can now choose whether or not to join their scheme. Today it is probably more appropriate to think of your pension scheme as an employee benefit rather than as compensation for salary forgone, particularly as all public sector schemes will remain defined benefit schemes whereas the vast majority of the remaining options for those in the private sector are defined contribution schemes.
Q21. The Government made another announcement about public sector pensions changes on 2 November. What was this about? Are more changes expected?
A21. The Treasury has been involved in negotiations with the Trades Union Congress over the last few months on the basis for reform of the public sector pension schemes. As a result of these negotiations the Treasury has decided to improve some of the benefit changes that they are proposing.
The two main improvements they have offered are:
These new proposals will be presented at the scheme specific discussions taking place next week and will be considered by the relevant government departments, trade unions and employer representatives as part of the overall package of reforms.
For more information pensions managers can contact Emelda Conroy, UCEA’s Head of Pensions Policy by emailing email@example.com